Accountancy Double Entry, Double Entry Accounting, Double Entry Bookkeeping
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Accountancy Double Entry, Double Entry Accounting, Double Entry Bookkeeping

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This Double Entry Ideas information page, child to Softhard Solutions Australia Accountancy Section page (accounting, accountancy, accounting theory etc.), is provided by Softhard Solutions Australia for our Auto Repair Shop Business users of our ShopMate Automotive Business Accounting Database Software and our visitors.
While you are searching up on the Double Entry Ideas here, if you happen to need Automotive Business Accounting Software for starting your new or existing automotive or any other business, at least you have found the Best Business Accounting Database Software in your search and is offered right here on our website.
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Double Entry Accounting
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.

It was first described by the Italian mathematician Luca Pacioli, in his 'Summa de arithmetica, geometrica, proportioni et proportionalita' (Venice, 1494).

Its premise is that a business' (or other organization's) financial condition and results of operations are best recorded in accounts.

Statue of Luca Pacioli, father of modern accountancy
Statue of Franciscan monk Luca Pacioli, father of modern accountancy.

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Each account maintains a "history" of changes in monetary values about a particular aspect of the business.

This system is called Double Entry Accounting because each transaction is recorded in at least two accounts. Each transaction results in at least one account being debited and at least one account being credited, with the total debits of the transaction equal to the total credits. This requirement has a benefit to the bookkeeper, but also introduces confusion to the layman.

The benefit is that the accuracy of the accounts can be checked quickly - for, when all the accounts that have debit balance are summed, they should equal the sum of all the accounts which have a credit balance. Without this requirement, there would be no quick means to check accuracy. The confusion arises because a healthy business with money in the bank will have a debit balance in the account called "Bank". This is contrary to the layman's experience that, when the layman's bank balance is healthy, his bank statement shows a credit balance. An easy way to visualize this is to consider that the bank writes the statement from its own point of view; hence if you are in credit, you are a liability on their balance sheet - you can turn up and draw your money out.

To understand why the double entry account called "Bank" is normally in debit, consider the recording of the transaction where the owner of a business contributes cash to the business. The two accounts affected by this transaction are "Bank" and "Capital". Given that the reader can easily accept that the "Capital" account is credited, then applying the double-entry rule that at least one account must be debited, it is clear that the account called "Bank" has to be debited. Note that the terms "debit" and "credit" do not mean that one term is somehow good and the other is somehow bad, or that one is positive and the other is negative. In bookkeeping, debits and credits are simply a way of making an account change.

If a business's assets increase, then the relevant asset account is debited. Therefore, if a business receives money, its assets have increased, and so the account called "Bank" is debited. If the money received was because the business had taken out a loan, the account that would be credited is the liability account called "Loan". This latter point demonstrates that when liabilities are increased, the affected liability account is credited. (This also helps explain why the layman's healthy bank statement shows a credit balance, because from the viewpoint of the bank, the layman's account is a liability account. For, each time the layman deposits money to a healthy bank account, the bank's liabilities are increased because the bank now owes the layman more money).

Consider also these two examples, if Business A sells an item for cash to Business B, the bookkeeper of the Business A would credit the account called "Sales" and debit the account called "Bank". Conversely, the bookkeeper of Business B, would debit the account called "Purchases" and credit the account called "Bank".

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.


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Early History

The origins of a primitive Double Entry Accounting system have been traced as far back as the 12th century. Some sources suggest that Giovanni di Bicci de' Medici first introduced this method for the Medici bank. The earliest extant records that follow the modern Double Entry Accounting form are those of Amatino Manucci, a Florentine merchant at the beginning of the 14th 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 mathematics textbook of 1494. Luca Pacioli is often called the "father of accounting" because he was the first to publish a detailed description of the Double-Entry Accounting system, thus enabling others to study and use it.

Double-entry bookkeeping was initially introduced in Japan during the Meiji period in the 1870s. The newly-established Japan Mint was the earliest Japanese government institution to begin using double-entry bookkeeping in it's Osaka headquarters.


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The Bookkeeping and Accounting Process

In the normal course of business, a document is produced each time a transaction occurs. Sales and purchases usually have invoices or receipts. Deposit slips are produced when lodgements (deposits) are made to a bank account. Cheques are written to pay money out of the account. Bookkeeping involves recording the details of all of these source documents into multi-column journals (also known as a books of first entry or daybooks).

For example, all credit sales are recorded in the Sales Journal, all Cash Payments are recorded in the Cash Payments Journal. Columns in the journal, normally correspond to an account. In the single entry system, each transaction is recorded only once. Most individuals who balance their cheque-book each month are using such a system, and most personal finance software follows this approach.

After a certain period, typically a month, the columns in each journal are each totalled to give a summary for the period. Using the rules of double entry, these journal summaries are then transferred to their respective accounts in the ledger, or book of accounts. The process of transferring summaries or individual transactions to the ledger is called Posting. Once the posting process is complete, accounts kept using the "T" format undergo balancing which is simply a process to arrive at the balance of the account.

To quickly check that the posting process was done correctly, a working document called an unadjusted trial balance is created. In its simplest form, this is a three column list. The first column contains the names of those accounts in the ledger which have a non-zero balance. If an account has a debit balance, the balance amount is copied into column two (the debit column). If an account has a credit balance, the amount is copied into column three (the credit column). The debit column is then totaled and then the credit column is totaled.

The two totals must agree - this agreement is not by chance - it happens because under the double-entry rules, whenever there is a posting, the debits of the posting equal the credits of the posting. If the two totals do not agree therefore, an error has been made in either the journals or made during the posting process. The error(s) must be located and rectified and the totals of debit column and credit column re-calculated to check for agreement before any further processing can take place.

Once there are no errors, the accountant produces a number of adjustments and changes the balance amounts of some of the accounts. For example, the "Inventory" account and "Office Supplies" asset accounts are changed to bring them into line with the actual numbers counted during a stock take. At the same time, the expense accounts associated with usage of inventory and with the usage of office supplies are adjusted. Other refinements necessary to ensure that accounting principles are complied with are also done at this time.

This results in a listing called, not surprisingly, the adjusted trial balance. It is the accounts in this list and their corresponding debit or credit balances that are used to prepare the 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

  • The statement of retained earnings

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Debits and Credits

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

  • Assets = Liabilities + Equity

This can be further expanded and the (extended) equation becomes:

  • Assets = Liabilities + Equity + (Revenue − Expenses)

Or:

  • Assets = Liabilities + (Capital − Drawings) + (Revenue − Expenses)
  • A = L + C − D + R − E

Finally, the equation may be rearranged algebraically as follows:

  • A + E + D = L + R + C

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 made by debits and credits to the accounts. 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.

Assets, Expenses, and Drawings accounts (on the left side of the equation) have a normal balance of debit. Liability, Revenue, and Capital 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 made to one or several accounts and a credit made to one or several accounts. The sum of all debits made in any transaction must equal the sum of all credits made. After a series of transactions, therefore, the sum of all the accounts with a debit balance will equal the sum of all the accounts with a credit balance.

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 (income) 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).

  • Capital.

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Business Tips

Some tips on how to avoid business failure:

  • Don't underestimate the capital you need to start up the business.

  • Understand and keep control of your finances - income earned is not the same as cash in hand.

  • More volume does not automatically mean more profit - you need to get your pricing right.

  • Make sure you have good software for your business, software that provides you with a good reporting picture of all aspects of your business operations.


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Important Note
Because the material covered here and other pages is considered an introduction to the topic of Accountancy and Accounting, there are many complexities not presented. You should always consult with a business accounting professional for assistance with your own specific circumstances.







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