Double Entry System of Book Keeping
As per Double Entry System of book-keeping, all the business transactions recorded in accounts
have two aspects - Debit aspect (receiving) and Credit aspect (giving). For example, when a
business acquires an asset (receiving) and pays cash (giving) for it. This accounting technique
records each transaction as debit and credit, where every debit has a corresponding credit and
vice versa.
Features of Double Entry System of Book Keeping
The Double entry system of book keeping comprises of the following features :
- Every business transaction affects two accounts
- Each transaction has two aspects, i.e., debit and credit
- Maintains a complete record of all business transactions
- Helps to check the accuracy of the accounting transactions, by preparation of trial balance
- Helps ascertaining profit earned or loss occured during a period, by preparation of Profit & Loss Account
- Helps ascertaining financial position of the concern at the end of each period, by preparation of Balance Sheet
- Helps timely decision making based on sufficient information
- Minimises the possibilities of fraud due to its systematic and scientific recording of business transactions
The following chart explains the way in which accounting transactions are recorded in the Double Entry system and financial statements are prepared
Mode of Accounting:
Accounting process begins with identifying and recording the transactions in the books of
accounts i.e., the first step in the Accounting Process is recording of transactions in the books of
accounts. Accounting identifies only those transactions and events which involves money and is
sorted based on various source documents.
The following are the most common source documents.
- Cash Memo
- Invoice or Bill
- Vouchers
- Receipt
- Debit Note
- Credit Note
Voucher
A voucher is a document in support of a business transaction, containing the details of such transaction.
Receipt
When a trader receives cash from a customer against goods sold by him, issues a receipt containing
the name of such customer, details of amount received with date.
Invoice or Bill
When a trader sells goods to a buyer, he prepares a sales invoice containing the details of name
and address of buyer, name of goods, amount and terms of payments and so on. Similarly, when
the trader purchases goods on credit receives a Invoice/bill from the supplier of such goods.
Journals and Ledgers
A journal is a record in which all business transactions are entered in a chronological order. A
record of a single business transaction is called a journal entry. Every journal entry is supported
by a voucher, evidencing the related transaction.
Account
An account is a statement of transactions affecting any particular asset, liability, expense or
income.
Ledger
A Ledger is a book which contains all the accounts whether personal, real or nominal, which are
entered in journal or subsidiary books.
Chart of Accounts
A chart of accounts is a list of all accounts used by an organisation. The chart of accounts also
displays the categorisation and grouping of its accounts.
Posting
Posting is the process of transferring the entries recorded in the journal or subsidiary books to
the respective accounts opened in the ledger i.e., grouping of all the transactions relating to a particular account to a single place.
Accounting Period
Generally, the financial statements are generated for a regular period such as a quarter or a year,
for timely and accurate ascertainment of operating and financial position of the organisation.
Trial Balance
Trial balance is a statement which shows debit balances and credit balances of all Ledger accounts. As per the rules of double entry system, every debit should have a corresponding credit, the total of the debit balances and credit balances should agree. A detailed trial balance has columns for
- Account name
- Debit balance
- Credit balance
Financial Statements
Financial statements are final result of accounting work done during the accounting period. Financial statement serves a significant purpose to users of accounting information in knowing about the profitability and financial position of the organisation. Financial statements normally include
- Trading
- Profit and Loss Account
- Balance Sheet
Trading Account
Trading refers to buying and selling of goods. The trading account displays the transactions pertaining to buying and selling of goods.
The difference between the two sides of the Trading Account indicates either Gross Profit or
Gross Loss. If the credit side total is in excess of the debit side total, the difference represents
Gross Profit. On the other hand, if the total of the debit side is in excess of the credit side total, the
difference represents Gross Loss. Such Gross Profit / Gross Loss is transferred to Profit & Loss
Account. The Gross Profit is expressed as :
Gross Profit = Net Sales – Cost of Sales
Profit and Loss Account
The profit and loss account helps to ascertain the net profit earned or net loss suffered during a particular period. after considering all other incomes and expenses incurred over a period. This helps the company to monitor and control the costs incurred and improve its efficiency. In other words, the profit and loss statement shows the performance of the company in terms of profits or losses over a specified period.
The Net Profit is expressed as :
Net Profit = (Gross Profit + Other Income) – (Selling and Administrative Expenses + Depreciation
+ Interest + Taxes + Other Expenses)
A key element of the Profit and Loss Account, and one that distinguishes it from a balance sheet, is that the amounts shown on the statement represent transactions over a period of time, while the items represented on the balance sheet show information as on a specific date.
All revenue and expense accounts are closed once the profit and loss account is prepared. The Revenue and Expenses accounts will not have an opening balance for the next accounting period.
Balance Sheet
The balance sheet is a statement that summarises the assets and liabilities of a business. The excess of assets over liabilities is the net worth of a business. The balance sheet provides information that helps in assessing
- A company’s Long-term financial strength
- A company’s Efficient day-to-day working capital management
- A company’s Asset portfolio
- A company’s Sustainable long-term performance
The balances of all the real, personal and nominal (capital in nature) accounts are transferred from trial balance to balance sheet and grouped under the major heads of assets and liabilities. The balance sheet is complete when the net profit/ loss is transferred from the Profit and Loss account.
Transactions
A transaction is a financial event that takes places in the course or furtherance of business and effects the financial position of the company. For example, when you deposit cash in the bank, your cash balance reduces and bank balance increases or when you sell goods for cash, your cash balance increases and your stock reduces.
Transactions can be classified as follows :
- Receipts – cash or bank
- Payments – cash or bank
- Purchases
- Sales
Recording Transactions
The important aspect of accounting is to record transactions promptly and correctly to ascertain the financial status of a company as on a particular date.
Generally, the business transactions may be of the folowing nature :
- Purchase of goods either as raw materials for processing or as finished goods for resale
- Payment of expenses incurred towards business
- Sale of goods or services
- Receipts (in Cash or by Cheques)
- Payments (in Cash or Cheques)
The Accounting information is useful to various interested parties, both internal and external viz.,
- Suppliers, who supply goods and services for cash or on credit
- Customers, who buy goods or services for cash or on credit
- Employees, who provide services in exchange of salaries and wages.
- Banks, with whom accounts are maintained
- Suppliers of equipment, buildings and other assets needed to carry on the business.
- Lenders from whom, you borrow money to finance your business
- Owners, who hold a share in the capital of your business
Parties dealt with in a business process
Points to Remember
- Accounting is a comprehensive system to collect, analyse and communicate financial information.
- Double Entry accounting is a system of recording transactions in a way that maintains the equality of the accounting equation.
- The three types of accounts maintained for transactions are real accounts, personal accounts and nominal accounts.
- Entity is the organisational unit for which accounting records are maintained.
- Journal entry is a record of a single business transaction.
- Voucher is a document evidencing the details of a financial transaction.
- Ledger is a book in which accounts are maintained.
- Trial balance is a list of the balances of all the ledger accounts.
- Profit and loss statement shows the performance of the company in terms of profits or losses made by it over a specified period.
- Balance sheet gives an overview of the financial position of a company as on a specific date.
The above Inventory Masters types are explained in detailed in the following sections.
