Double-entry bookkeeping system

In accountancy, the double-entry bookkeeping (or double-entry accounting) system is the basis of the standard system used by businesses and other organizations to record financial transactions. Its premise is that a business' (or other organization's) financial condition and results of operations are best represented by several variables, called accounts, each of which reflects a particular aspect of the business as a monetary value.

Every transaction is recorded by entries in at least two accounts. The total of the debit values must equal the total value of the credit values. Most transactions consist of two entries, but can have three or more entries e.g. Supplier Invoice Total = Net value + taxes. Normally there are only two transactions and hence the name double entry, with the transaction recorded once on the debit side and once on the credit side. e.g. Supplier Invoice recorded on the debit side in expense a/c and on the credit side in supplier a/c.

Historically debit entries have been recorded on the left hand side and credit values on the right hand side of a general ledger account. The ledger accounts are set up as T accounts so called because they resemble the letter T when the account is empty.

History

The origins of double-entry bookkeeping have been traced as far back as the 12th century. By the end of the 15th century, the merchant venturers of Venice used this system widely. Luca Pacioli, a monk and collaborator of Leonardo da Vinci, first codified the system in a 1494 mathematics textbook Pacioli is often called the "father of accounting" because he was the first to publish a detailed description of the double-entry system, which enabled others to study and use it. [http://home.hetnet.nl/~annejvanderhelm/paper.html Bookkeeping instructions from the mid-fifteenth century

The bookkeeping and accounting process

When a transaction occurs, a document is produced. This document is referred to as a source document. Some examples of source documents are:

The sales invoice, sales receipt, purchase invoice.
The deposit slips and checks that effect credits (additions) to and debits (subtractions) from a checking account.

(Non US equivalents: check = cheque, checking account = bank current a/c, deposit = lodgement)

These source documents are then recorded in a journal. This is also known as a book of first entry or daybook. The journal records both sides of the transaction recorded by the source document. These write-ups are known as journal entries.

These Journal entries are then transferred to a ledger. A ledger is also known as a book of accounts. The purpose of a ledger is to bring all of the amounts recorded for that account from the journal together. This process of transferring the values is known as posting.

Once the entries have all been posted, the ledger accounts are added up in a process called balancing. A particular working document called an unadjusted trial balance is created. This lists all the balances from all the accounts in the ledger. Notice that the values are not posted to the trial balance, they are merely copied.

At this point accounting happens. The accountant produces a number of adjustments which make sure that the values comply with accounting principles. These values are then passed through the accounting system resulting in an adjusted trial balance. This process continues until the accountant is satisfied that the resulting figures are correct and can be used to produce financial statements.

Finally financial statements are drawn from the trial balance, which may include:

the income statement, also known as a statement of financial results, profit and loss statement, or simply P&L
the balance sheet
the cash flow statement

Short Examples

Buying an asset (such as a new machine):

The amount of fixed assets in the business increases.
The amount of cash (a current asset) is reduced.

Selling merchandise on credit:

The amount of trade receivables (an asset) for the business increases.
The sales revenue for the business increases (eventually this will become part of equity).

Upon payment, the trade receivables account decreases while the cash account increases.

Should the receivable be "written off" as uncollectible debt, the receivable account decreases and the bad debt is added to expenses (which also becomes part of equity when netted against income and cost of goods sold). In larger firms, a portion of the receivable account is written off beforehand as expected to be uncollectible.

Paying a trade creditor:

The amount of trade payables (a liability) for the business decreases.
The amount of cash in the business is reduced.

An explanation of Debits and Credits

Double-entry bookkeeping is governed by the accounting equation. At any point in time, the following equation must be true:

assets = liabilities + equity

For a particular time period, the equation becomes:

assets = liabilities + equity + (revenue − expenses)

Finally, this equation may be rearranged algebraically as follows:

assets + expenses = liabilities + equity + revenue

This equation must be true, for any time period. If it is, then the accounts are said to be in balance. If the accounts are not in balance, an error has occurred.

For the accounts to remain in balance, a change in one account must be matched with a change in another account. These changes are known as debits and credits. Note that the usage of these terms in accounting is not identical to their everyday usage. Whether one uses a debit or credit to increase or decrease an account depends on the normal balance of the account. Asset and expense accounts (on the left side of the equation) have a normal balance of debit. Liability, equity, and revenue accounts (on the right side of the equation) have a normal balance of credit. On a general ledger, debits are recorded on the left side and credits on the right side for each account. Since the accounts must always balance, for each transaction there will be a debit and a matching credit, and the sum of all debits for all accounts must equal the sum of all credits.

Debits and credits are then defined as follows:

debit: an increase in one of the accounts with a normal balance of debit or a decrease in one of the accounts with a normal balance of credit. A debit is recorded on the left hand side of a 'T' account
credit: an increase in one of the accounts with a normal balance of credit or a decrease in one of the accounts with a normal balance of debit. A credit balance is recorded on the right hand side of a 'T' account

Debit accounts = Asset and Expenses (also debit money received into bank accounts)
Credit accounts = Gains and Liabilities (also credit money paid out of bank accounts)

The following accounts have a normal balance of debit:

Assets
Accounts receivable: debts promised by other entities but not yet paid
Drawings by the owners on equity
Expenses
Losses (that is, when expenses exceed revenue)

The following accounts have a normal balance of credit:

Liabilities
Accounts payable and taxes, notes or loans payable: debts promised to outsiders but not yet paid
Revenue
Profit (that is, when revenue exceeds expenses)

Examples of debits and credits:
Purchase of a Computer
Debit = Computer A/c (Fixed Asset A/c)
Credit = Creditors A/c (Liability A/c)

Paying supplier for the computer
Debit: Creditors A/c (Liability A/c) You are reducing a Liability A/c
Credit: Bank A/c (Asset A/c) Money going Out, you are reducing an asset account

Credit and debit items are summarised at the end of a recording period in a trial balance which is a list of all the debit and credit balances. The trial balance acts as a self checking mechanism for the correctness of entries in the individual accounts and also as a starting point for the preparation of the balance sheet and a profit and loss account.

The following table summarizes the basic accounts. A "+" indicates an increase; a "−" indicates a decrease.

**Debit/credit**
Account	Debit	Credit
Assets	+	−
Liabilities	−	+
Shareholder Equity	−	+
Revenue	(−)	+
Expenses	+	(−)

An explanation of a T account

Why is a T account called a T account, because it looks like the letter "T" when drawn ____________________ Debits | Credits | | | | | | You enter all your debit entries on the left side of the middle line and all the credit entries on the right side of the middle line.

Double-entry working examples

Example 1

In this example the following will be used: Books of first entry (a.k.a. Books of prime entry)

Sales Invoice Daybook (records customer Invoice Daybook)
Bank Receipts Daybook (records customer & non customer receipts)
Purchase Invoice Daybook (records supplier Invoice Daybook)
Bank Payments Daybook (records supplier & non supplier payments)

Ledger Cards

Customer Ledger Cards
Supplier Ledger Cards

General Ledger (Nominal Ledger)
Bank Account Ledger
Trade Creditors Ledger
Trade Debtors Ledger

From the above we will create:

Trial Balance
Profit and Loss Statement (Dr & Cr Formating, classic format)
Profit and Loss Statement (List Format, Modern version used today)
Balance Sheet (Dr & Cr Formatting, classic format)
Balance Sheet (List Format, Modern version used today)

Purchases/Creditors

=Purchase Invoice Daybook

**Purchase Invoice Daybook**
Date	Supplier Name	Reference	Amount	Electricity	Widgets
10 Jul 2006	Electricity Company	PI1	1000	1000
12 Jul 2006	Widget Company	PI2	1600		1600
			---	---	---
		Total	2600	1000	1600

			Credit	Debit	Debit
			Trade	Profit	Profit
			Creditors	& loss	& loss
			control a/c	control a/c	control a/c

Each indivdual line is posted as follows:
The amount value is posted as a credit to the individual supplier's ledger a/c
The analysis amount is posted a debit to the relevant general ledger a/c
From example above:
Line 1 - Amount value 1000 is posted as a credit to the Supplier's ledger a/c ELE01-Electricy Company
Line 1 - Electricty value 1000 is posted as a debit to the Electricity general ledger a/c code
Double-entry has been observed Dr = 1000 Cr = 1000
Line 2 - Amount value 1600 is posted as a credit to the Supplier's ledger a/c WID01-Widget Company
Line 2 - Widget value 1600 is posted as a debit to the Widget general ledger a/c code
Double-entry has been observed Dr = 1600 Cr = 1600

The totals' of each column are posted as follows:
Amount total value 2600 posted as a credit to the Trade creditors control a/c
Electricity total value 1000 posted as a debit to the Profit & loss control a/c
Widget total value 1600 posted as a debit to the Profit & loss control a/c
Double-entry has been observed Dr = 2600 Cr = 2600

=Bank Payments Daybook

**Bank Payments Daybook**
Date	Supplier Name	Reference	Amount	Trade Creditors	Other
17 Jul 2006	Electricity Company	BP701	1000	1000
19 Jul 2006	Widget Company	BP702	900	900
28 Jul 2006	Owner's Wages	BP703	400		400
			---	---	---
		Total	2300	1900	400

			Credit	Debit	Debit
			Profit &	Trade	Wages
			loss	Creditors	control a/c
			control a/c	control a/c

Keys: PI = Purchase Invoice, BP = Bank Payment

Each indivdual line is posted as follows: The amount value is posted as a debit to the individual supplier's ledger a/c
The analysis amount is posted as a credit to the relevantgeneral ledger a/c
From example above:
Line 1 - Amount value 1000 is posted as a debit to the Supplier's ledger a/c ELE01-Electricity Company
Line 1 - Trade creditors value 1000 is posted as a credit to the Bank general ledger a/c code
Double-entry has been observed Dr = 1000 Cr = 1000
Line 2 - Amount value 900 is posted as a debit to the Supplier's ledger a/c WID01-Widget Company
Line 2 - Trade creditors value 900 is posted as a credit to the Bank general ledger a/c code
Double-entry has been observed Dr = 900 Cr = 900
Line 3 - Amount value 400 is posted as a debit to the Wages general ledger a/c code
Line 3 - Trade creditors value 400 is posted as a credit to the Bank general ledger a/c code
Double-entry has been observed Dr = 400 Cr = 400

The totals' of each column are posted as follows:
Amount total value 2300 posted as a debit to the Trade creditors control a/c
Electricity total value 1900 posted as a credit to the Profit & loss control a/c
Widget total value 400 posted as a credit to the Profit & loss control a/c
Double-entry has been observed Dr = 2300 Cr = 2300

The daybooks are the key documents (books) to the double entry system. From these daybooks we create the ledger accounts. Each transaction will be recorded in at least two ledger accounts.

=Supplier Ledger Cards

**SUPPLIER LEDGER CARDS**
A/c Code: ELE01 - Electricity Company
Date	Details	Reference	Amount	Date	Details	Reference	Amount
17 Jul 2006	Bank Payments Daybook	BP701	1000	10 Jul 2006	Invoice	PI1	1000
31 Jul 2006	Balance c/f		0
			---				---
			1000				1000

				01 Aug 2006	Balance b/f		0
A/c Code: WID01 - Widget Company
Date	Details	Reference	Amount	Date	Details	Reference	Amount
19 Jul 2006	Bank Payments Daybook	BP702	900	12 Jul 2006	Invoice	PI2	1600
31 Jul 2006	Balance c/f		700
			---				---
			1600				1600

				01 Aug 2006	Balance b/f		700

Sales/Customers

=Sales daybook

**Sales Invoice Daybook**
Date	Customer Name	Reference	Amount	Parts	Service
02 Jul 2006	JJ Manufacuring	SI1	2500	2500
29 Jul 2006	JJ Manufacturing	SI2	3200		3200
			---	---	---
		Total	5700	2500	3200

			Debit	Credit	Credit
			Trade	Profit	Profit
			debtors	& loss	& loss
			control a/c	control a/c	control a/c

Each indivdual line is posted as follows:
The amount value is posted as a debit to the individual customer's ledger a/c
The analysis amount is posted a credit to the relevant general ledger a/c
From example above:
Line 1 - Amount value 2500 is posted as a debit to the Customer's ledger a/c JJM01-JJ Manufacturing
Line 1 - Electricty value 2500 is posted as a credit to the Sales-parts general ledger a/c code
Double-entry has been observed Dr = 2500 Cr = 2500
Line 2 - Amount value 3200 is posted as a credit to the Customer's ledger a/c JJM01-JJ Manufacturing
Line 2 - Electricty value 3200 is posted as a debit to the Sales-service general ledger a/c code
Double-entry has been observed Dr = 3200 Cr = 3200

The totals' of each column are posted as follows:
Amount total value 5700 posted as a debit to the Trade debtors control a/c
Sales-parts total value 2500 posted as a credit to the Profit & loss control a/c
Sales-service total value 3200 posted as a credit to the Profit & loss control a/c
Double-entry has been observed Dr = 5700 Cr = 5700

=Bank Receipts daybook

**Bank Receipts Daybook**
Date	Customer Name	Reference	Amount	Customers	Other
20 Jul 2006	JJ Manufacturing	BR1	2500	2500	0
			---	---	---
		Total	2500	2500	0

			Debit	Credit	Credit
			Bank a/c	Trade	Other
			control a/c	Debtors	control a/c
				control a/c

Keys: SI = Sales Invoice, BR = Bank Receipt

Each indivdual line is posted as follows: The amount value is posted as a credit to the individual customer's ledger a/c
The analysis amount is posted as a debit to the relevantgeneral ledger a/c
From example above:
Line 1 - Amount value 2500 is posted as a credit to the Customer's ledger a/c JJM01 - JJ Manufacturing
Line 1 - Customers value 2500 is posted as a credit to the Bank general ledger a/c code
Double-entry has been observed Dr = 2500 Cr = 2500

The totals' of each column are posted as follows:
Amount total value 2500 posted as a credit to the Trade debtors control a/c
Customers total value 2500 posted as a debit to the Profit & loss control a/c
Double-entry has been observed Dr = 2500 Cr = 2500

The daybooks are the key documents (books) to the double entry system. From these daybooks we create the ledger accounts. Each transaction

will be recorded in at least two ledger accounts.

=Customer Ledger Cards

**CUSTOMER LEDGER CARDS**
A/c Code: JJM01 - JJ Manufacturing
Date	Details	Reference	Amount	Date	Details	Reference	Amount
02 Jul 2006	Sales invoice daybook	SI1	2500	20 Jul 2006	Bank receipts daybook	BR1	2500
02 Jul 2006	Sales invoice daybook	SI2	3200	31 Jul 2006	balance c/f		3200
			---				---
			5700				5700

01 Aug 2006	Balance b/f		3200

General Ledger

=General Ledger

**GENERAL LEDGER**
Sales parts
Date	Details	Reference	Amount	Date	Details	Reference	Amount
31 Jul 2006	Balance c/f		2500	02 Jul 2006	Sales invoice daybook	SI1	2500
			---				---
			2500				2500

				01 Aug 2006	Balance b/f		2500
Sales service
Date	Details	Reference	Amount	Date	Details	Reference	Amount
31 Jul 2006	Balance c/f		3200	29 Jul 2006	Sales invoice daybook	SI2	3200
			---				---
			3200				3200

				01 Aug 2006	Balance b/f		3200
Electricity
Date	Details	Reference	Amount	Date	Details	Reference	Amount
10 Jul 2006	Electricity Co.	PI1	1000	31 Jul 2006	Balance c/f		1000
			---				---
			1000				1000

01 Aug 2006	Balance b/f		1000
Widgets
Date	Details	Reference	Amount	Date	Details	Reference	Amount
12 Jul 2006	Widget Co.	PI2	1600	31 Jul 2006	Balance c/f		1600
			---				---
			1600				1600

01 Aug 2006	Balance b/f		1600
Other a/c
Date	Details	Reference	Amount	Date	Details	Reference	Amount
28 Jul 2006	Owner's Wages	BP703	400	31 Jul 2006	Balance c/f		400
			---				---
			400				400

01 Aug 2006	Balance b/f		400
Bank Control A/c
Date	Details	Reference	Amount	Date	Details	Reference	Amount
31 Jul 2006	Bank receipts daybook	BR-Jul	2500	31 Jul 2006	Bank payments daybook	BP-Jul	2300
				31 Jul 2006	Balance c/f		200
			---				---
			2500				2500

01 Aug 2006	Balance b/f		200
Trade Debtors Control A/c
Date	Details	Reference	Amount	Date	Details	Reference	Amount
01 Jul 2006	Balance b/f		0	31 Jul 2006	Bank receipts daybook	BR-Jul	2500
31 Jul 2006	Sales Invoice Daybook	SI-Jul	5700	31 Jul 2006	Balance c/f		3200
			---				---
			5700				5700

01 Aug 2006	Balance b/f		3200
Trade Creditors Control A/c
Date	Details	Reference	Amount	Date	Details	Reference	Amount
31 Jul 2006	Bank Payments Daybook	BP-Jul	1900	01 Jul 2006	Balance b/f		0
31 Jul 2006	Balance c/f		700	31 Jul 2006	Purchase Daybook	PI-Jul	2600
			---				---
			2600				2600

				01 Aug 2006	Balance b/f		700

Profit & loss control A/c
Date	Details	Reference	Amount	Date	Details	Reference	Amount
31 Jul 2006	Purchase invoice daybook	PI-Jul	2600	31 Jul 2006	Sales invoice daybook	SI-Jul	5700
31 Jul 2006	Bank payments daybook	BP-Jul	400
31 Jul 2006	Balance c/f		2700
			---				---
			5700				5700

				01 Aug 2006	Balance b/f		2700

The cutomers ledger cards shows the breakdown of how the trade debtors control a/c is made up. The trade debtors control a/c is the total of outstanding debtors and the customer ledger cards shows the amount due for each individual customer. The total of each individual customer account added together should equal the total in the trade debtors control a/c.

The supplier ledger cards shows the breakdown of how the trade creditors control a/c is made up. The trade creditors control a/c is the total of outstanding creditors and the suppliers ledger cards shows the amount due for each individual supplier. The total of each individual supplier account added together should equal the total in the trade creditors control a/c.

Each Bank a/c shows all the money in and out through a bank. If you have more than one bank account for your company you will have to maintain separate bank account ledger in order to complete bank reconcilliation statements and be able to see how much is left in each account.

The Bank control a/c keeps the total for all bank accounts. The balance of each individual bank acount, when added together, must equal the balance in the bank control a/c.

=Bank account

Bank A/c
Date	Details	Reference	Amount	Date	Details	Reference	Amount
01 Jul 2006	Balance b/f		0	17 Jul 2006	Bank Payments Daybook	BP701	1000
20 Jul 2006	Bank Receipts Daybook	BR1	2500	19 Jul 2006	Bank Payments Daybook	BP702	900
				28 Jul 2006	Bank Payments Daybook	BP703	400
				31 Jul 2006	Balance c/f		200
			---				---
			2500				2500

01 Aug 2006	Balance b/f		200

=Unadjusted Trial balance

Trial balance as at 31st July 2006
	A/c description	Debit	Credit
	Sales-parts		2500
	Sales-sevice		3200
	Widgets	1600
	Electricity	1000
	Other	400
	Bank Control A/c	200
	Trade Debtors Control A/c	3200
	Trade Creditors Control A/c		700
		---	---
		6400	6400
		=	=
Both sides must have the same overall total
Debits = Credits.

The individual customer accounts are not to be listed in the trial balance, as the Trade debtors control a/c is the summary of each individual customer a/c.

The individual supplier accounts are not to be listed in the trial balance, as the Trade creditors control a/c is the summary of each individual supplier a/c.

The individual bank accounts are not to be listed in the trial balance, as the Bank control account is the summary of each individual bank a/c. _{see note 2 below}

The profit & loss control account is not to be listed in the trial balance, as thr profit & loss control account is a summary of the trial balance.

Important notes:
1. This example is designed to show double entry. There are methods of creating a trial balance that significantly reduce the time it takes to record entries in the general ledger and trial balance.
2. In practice it is the norm to list each bank account in the trial balance. This allows you to distinguish between bank accounts which are overdrawn or not and which bank accounts are loans or savings accounts.

=Journal Entries

= Depreciation Wages Stock Accurals Prepayments

=adjusted Trial balance

Trial balance as at 31st July 2006
	A/c description	Debit	Credit

=Profit & Loss Statement and Balance Sheet

Classic Format (Debits & Credits)

**Profit and loss statement**
for the month ending 31st July 2006
			Dr			Cr
x	Cost of Sales			Sales
x	Widgets	1600		Sales-parts	2500
x		---		Sales-service	3200
x			1600			---
x	Gross Profit	4100				5700
x	Less expenses
x	Electricity	1000
x	Other	400
x		---
x			1400
x	Net Profit		2700
x			---			---
x			5700			5700
x

**Balance sheet**
as at 31st July 2006
		Dr		Cr
x	Current Assets		Current Liabilities
x	Bank A/c	200	Trade Creditors	700
x	Trade Debtors	3200	Capital & Reserves
x			Revenue Reserves a/c	2700
x		---		---
x		3400		3400
x

Modern Format (List method)

**Profit and loss statement**
for the month ending 31st July 2006

**Balance sheet**
as at 31st July 2006

Example 2

Transcactions

XYZ Company is closing its books for the end of the month. Each of the daily journals has been summarized and the amounts are ready to be transferred to the general ledger. The amounts to be transferred are:

Purchase raw materials by using line of credit: $500,000
Pay workers from cash in bank to make goods: $1,500,000
Pay sales force from cash in bank to sell goods: $1,000,000
Sell goods for cash: $3,500,000

To close the books for the month, we will adjust expenses and revenue to be zero by appropriately crediting and debiting the income summary and then closing the income summary to retained earnings (part of equity).

These items are entered in the ledger below; each matching credit and debit have been numbered to make finding them in the ledger easier.

Ledgers

**General Ledger (in 000s)**
Transaction	Debit	Credit	Balance
Expenses
Balance forward			-0-
1 Raw materials	$ 500		$ 500
2 Labor	$ 1500		$ 2000
3 Sales costs	$ 1000		$ 3000
5 Income summary		($ 3000)	-0-
Total	$ 3000	$ 3000
Revenue
Balance forward			-0-
4 Revenue from sales		$ 3500	$ 3500
6 Income summary	($ 3500)		-0-
Total	$ 3500	$ 3500
Cash
Balance forward			$11000
2 Labor		$ 1500	$ 9500
3 Sales costs		$ 1000	$ 8500
4 Revenue from sales	$ 3500		$12000
Total	$ 3500	$ 2500
Accounts Payable
Balance forward			$ 1000
1 Raw materials		$ 500	$ 1500
Total	-0-	$ 500
Income summary
Balance forward			-0-
5 Expense	$ 3000		−$ 3000
6 Revenue		$ 3500	$ 500
7 Retained earnings	$ 500		-0-
Total	$ 3500	$ 3500
Retained earnings
Balance forward			$10000
7 Income summary		$ 500	$10500
Total	-0-	$ 500
Total all accounts:	$13500	$13500

The amount in equity (in the form of retained earnings) has changed with a net credit of $500,000. Since equity has a normal balance of credit, this means there is now $500,000 more in equity than at the beginning of the month.

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