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Assets
= Capital
+ Liabilities
$
$
$
Stall
1,800
As at end of 10 July
2,690
Loan
500
Flowers and plants
0
Additional capital put in
250
Cash (890 + 750)
1,640
3,440
=
2,940 +
500
The purchase of the van (cost $700) on credit
Assets
= Capital
+ Liabilities
$
$
$
Stall
1,800
As at end of 10 July
2,690
Loan
500
Van
700
Additional capital
250
Payables
700
Cash
1,640
4,140
=
2,940
+
1,200
(ii)
The sale of goods to Uncle George on credit ($350) which cost the business $300 (cash paid)
Assets
= Capital
+ Liabilities
$
$
$
Stall
1,800
As at end of 10 July
2,690
Loan
500
Van
700
Additional capital
250
Payables
700
Receivable
350
Profit on sale to
Cash
(1,640 – 300)
1,340
Uncle George
(350 – 300)
50
4,190 =
2,990 +
1,200
(iii)
After the purchase of goods for the weekly market ($750 paid in cash and $50 of purchases
on credit)
Assets
=
Capital
+
Liabilities
$
$
$
Stall
1,800
As at end of 10 July
2,690
Loan
500
Van
700
Additional capital
250
Payables
Flowers and plants
800
Profit on sale to
(van)
700
Receivables
350
Uncle George
50
Payables
Cash
(goods)
50
(1,340 – 750)
590
4,240
=
2,990
+
1,250
(iv)
After market trading on 17 July
Sales of goods costing $800 earned revenues of $1,250. Ethel's wages were $40 (paid), Uncle
Henry's interest charge is $5 (not paid yet) and withdrawals on account of profits were $240
(paid). The profit for market trading on 17 July may be calculated as follows, taking the full $5 of
interest as a cost on that day.
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69
$
$
Sales
1,250
Cost of goods sold
800
Wages
40
Interest
5
845
Profit earned on 17 July
405
Drawings
240
Retained profit
165
Assets
=
Capital
+ Liabilities
$
$
$
Stall
1,800
As at end of 10 July
2,690
Loan
500
Van
700
Additional capital
250
Payable for
Flowers and plants
Profit on sale to
van
700
(800 – 800)
0
Uncle George
50
Receivables
350
Payable for
Cash (590 +
Profits retained
165
goods
50
1,250 40 240)
1,560
Payable for
interest
payment
5
4,410
3,155
1,255
3.7 Matching
The matching convention requires that revenue earned is matched with the expenses incurred in earning
it.
The matching convention comes from the accruals assumption. In the example above, we have 'matched'
the revenue earned with the expenses incurred in earning it. So in part (iv), we included all the costs of
the goods sold of $800, even though $50 had not yet been paid in cash. Also, the interest of $5 was
deducted from revenue, even though it had not yet been paid. This is an example of the matching
convention.
QUESTION
The accounting equation
How would each of these transactions affect the accounting equation?
A
Purchasing $800 worth of inventory on credit
B
Paying the telephone bill $25
C
Selling $450 worth of inventory for $650
D
Paying $800 to the supplier
ANSWER
A
Increase in liabilities (payables)
$800
Increase in assets (inventory)
$800
B
Decrease in assets (cash)
$25
Decrease in capital (profit)
$25
C
Decrease in assets (inventory)
$450
Increase in assets (cash)
$650
Increase in capital (profit)
$200
D
Decrease in liabilities (payables)
$800
Decrease in assets (cash)
$800
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PART C: THE USE OF DOUBLE-ENTRY AND ACCOUNTING SYSTEMS
70
4
Double entry bookkeeping
Double entry bookkeeping is based on the idea that each transaction has an equal but opposite effect.
Every accounting event must be entered in ledger accounts both as a debit and as an equal but opposite
credit.
4.1 Dual effect (duality concept)
Double entry bookkeeping is the method used to transfer the weekly/monthly totals from the books of
prime entry into the nominal ledger.
Double entry bookkeeping
is the method by which a business records financial transactions. An
account is maintained for every asset, liability, income and expense. Every transaction is recorded twice
so that every debit is balanced by a credit.
Central to this process is the idea that every transaction has two effects, the dual effect. This feature is
not something peculiar to businesses. If you were to purchase a car for $1,000 cash, for instance, you
would be affected in two ways.
(a)
You own a car worth $1,000
(b)
You have $1,000 less cash
If instead you got a bank loan to make the purchase:
(a)
You own a car worth $1,000
(b)
You owe the bank $1,000
A month later if you pay a garage $50 to have the exhaust replaced:
(a)
You have $50 less cash
(b)
You have incurred a repairs expense of $50
Ledger accounts, with their debit and credit sides, are kept in a way which allows the two-sided nature
of every transaction to be recorded. This is known as the 'double entry' system of bookkeeping, because
every transaction is recorded twice in the accounts.
4.2 The rules of double entry bookkeeping
A debit entry will:
Increase an asset
Decrease a liability
Increase an expense
A credit entry will:
Decrease an asset
Increase a liability
Increase income
The basic rule, which must always be observed, is that every financial transaction gives rise to two
accounting entries, one a debit and the other a credit. The total value of debit entries in the nominal
ledger is therefore always equal at any time to the total value of credit entries. Which account receives
the credit entry and which receives the debit depends on the nature of the transaction.
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LEDGER ACCOUNTS AND DOUBLE ENTRY
71
An
increase in an expense (eg a purchase of stationery) or an increase in an asset (eg a purchase
of office furniture) is a
debit
.
An
increase in revenue (eg a sale) or an increase in a liability (eg buying goods on credit) is a
credit
.
A decrease in an asset (eg making a cash payment) is a
credit
.
A decrease in a liability (eg paying a creditor) is a
debit
.
In terms of T-accounts:
ASSET
LIABILITY
CAPITAL
DEBIT $
CREDIT
$
DEBIT $ CREDIT
$ DEBIT $
CREDIT
$
Increase Decrease
Decrease Increase
Decrease
Increase
For income and expenses, think about profit. Profit retained in the business increases capital. Income
increases profit and expenses decrease profit.
INCOME EXPENSE
DEBIT $
CREDIT
$ DEBIT $ CREDIT
$
Decrease Increase
Increase Decrease
Have a go at the question below before you learn about this topic in detail.
QUESTION
Debits and credits
Complete the following table relating to the transactions of a bookshop. (The first two are done for you.)
A
Purchase of books on credit
(i)
accounts payable increase
CREDIT accounts payable
(increase in liability)
(ii)
purchases expense increases DEBIT
purchases
(item of expense)
B
Purchase of cash register
(i)
own a cash register
DEBIT
cash register
(increase in asset)
(ii)
cash at bank decreases
CREDIT cash at bank
(decrease in asset)
C
Payment received from a credit customer
(i)
accounts receivable decrease
(ii)
cash at bank increases
D
Purchase of van
(i)
own
a
van
(ii)
cash at bank decreases
ANSWER
C
Payment received from a credit customer
(i)
accounts receivable decrease CREDIT accounts receivable
(decrease in asset)
(ii)
cash at bank increases
DEBIT
cash at bank
(increase in asset)
D
Purchase of van
(i)
own a van
DEBIT
van
(increase in asset)
(ii)
cash at bank decreases
CREDIT cash at bank
(decrease in asset)
How did you get on? Students coming to the subject for the first time often have difficulty in knowing
where to begin. A good starting point is the cash account, ie the nominal ledger account in which
receipts and payments of cash are recorded. The rule to remember about the cash account is as follows.
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