THE UNIVERSITY OF

NEW SOUTH WALES

Australian School of Business

School of Accounting
ACCT 1501: Accounting and Financial Management
1A
Week 3

The Double Entry System

Student Handout

Lecturer:
Dr. Youngdeok Lim
School of Accounting
UNSW

QUAD 3069
[email protected]

Blackboard: http://telt.unsw.edu.au.
 WEEK 3: The Double Entry System

1. Introduction
Last week we discussed the importance of the balance sheet and income statement to
managers. It is therefore critical that every manager understand the impact of transactions
on these financial reports. This week covers those skills by extending transaction analysis,
which considers the impact of specific transactions on the accounting equation. The
double entry system involving debits and credits, which forms the basis of modern
accounting, is then addressed.

Learning objectives
At the end of this topic you should be able to:

• Carry out transaction analysis and determine the impact of transactions on elements
of balance sheets and income statements
• Describe how debits and credits work in the double entry accounting system.
• Understand debits and credits in the context of transaction analysis

Required reading

Trotman, Gibbins & Carson Chapter 3

AASB: Framework for Presentation of Financial Statements (downloadable from your
course website or http://www.aasb.gov.au )

2. Tutorial Questions – Week 4

Students should attempt these questions before the tutorial.

Preparation Questions:
DQ 3.2 3.4;
P3.16, P3.18
Tutorial Questions:
DQ 3.3, 3.5, 3.7
P3.12, P3.19
Accounting and Financial
Management 1A

Week 3, Session 1, 2013

The Double Entry System

Dr. Youngdeok Lim

Quad 3069
Today’s lecture objectives:
Carry out transaction analysis and determine the impact of
transactions on elements of balance sheets and income statements

Hot: Describe how debits and credits work in the double entry
accounting system.

Understand debits and credits in the context of transaction analysis

Revisit balance sheet and income statement

Beginning period (t-1) Ending Period (t)

L t-1 Lt
A t-1 At
SE t-1 SE t
Incorporated into B/S

A t-1 = L t-1 + SE t-1 A t = L t + SE t

E R

Capture of income
R – E = Profit for the period

Retained profits: the sum of net profits earned over the life of a company less dividends
declared to shareholders
 Consolidated B/S –Woolworths Limited

As at 24 June 2012

Current Assets $5,802 M Current Liabilities $6,766 M

Noncurrent $15,779 M Noncurrent Liabilities $6,369 M

Assets
Total Liabilities $13,135 M
Equities $8,446 M

Total Assets $21,581 M Total Liabilities and $21,581 M

Equities
 Consolidated I/S –Woolworths Limited

For the 52 weeks ended on 24 June 2012

Revenue $55,268 M
- Cost of sales (Cost of goods sold) ($40,792 M)
Gross profit $14,476 M
+/- other revenue/expense ($12,659 M)
Net profit $1,817 M
Transactions

Transactions are events that affect

the operations or finances of an organisation.
Analyze each transaction from the perspective of a
company!
Accounting systems record transactions.
Business Model

Investors (e.g. banks,

shareholders)
Financing

Purchase Sale

Suppliers Company Customers

(e.g. farmers) (e.g. Woolworths) (e.g. You)

Payment Payment
(Cash/Accounts (Cash/Accounts
Payable) Investing
Receivable)

Property Plant and Equipment,

financial securities etc
 Transaction analysis

Transaction analysis involves an examination of each business

transaction with the aim of understanding its effect on the
accounting equation.

Example: Borrow $10 000 from the bank.

A liability (source) has increased Loan
An asset (resource) has increased Cash

After this transaction the accounting equation is in balance.

Let’s consider seven transactions.
Transaction 1

Issued shares for $300 000 cash.

Share capital
Cash

A = L + SE
Does the accounting equation balance?
YES! It must balance!
 Transaction 1

Issued shares for $300 000 cash.

Assets = Liabilities + Shareholders’ equity

Accounts
Receivable/ Share Retained
Cash Debtors Equipment Bank Loan Capital Profits
1 +300,000 +300,000
Transaction 2

Borrowed $50 000 cash from the bank.

Cash Bank Loan

A = L + SE
Does the accounting equation balance?
YES! It must balance!
 Transaction 2

Borrowed $50 000 cash from the bank.

Assets = Liabilities + Shareholders’ equity

Accounts
Receivable/ Share Retained
Cash Debtors Equipment Bank Loan Capital Profits
1 +300,000 +300,000
2 +50,000 +50,000
Transaction 3

Purchase equipment for $100 000 cash.

Equipment

A = L + SE
Cash

Does the accounting equation balance?

YES! It must balance!
 Transaction 3

Purchase equipment for $100 000 cash.

Assets = Liabilities + Shareholders’ equity

Accounts
Receivable/ Share Retained
Cash Debtors Equipment Bank Loan Capital Profits
1 +300,000 +300,000
2 +50,000 +50,000
3 -100,000 +100,000
Transaction 4

Signed six-month agreement to provide catering service for a

monthly fee of $2500 starting next month.

A = L + SE
What if the company received $2500 in advance for the
service to be provided in this month?
Transaction 4

Not a transaction:
no service provided.
no current right to receive.
no cash movement that needs to be recorded.
Transaction 5

Catering services provided for an office function; billed

customer for $2500.
Accounts Revenue
receivable

A = L + SE
Does the accounting equation balance?
YES! It must balance!
 Transaction 5

Catering services provided for an office function; billed

customer for $2500.

Assets = Liabilities + Shareholders' equity

Accounts
Receivable/ Share Retained
Cash Debtors Equipment Bank Loan Capital Profits
1 +300,000 +300,000
2 +50,000 +50,000
3 -100,000 +100,000
4
5 +2,500 +2,500 Revenue
Transaction 6

Customer paid $2500 they owed on their account.

Cash

A = L + SE
Accounts
receivable

Does the accounting equation balance?

YES! It must balance!
Transaction 6

Customer paid $2500 they owed on their account.

Assets = Liabilities + Shareholders’ equity

Cash Accs Equipment Bank loan Share Retained
rec. capital profits

1 +300,000 +300,000

2 +50,000 +50,000

3 -100,000 +100,000

5 +2,500 +2,500 Revenue

6 +2,500 -2,500
 Transaction 7

Paid the bank $5000 as part repayment of the loan.

A= L + SE
Cash Bank loan

Does the accounting equation balance?

YES! It must balance!
Transaction 7

Paid the bank $5000 as part repayment of the loan.

Assets = Liabilities + Shareholders’ equity
Cash Accs Equipment Bank loan Share Retained
rec. capital profits

1 +300,000 +300,000

2 +50,000 +50,000

3 -100,000 +100,000

5 +2,500 +2,500 Revenue

6 +2,500 -2,500

7 -5,000 -5,000
Transaction analysis complete
Assets = Liabilities + Shareholders’ equity
Cash Accs Equipment Bank loan Share Retained
rec. capital profits

1 +300,000 +300,000

2 +50,000 +50,000

3 -100,000 +100,000

5 +2,500 +2,500 Revenue

6 +2,500 -2,500

7 -5,000 -5,000

247,500 0 100,000 = 45,000 + 300,000 2,500

347,500 = 45,000 + 302,500

A = L + SE
Balance sheet

ASSETS LIABILITIES
Cash 247 500 Bank loan 45 000
Equipment 100 000
SHAREHOLDERS’ EQUITY
Share capital 300 000
Retained profits 2 500
347 500 347 500

Assets = Liabilities + Shareholders’ equity

Income statement

Revenue 2 500
Expense 0

Net profits 2 500

MCQ: Inventory was purchased for cash, when:

1. an asset increased and another asset decreased

2. an asset decreased and an expense increased
3. an asset decreased and a liability decreased
4. a liability increased and an expense increased
Transaction analysis: The accounting equation extended

The equation you were introduced to earlier is as follows:

Assets = Liabilities + Equity
This is extended to:
A = L + SE
CA + NCA = CL + NCL + SE
What is SE made up of?
Accounting equation, cont.

Shareholders’ equity
contributions by shareholders

Profit
revenues
expenses

Distribution to shareholders
(dividends)
 Expanding the accounting equation

A = L + SE
CA + NCA = CL + NCL + SE
Where SE:
SC + opening RP at the start of the period + RP for the period
SC + opening RP + profit – dividends
SC = Capital contributions by equity holders (share capital)
RP = Retained profits
Op RP = Opening retained profits
Profit = R – E
R = Revenue
E = Expenses
Dividends = Distributions to equity holders

CA + NCA = CL + NCL + SC + Op. RP + R – E – D

Link between the balance sheet and the income statement

Balance sheet

CA + NCA = CL + NCL + SE

CA + NCA = CL + NCL + SC + Op. RP + R – E – D

Income statement
An illustrative example: Prepare transaction analysis

LRM Ltd: Balances as at 1 April 2012

Cash 140 000
Inventory 55 000
Land and buildings 300 000
Equipment 90 000
Accounts payable 15 000
Notes payable 70 000
Loans 300 000
Share capital 200 000
Transactions for April 2012

8 Cash sales of $30 000; Cost of goods sold = $12 000.

9 Credit sales of $40 000; Cost of goods sold = $16 000.
10 $8000 payments to suppliers.
11 $20 000 wages paid for first 2 weeks of April.
12 Received invoice for $2000 for an advertisement on
April 5.
13 Received $25 000 from accounts receivable.
14 At end of month: $18 000 wages is owing for last 2
weeks of the month. Due to be paid on May 1.
 LRM Ltd: Exhibit 3.3, page 100

Accounts Land and Accounts Notes Wages Share Retained

Transaction Cash receivable Inventory building Equipment payable payable payable Loans Capital profits
Balance 140,000 0 55,000 300,000 90,000 15,000 70,000 0 300,000 200,000 0
8 30,000 30,000 Revenues
-12,000 -12,000 Expenses
9 40,000 40,000 Revenues
-16,000 -16,000 Expenses
10 -8,000 -8,000
11 -20,000 -20,000 Expenses
12 2,000 -2,000 Expenses
13 25,000 -25,000
14 18,000 -18,000 Expenses

Total 167,000 15,000 27,000 300,000 90,000 9,000 70,000 18,000 300,000 200,000 2,000
Stockholder's
Assets 599,000 Liabilities 397,000 equity 202,000

A=L+SE
LRM Ltd: Exhibit 3.4, page 101
LRM Ltd
Income statement for the month ended 30 April 2012

$ $
Sales 70 000
Cost of goods sold 28 000
Gross profit 42 000
Operating expenses
Wages 38 000
Advertising 2 000 40 000
Net profit 2 000
LRM Ltd: Exhibit 3.5, page 101
LRM Ltd

Balance sheet as at 30 April 2012

Assets Liabilities and shareholders equity

$ $
Current assets Current liabilities
Cash 167 000 Accounts payable 9 000
Accounts receivable 15 000 Notes payable 70 000
Inventory 27 000 Wages payable 18 000
209 000 97 000

Non-current assets Non-current liabilities

Land and building at 300 000 Loans 300 000
cost
Office equipment at 90 000 Total liabilities 397 000
cost
390 000
Shareholders’ equity
Share capital 200 000
Retained profit * 2 000
Total shareholders’
equity 202 000
Total liabilities and
Total assets 599 000 shareholders’ equity 599 000

* Retained profit = opening retained profits (0) + profit (2000)

– dividends declared (0) = 2000
 Double entry accounting

A = L + SE
The Golden Rule:

The accounting equation must always balance

It means Debits = Credits.

In accounting we use debit (Dr) and credit (Cr) to describe

changes in accounts
Debit–credit convention

Remember the equation:

Assets = Liabilities + Equity
We define increases in Assets to be debits (DR) –
decreases in Assets therefore must be credits (CR)
DR = CR, therefore increases in Liabilities (and Equity)
must be credits, decreases must be debits.
Basic orientation of the “double-entry bookkeeping system”

Always record on the Uses of Capital Sources of Capital Always record on the
left-hand side right-hand side

Assets (A) Liabilities (L)

Capital (SE) Simultaneous

recording of the use of
capital and the source
of capital

Expenses (+E) Revenues (+R)

Double entry system: Debit and Credit

Debit Credit
+A +L
+SE
+E +R
-L -A
-SE
-R -E
Remembering debits/credits

Type Normal Incr. Decr.

Assets Debit Debit Credit
Liabilities Credit Credit Debit
Shareholder’s equity Credit Credit Debit
Revenues Credit Credit Debit
Expenses Debit Debit Credit
Debit and credit

Company record v.s. Bank statement

Journal entries

Journal entries are, essentially, a shorthand version on

transaction analysis.
They are prepared using the rules of debit and credit.
Debits must always equal credits.
Journal entries

Example
Machinery is purchased for $10 000 cash.

Journal entry:

Dr Machinery 10 000
Cr Cash 10 000
MCQ. Identify the journal entry required to correctly record each of the
following transactions.

Cash received from accounts receivable

1. Dr Accounts Receivable Cr Cash

2. Dr Cash Cr Accounts Payable
3. Dr Cash Cr Accounts Receivable
4. none of the above
Link transaction analysis and journal entries

Back to the previous transactions.

Prepare journal entries for transaction 1-7.
Prepare journal entries for LRM ltd.
 Transaction 1-7

1: Issued shares for $300 000 cash.

2: Borrowed $50 000 cash from the bank.
3: Purchase equipment for $100 000 cash.
4: Signed six-month agreement to provide catering
service for a monthly fee of $2500 starting next month.
5: Catering services provided for an office function; billed
customer for $2500.
6: Customer paid $2500 they owed on their account.
7: Paid the bank $5000 as part repayment of the loan.
 Solution: Transaction 1-7
1.

2.

3.

4.

5.

6.

7.
LRM ltd transactions for April 2012

8 Cash sales of $30 000; Cost of goods sold = $12 000.

9 Credit sales of $40 000; Cost of goods sold = $16 000.
10 $8000 payments to suppliers.
11 $20 000 wages paid for first 2 weeks of April.
12 Received invoice for $2000 for an advertisement on
April 5.
13 Received $25 000 from accounts receivable.
14 At end of month: $18 000 wages is owing for last 2
weeks of the month. Due to be paid on May 1.
 Solution: LRM ltd case
8.

9.

10.

11.

12.

13.

14.
Wrap-Up
• Double entry system: Debit and Credit
– Debit Credit
+A +L
+SE
+E +R
-L -A
-SE
-R -E

Relationship between transaction analysis and

journal entries
A negative figure in transaction analysis implies the
abnormal side in journal entries.
Next Lecture…

Record-Keeping

Please bring comprehensive class example from

the black board.