Chapter 3: Double-Entry Bookkeeping
•Double-entry bookkeeping underpins accounting
•A way of systematically recording the financial transactions of a
company so that each transaction is recorded twice.
•Basic accounting equation:
Assets = Liabilities + Equity + Profit (Income-Expenses)
Assets + Expenses = Liabilities + Equity+ Income
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Basic Rules
1. For every transaction there will be a debit and credit entry.
2. These debits and credits will be equal and opposite.
3. E.g. in bank account all records are paid in on debit side and paid
out on credit side.
• The choice of the right account side
is the core of the art of bookkeeping
• debiting an account Æ make an entry on the left-hand side of an
account
• crediting an account Æ make an entry on the right-hand side of an
account
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Derived rules
Recall the basic accounting equation
Assets + Expenses = Liabilities + Equity+ Income
Ö if a debit increases assets, then a credit counter item has to
increase liabilities or owner‘s equity
Ö i.e. increases and decreases in assets and liabilities (or
owner‘s equity) must be recorded opposite to each other!
• Increases in assets are debited. Decreases in assets are credited.
• Increases in liabilities are credited. Decreases in liabilities are
debited.
Assets Liabilities
Debit Credit Debit Credit
for for for for
Increase Decrease Decrease Increase
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Owner‘s Equity
• Recall that owner‘s investments and revenues increase owner‘s
equity, while owner‘s withdrawals and expenses decrease owner‘s
equity.
• Frequently separate accounts are kept for these items.
(a) Owner‘s Capital. This account is affected by, for example,
owner‘s investment.
• Increases in owner‘s capital are credited. Decreases in owner‘s
capital are debited.
Owner's Capital
Debit Credit
for for
Decrease Increase
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Owner‘s Withdrawals
(b) Owner‘s Withdrawals
• The owner may, for example, withdraw cash for personal use. It
could be debited directly to Owner‘s Capital but a separate account
is kept to determine total withdrawals.
• Increases in owner‘s withdrawals are debited. Decreases in owner‘s
withdrawals are credited.
Owner's Withdrawal
Debit Credit
for for
Increase Decrease
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Revenues and Expenses
• Revenues increase owner‘s equity, just as an increase in owner‘s
capital does. Thus, debiting and crediting of a revenue account is
the same as debiting and crediting of owner‘s capital account.
Expenses, however, have the opposite effect.
Revenues Expenses
Debit Credit Debit Credit
for for for for
Decrease Increase Increase Decrease
• Increases in revenues are credited. Decreases in revenues are
debited.
• Increases in expenses are debited. Decreases in expenses are
credited.
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Balancing off the accounts
When all entries completed, we need to balance
off the accounts
• All Income Statement items will be closed off
• All Balance Sheet items brought forward
• Balancing off enables us to:
1. Prepare a trial balance
2. Close down income and expense accounts
3. Bring forward assets, liabilities and equity
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Balancing off the cash account
1. Sum the entries on the larger side below the line
2. repeat the sum below the line on the other side
3. strike the balance: insert the amount missing such that the sums of
entries on both sides are equal (i.e. solving the account equation)
4. enter the counter item to the appropriate account e.g. Trial Balance
Cash Trial Balance
Beginning balance 100 Outflows 400 4. Beginning balance 600
Inflows 400 3. Balance 600
200
300
1. 1000 2. 1000
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Debit and Credit Balance
total of debit amounts > total of credit amounts debit balance
total of debit amounts < total of credit amounts credit balance
• note that a debit balance occurs on the credit side on account
closing and vice versa.
• normal balance ≡ side (debit or credit) that increases the stock or
flow represented in the account
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Booking of the counter item (in theory)
• appropriate account need not be the trial balance
– could be a hierarchically superior closing account, e.g. “cash and cash
equivalents”
– this could be closed to the balance sheet
– in order to reopen accounts for the next period the line item cash and
cash equivalents in the balance sheet could be counterbooked to an
account which is closed by booking out the individual items to the
respective accounts, e.g. the cash account for the next period
• This is not the practical procedure, this theoretically possible
procedure shall only make clear the mechanics of double entry
bookkeeping
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Example
A small company named ZiscoSys. The transactions are stated in
chronological order:
(1) € 8.000 Owner‘s Investment to start up the business
(2) Purchase of equipment for € 4.000 paid in cash
(3) Purchase of supplies on credit for € 500
(4) € 400 payment of a liability (accounts payable resulting from
delivery of supplies)
(5) € 5.000 revenues earned on credit
(6) € 3.000 collection of accounts receivable
(7) Incurring expenses of € 500 for rent (cash) and € 200 (on credit) for
utility and prepaid insurance of € 1.200
(8) reception of a down payment of € 2.400 for services to be
performed (unearned revenue or deferred revenue), and
(9) Owner‘s withdrawal of € 800.
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Transaction 1 – initial investment
Cash Owner's Equity
8.000 8.000
Increase in cash is debited; increase in owner‘s equity is credited.
Transaction 2 – purchase of equipment
Cash Equipment
4.000 4.000
Decrease in cash is credited; increase in equipment is credited.
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Transaction 5 – services rendered on credit
Accounts Receivable Revenues
5.000 5.000
Increase in accounts receivable is debited; incr. in revenues is credited.
Transaction 7 – insurance policy bought
Prepaid Insurance Cash
1.200 1.200
Increase in prepaid insurance is debited; decrease in cash is credited.
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Asset Accounts
Cash Accounts Receivable Equipment Supplies Prepaid Insurance
8.000 4.000 5.000 3.000 4.000 500 1.200
3.000 400
2.400 500
1.200
800
6.500 2.000 4.000 500 1.200
= Owner's Equity Accounts
Owner's Investment Owner's Withdrawal
Liability Accounts 8.000 800
Accounts Payable Unearned Revenue
+
8.000 800
400 500 2.400
200
Revenues Expenses
300 2.400
5.000 500
200
5.000 700
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Commonly Used Accounts
• Different enterprises may use different accounts ⇒ the number and
type (and name) depends on the nature of business and the size of
the enterprise
Caretaker service
9 sole proprietorship
9 one account for wage ... rather low number of accounts
expenses
9 (probably) no account for
plant and property
Automobile manufacturer
9 corporate giant ... numerous accounts
9 separate accounts for wage expenses
of, say, production and clerical workers
9 certainly (at least) one account for
plant and property 15
Some important accounts common
to most enterprises
Chart of Accounts for a Small Business
Assets Liabilities Revenues
Cash 111 Notes Payable 211 Sales 411
Notes Receivable 112 Accounts Payable 212 Commissions Earned 412
Accounts Receivable 113 Wages Payable 213
Fees Receivable 114 Unearned Revenues 231 Expenses
Office Supplies 115
Prepaid Rent 116 Owner's Equity Wages Expense 511
Prepaid Insurance 117 Utility Expense 512
Land 141 Capital 311 Telephone Expense 513
Building 142 Withdrawal 312 Insurance Expense 514
Equipment 148 Income Summary 313 Depreciation Expense, 521
Equipment
Depreciation Expense, 522
Building
• For tractability reasons, accounts are numbered!
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The Recording Process
Step 1: Journalizing
• The journal is a complete and chronological list of all transactions
that occurred.
journal is the book of original entry!
• common to have more than one kind of journal special purpose
journals, e.g. cash receipts journal or sales journal
• general journal: all transactions are recorded in this journal
• a complete entry provides the following information
– date of recording
– date of transaction
– accounts and amounts to be debited and credited
– short explanation of the transaction
– number of account (if posted) 17
ZiscoSys‘ general journal
General Journal Page 1
Date Description Post. Ref. Debit Credit
2013 1 Cash 8.000
Sept. Owner´s Investment 8.000
Personal funds transferred to
the account of ZiscoSys Simple entry
3 Equipment 4.000
Cash 4.000
Equipment bought with cash
payment Compound entry
8 Supplies 500
Cash 400
Accounts Payable 100
Purchase of supplies partially
with cash and on credit
Simple entry ⇒ one debit and credit entry Compound entry ⇒ more than one debit and/or credit entry
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Journal: the basic accounting document
• The journal contains the complete information on transactions that
enter the accounting system
– it is the basic documentation and serves as instrument of evidence in
litigation
– it is not allowed to cancel journal entries
• mistaken entries have to be reversed by a contra-entry
• In electronic accounting systems the journal is the only data base on
transactions
– the system has to assure that once an entry is made, it can no longer be
influenced or altered by anyone
– ledger accounts are „views“ of the data base that are generated online,
they are not records in their own right (Principle of data integrity: any
information is only stored once)
• the system of ledger accounts can thus be altered at any time
according to new needs for analysis
– A sufficient number of safety copies (mirror images) of the journal have
to be kept up-to-date.
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Step 2: Posting
• all accounts taken together in one file ⇒ the ledger
• process of transferring journal entries to the ledger accounts ⇒
posting
• as with journals, there may be more than one kind of ledger
• general ledger contains all accounts
general ledger
asset accounts liability accounts owner‘s equity accounts
cash notes payable owner‘s capital
accounts receivable accounts payable owner‘s withdrawal
prepaid expenses unearned revenues expenses
equipment bonds revenues
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Posting – ZiscoSys Magdeburg
General Journal Page 2
Date Description Post. Ref. Debit Credit
2013 Sept. 3 Equipment 148 4.000
Cash 111 4.000
Equipment bought with date
cash payment
General Ledger page in journal
Equipment Account No. 148
Balance
Date Item Post. Ref. Debit Credit Debit Credit
2013 Sept. 2 J1 1.000 1.000
3 J2 4.000 5.000
account numbers
General Ledger
Cash Account No. 111
Balance
Date Item Post. Ref. Debit Credit Debit Credit
2013 Sept. 1 J1 8.000 8.000
3 J2 4000 4.000
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The Trial Balance
• .... is a list of accounts and their balances at any equal point in time
• usually prepared periodically (end of accounting period)
• used to double-check equality of debits and credits
• limitations: omission errors cannot be detected!
possibly offsetting errors!
• Input to preparation of financial statements (we‘ll see that later)
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Trial Balance – ZiscoSys Magdeburg
Trial Balance
ZiscoSys Magdeburg
Trial Balance
September 30, 2013
Cash 6.500
Accounts Receivable 2.000
Equipment 4.000
Supplies 500
Prepaid Insurance 1.200
Accounts Payable 300
Unearned Revenue 2.400
Owner´s Investment 8.000
Owner´s Withdrawal 800
Revenues 5.000
Expenses 700
15.700 15.700
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