THE ACCOUNTING EQUATION ANDDOUBLE-ENTRY BOOK-KEEPING · Book-keeping Book-keeping is the process of...

www.knust.edu.gh

Kwame Nkrumah University of

Science & Technology, Kumasi, Ghana

THE ACCOUNTING EQUATION ANDDOUBLE-ENTRY BOOK-KEEPING

www.knust.edu.gh

Book-keeping

Book-keeping is the process of recording financial transactions in

theaccounting records(the ‘books’) of an entity.

Transactionsare recorded in accounts, and thereis aseparate

account for each different type of transaction.

www.knust.edu.gh

In a manual accounting system (a system that is not computerised)individual transactionsare not recorded in the ledger accounts as they occur,

becausethis wouldbe too time-consuming. Instead, they are recorded initially in books ofprime entry, or books of original entry. They are

transferred at a later time from thebooks ofprime entry to the accounts in the ledgers.

Thebooks of original entryare:

i. asales day book, for recording sales on credit (receivables) from salesinvoices

ii. asales returns day book, for recording items returned by creditcustomers (creditnotes issued to customers)

iii. apurchases day book, for recording purchases on credit from suppliers (trade payables) from purchaseinvoices

iv. apurchases returns day bookfor recording returns of purchases oncredit

v. acash book, for recording cash received into the business bank account andcash paidout of the bankaccount

vi. apetty cash book, for recording transactions relating to petty cash: pettycash consistsof notes and coins held by a business to pay for

smallincidental expensessuch as bus or taxi fares, or coffee and milk for theoffice

vii. ajournalfor recording transactions that are not recorded in any of theother booksof original entry.

BOOKS OF PRIME ENTRY (ORIGINAL ENTRY)

www.knust.edu.gh

Thesales day bookisthe bookof prime entry for credit sales. The sales day book is used to keep a list of all invoices sent to customers each day.

An extract from the sales day book might look like this.

SALES DAY BOOK

DateInvoiceCustomerTotalAmount Invoiced

20X0GHS

Jan 10247Asamoah& Co105.00

248OforiCo86.40

249Koree& Co 31.80

250Penton College1,264.60

1,487.80

THE SALES DAY BOOK

www.knust.edu.ghwww.knust.edu.gh

Most businesses ‘analyze’ their sales. For example this business sells boots and shoes. The sale toOforiCo was

entirely boots, the sale toKoree& Co was entirely shoes and the other two sales was a mixture of both.

SALES DAY BOOK

DateInvoice CustomerTotalAmount InvoicedBook sales Shoesales

20X0GHSGHSGHS

Jan10 247Asamoah& Co105.0060.0045.00

248OforiCo86.4086.40-

249Koree& Co31.80-31.80

250PentonCollege1,264.60800.30464.30

1,487.80946.70541.10

Theanalysis gives the managers of the business useful information which helps them to decide how best to run

the business.


Abusiness also keeps a record of the purchase day book of all the invoices it receives. The

purchase day book is a book of prime entry for credit purchases.Anextract from a purchase

day book might look like this.

PURCHASE DAY BOOK

DateSupplierTotalAmount Invoiced PurchasesElectricityetc.

20X8GHSGHSGHS

Mar 15Cook& Co315.00315.00 -

Acheampong29.4029.40-

EEB116.80-116.80

ShowFair Co100.00100.00- .

561.20444.40116.80

THE PURCHASE DAY BOOK


Note that:

There is no 'invoice number' column, because the purchase day book

records other people's invoices, which have all sorts of different numbers.

Like the sales day book, the purchase day book analyses the invoices

which have been sent in. In this example, three of the invoices related to

goods which the business intends to re-sell (calledsimply 'purchases') and

the other invoice was an electricity bill.


Whencustomers return goods for some reason, a credit note is raised. All credit notes are recorded in the

sales returns day book. An extract from the sales returns day book follows.

SALES RETURNS DAY BOOK

Date Credit note Customer and goods Amount

20X8GHS

30 AprilCR008MOppong

3pairs boots 135.00

THE SALES RETURNS DAY BOOK

The sales returns day book is the book of prime entry for credit notes raised.

Not all sales returns day books analyze what goods were returned, but it makes sense to keep as complete a

record as possible. Where a business has very few sales returns, it may record a credit note as a negative

entry in the sales day book.


Thepurchases returns day book is a book of prime entry for credit notes received from

suppliers. Not surprisingly, the purchase returns day book records credit notes received in

respect of goods which the business sends back to its suppliers.

An extract from the purchase returns day book follows.

PURCHASE RETURNS DAY BOOK

DateSupplierand goods Amount

20X8GHS

29 April Boxes Co

300 cardboard boxes46.60

Once again, a business with very few purchases returns may record a credit note received as

a negative entry in the purchase day book.

THE PURCHASE RETURNS DAY BOOK

www.knust.edu.gh

Cashbook

The cash book may be a manual record or a computer file. It records all transaction that go through the bank account.

The cash book is also a day book, used to keep a record of money received and money paid out by the business. The

cash book deals with money paid into and out of the business bank account. This could be money received on the

business premises in notes, coins and cheques, subsequently paid into the bank. There are also receipts and payments

made by bank transfer, standing order, direct debit and bank interest and charges, directly by the bank.

• Some cash, in notes and coins, is usually kept on the business premises in order to make occasional payments for

odd items of expense. This cash is usually accounted for separately in a petty cash book.

• One side (the left) of the cash book is used to record receipts of cash, and the other side (the right) is used to

record payments. The best way to see how the cash book works is to follow through an example. For convenience,

we are showing the cash receipts and cash payments sides separately, but they are part of the same book.


Example: Cash book

At the beginning of 1 September, Robin Plenty had GHS900 in the bank.

During 1 September 20X7, Robin Plenty had the following receipts and payments.

(a) Cash sale: receipt of GHS80

(b) Payment from credit customer Hay GHS400 less discount allowed GHS20

(c) Payment from credit customer Been GHS720

(d) Payment from credit customer Seed GHS150 less discount allowed GHS10

(e) Cheque received from Len Dinger GHS1,800 to provide a short-term loan

(f) Second cash sale: receipt of GHS150

(g) Cash received for sale of machine GHS200

(h) Payment to supplier Kew GHS120

(i) Paymentto supplier Hare GHS310

(j) Payment of telephone bill GHS400

(k) Payment of gas bill GHS280

(l) GHS100 in cash withdrawn from bank for petty cash

(m) Payment of GHS1,500 to Hess for new plant and machinery

If you look through these transactions, you will see that seven of them are receipts and six of them are payments.


CASH BOOK (RECEIPTS)

Date NarrativeTotal

20X7GHS

1 Sept Balance b/d*900

Cashsale80

Accountsreceivable: Hay 380

Accountsreceivable: Been 720

Accountsreceivable: Seed 140

Loan: Len Dinger1,800

Cashsale150

Saleof non-current asset200

4,370

* 'b/d' = brought down (i.e. brought forward)

The receipts part of the cash book for 1 September would look like this.


There is space on the right hand side of the cash book so that the receipts can be

analyzed under various headings – for example, 'cash from receivables', 'cash sales'

and 'other receipts'.

The cash received in the day amounted to GHS3,470. Added to the GHS900 at the

start of the day, this comesto GHS4,370. This is not the amount to be carried forward

to the next day, because first we have to subtract all the payments made during 1

September.


The payments part of the cash book for 1 September would look like this.

CASH BOOK (PAYMENTS)

Date NarrativeTotal

20X7GHS

1 SeptAccountspayable: Kew120

Accounts payable: Hare310

Telephone400

Gas bill280

Petty cash100

Machinery purchase1,500

Balance c/d (balancing figure)1,660

4,370


As you can see, this is very similar to the receipts part of the cash book. The only points to

note are as follows.

The analysis on the right would be under headings like 'payments to payables,

'payments into petty cash', 'wages' and 'other payments'.

Payments during 1 SeptembertotalledGHS2,710. We know that the total of receipts was

GHS4,370. That means that there is a balance of GHS4,370 – GHS2,710 = GHS1,660 to

be 'carried down' to the start of the next day. As you can see this 'balance carried

down' is noted at the end of the payments column, so that the receipts and payments

totals show the same figure of GHS4,370 at the end of 1 September.


With analysis columns completed, the cash book given in the examples above might look as follows.

CASH BOOK (RECEIPTS)

Accounts Cash

Date NarrativeTotalreceivable sales Other

20X7GHSGHSGHSGHS

1 Sept Balance b/d 900

Cash sale8080

Accounts receivable: Hay380380

Accounts receivable:Been720 720

Accounts receivable: Seed140140

Loan: Len Dinger1,8001,800

Cash sale150150

Sale of non-current asset200_______200

4,3701,2402302,000


CASH BOOK (PAYMENTS)

Accounts Petty

Date NarrativeTotalPayableCashWagesOther

GHSGHSGHSGHSGHS

20X7

1 SeptAccountpayable: Kew120120

Account payable: Hare310 310

Telephone400400

Gasbill280280

Pettycash 100100

Machinerypurchase 1,5001,500

Balancec/d1,660_____________

4,370430100-2,180

www.knust.edu.gh

Most businesses keep petty cash on the premises, which is topped up from the main bank account. Under the imprest system, the petty cash is kept at an agreed sum, so that each topping up is equal to the amount paid out in the period.

Mostbusinesses keep a small amount of cash on the premises to make occasional small payments in cash, e.g. staff refreshments, postage stamps, to pay the office cleaner, taxi fares, etc. This is often called the cash float or petty cash account. The cash float can also be the resting place for occasional small receipts, e.g. cash paid by a visitor to make a phone call, etc.

PETTY CASH


Underwhat is called the imprest system, the amount of money in petty cash is kept at an agreed sum or 'float' (say

GHS250). This is called the imprest amount. Expense items are recorded on vouchers as they occur, so that at any

time:

GHS

Cash still held in petty cash 195

Plus voucher payments (25+5+10+15)55

Must equal the imprest amount250

The total float is made up regularly (to GHS250, or whatever the imprest amount is) by means of a cash payment

from the bank account into petty cash. The amount of the 'top-up' into petty cash will be the total of the voucher

payments since the previous top-up.

IMPREST SYSTEM


A typical layout follows.

PETTY CASH BOOK

Receipts Date Narrative Total MilkPostageTravel Other

GHS 20X7GHSGHSGHSGHSGHS

250 1 Sept Bal b/d

Milkbill2525

Postagestamps 55

Taxifare1010

Flowersfor sick

staff1515

___Balc/d195_______

2502502551015

www.knust.edu.gh

Accountsand ledgers

There are accountsfor:

i. eachtype of asset, liability, income and expense, and accounts for theowners’ capital

ii. eachcustomer who purchases goods or services oncredit

iii. eachsupplier from which goods or services are bought oncredit.


Accounts are kept together in aledger. A ledger is a term meaning a collection of related accounts. There are

usually three ledgers in a financial accounting system:

1. Themain ledger, usually called either thenominal ledgeror thegeneralledger. Thisledger contains the

accounts for:

i. assets, liabilities andcapital

ii. incomeand expenses.

2. Thereceivables ledger, which contains the accounts for each customer who is sold items on credit. Each

receivables account shows how much the individual customer has purchased on credit, details of sales returns

(i.e. any credit notes), how much he has paid and what he currently owes.

3. Thepayables ledger, which contains the accounts for each supplier of goods or services on credit. Each

trade payables account shows how much the entity has bought on credit from a particular supplier, details of

purchase returns, how much it has paid and what it currently owes to the supplier.

www.knust.edu.gh

POSTING TRANSACTIONS FROM THE BOOKS OF PRIME ENTRY TO THE LEDGERACCOUNTS

The process of transferring the details of transactions from the books of primeentry tothe accounts in the ledgers is sometimes called ‘posting’ the transactions. Itis doneas follows.

From the sales day book (or sales returns day book)to:

i. themain ledgerand

ii.thereceivablesledger

Detailsof sales on credit (and also details of any credit notes for sales returns)are postedfrom the sales day book (or sales returns day book) to two ledgers. Thetotal valueof sales (or total value of sales returns) is recorded in the main ledger intwo accounts, the sales account and the account for total receivables, to reflect thedual natureof the transaction. Details of each individual sales transaction withcredit customersare also posted to the personal account for the customer, which is keptin thereceivables ledger.

www.knust.edu.gh

Sales day book/

sales returns day book

Main Ledger

1. Sales account or sales returns

account and

2. 2. Total receivables account (main

ledger )

Receivables ledger

Individual accounts of the customers

Total value of

transactions

Individual

transactions

SALES ON CREDIT/SALES RETURNS

www.knust.edu.gh

Suppose that a sales day book contains the following three transactions that havenot yetbeen posted to the ledger accounts.

Ifthese transactions are posted to theledgers:

• Salesof $750 will be recorded in themain ledger, both as $750 of sales and $750 ofmoney now owed by customers (trade receivables).

• Inthereceivables ledger,sales on credit of $250 will be recorded in theindividual account for Entity Green, sales of $100 in the account for P Roseand salesof $400 in the account for Yellow Company.

EXAMPLE

Customer Saleson credit/amount owed by customer

$

Entity Green 250

P Rose 100

Yellow Company 400

750

www.knust.edu.gh

From the purchases day book (or purchase returns day book) to

i. the main ledgerand

ii. thepayablesledger

Detailsof purchases of goods on credit (and also details of any credit notesfrom suppliersfor purchase returns) are posted from the purchases day book (or purchasereturns day book) to two ledgers.

Thetotal value of purchases (ortotalvalueof purchase returns) is recorded in the main ledger in two accounts,the purchasesaccount and the account for total trade payables, to reflect the dualnature ofthe transaction.

Detailsof each individual purchase transaction with suppliersare alsoposted to the personal account for the supplier, which is kept in thepayables ledger.

www.knust.edu.gh

Purchases day book/

Purchases returns day book

Main Ledger

1. Purchases account or Purchase

returns account and

2. 2. Total Payables account (main

ledger )

Payables ledger

Individual accounts of the

suppliers

Total value of

transactions

Individual

transactions

PURCHASES ON CREDIT/ PURCHASES RETURNS

www.knust.edu.gh

The purchase ledger is also used to record purchase invoices from suppliers ofother items, as well as purchases of goods. For example the purchase ledger is usedto recorddetails of invoices for rental costs of buildings or equipment, and invoicesfor telephoneexpenses and electricity and gas supplies.

Details of these expenses are posted from the purchases ledger to the mainledger, andthe accountsfor:

i. therelevant expense,and

ii. totaltrade payables.

Detailsof each individual invoice are also posted to the account of theindividual supplierin the payables ledger.

www.knust.edu.gh

Fromthe cash book to

i. themain ledger and

ii. thereceivables or payables ledger

Thecash book in a manual accounting system is often used as both a book ofprime entryand as an account in the main ledger. However it might be convenient tothink ofthe cash book as a book of prime entry and a different account, the bankaccount, asan account in the main ledger.

Thecash book has two sides, a side for receipts of money and a side for payments.

Detailsof cash received are posted to the main ledger, where the dual nature ofthe transactionis recorded. For example money received from a credit customeris recordedas an addition to money in the bank and a reduction in tradepayables. Moneyreceived for a cash sale is recorded as an addition to money in the bankand anincrease in total revenue from cashsales. Ifthe cash is received from a credit customer, the details of the money receivedare alsorecorded in the customer’s personal account in the receivables ledger.

www.knust.edu.gh

CASH RECEIVED/PAID

Cashpayments are recorded in a similar way to cash receipts. Payments arerecorded in both the main ledger and (if the payment is to a supplier) in theaccount ofthe supplier in the payables ledger.

www.knust.edu.gh

Example

Suppose that the cash book (payments side) contains the following transactionsthat havenot yet been posted to the ledgers.

Thesetransactions are posted to the ledgers as follows:

• Paymentsof $1,000 will be recorded in the main ledger, both as paymentsof $1,000from the bank account and $1,000 of money paid to suppliers (tradepayables).

• Inthe payables ledger, a payment of $300 will be recorded in theindividual accountfor Sepia Company, a payment of $150 in the account for G Red anda paymentof $550 in the account for Blue Company.

Supplier Cash payment to the supplier

$

Sepia Company 3,00

G Red 150

Blue Company 550

1,000

www.knust.edu.gh

Financial transactions are recorded in the accounts in accordance with a set ofrules orconventions. The following rules apply to the accounts in the mainledger (nominalledger or general ledger).

i. Everytransaction is recorded twice, as a debit entry in one account and asa creditentry in anotheraccount.

ii. Totaldebit entries and total credit entries must always be equal. Thismaintains theaccounting equation.

iii. Ittherefore helps to show accounts in the shape of a T, with a left-hand and aright handside. By convention:

a. debitentries are made on the left-hand sideand

b. creditentries are on the right-hand side.

DEBIT AND CREDIT ENTRIES, AND T ACCOUNTS

www.knust.edu.gh

Account Name

Debit Side $ Credit side $

Debit transactions

entered on this sideAmount

Credit transactions

entered on this sideAmount

Enter reference to the

account where the

matching credit entry

is made

XX

Enter reference to the

account where the

matching debit entry is

made

XX

www.knust.edu.gh

Therules of debits and credits

In the main ledger, there are accounts for assets, liabilities, equity, income andexpenses. The rules about debits and credits are as follows.

Debit Side Credit Side

Record as a debit entry: Record as a credit entry:

An increase in an asset An increase in a liability

(asset account) (liability account)

An increase in an expense An increase in income

(expense account) (income account for example, sales in the sales account)

An increase in capital

(capital account: for example profit or new capital introduced to the business

Record as a debit entry: Record as a credit entry:

A reduction in a liability A reduction in asset

(liability account) (asset account)

A Reduction in income (for example, a debit In the sales

returns account )

A reduction in an expense (expense account: for example, purchase returns are

a debit in the purchase returns account, because they reduce the cost of

purchases)

www.knust.edu.gh

Forexample, if a purchase invoice is received for electricity charges for $2,300,the doubleentry is (ignoring sales tax):

• Debit: Electricity charges (= increase inexpense)

• Credit: Total trade payables (= increase in liability)

Therules of double entry apply only to the main ledger and not to thereceivables ledgeror payables ledger, because there are accounts for total receivables andtotal payablesin the main ledger. Transactions recorded in individual customeraccounts inthe receivables ledger or in individual supplier accounts in the payablesledger areentered in just one side of the appropriate individual customer orsupplier account.

Dr and CrBy convention, the terms ‘debit’ and ‘credit’ are sometimes shortened to ‘Dr’and ‘Cr’ respectively.

www.knust.edu.gh

Double entry book-keeping and the cash account

It might help to learn the rules of double entry by remembering thattransactions involvingthe receipt or payment of cash into the bank account are recordedas follows:

• TheCash account, also called the Bank account, is an asset account (moneyin thebank is an asset).

• Receiptsof cash: These are recorded as a debit entry in the Cash account orBank account, because receipts add to cash (an asset).

• Paymentsof cash. Payments reduce cash, so these are recorded as a creditentry inthe Cash account or Bank account.

www.knust.edu.gh

Debit Side Credit Side

Record as a debit entry:

Record as a credit entry:

Transactions that provide anINCREASEin cash Transactions that results in aREDUCTIONin cash

The matching credit entry might be to

The matching debit entry might be to

(1) A sales account, for cash sales,) expenses (1) an expense account, for payments of cash

(2) The total trade receivables account, for payments

received from credit customers

(2) The total trade payables account, for payments to suppliers for purchases

on credit/amounts owing,

(3) The capital account (for new capital introduced by the

owner in the form of cash)(3) A payment in cash for a new asset

(4) A drawings account, for withdrawal of profit by the business owner


EXAMPLE

Transaction 1: Sam sets up a business by putting $5,000 into a bank account.

Transaction 2: Sam purchases goods for $4,000, paying $1,000 in cash andbuying

$3,000of goods on credit.

Transaction 3. Sam sells goods for $6,000. $2,000 of these sales are in cash and the

other $4,000 are on credit.

Transaction 4. Sam purchases some equipment for the business, costing $3,000.He

paysby cheque.

Transaction 5. Sam pays rent of $1,000 for six months, for office accommodation.

Rent is an expense.

www.knust.edu.gh

Example

This increases the cash of the business, and its capital.

Notes:(a) The entry in each account shows the other account where the matchingdebit orcredit entry appears.(b) The numbers are included for illustrative purposes only, to help you to matchthe debit and credit entry for each transaction.

Capital Account

$ $

(1) Bank 5,000

Bank Account

$ $

Capital 5,000

www.knust.edu.gh

Total purchases are an addition to expenses (purchases). The purchases reducecash by$1,000 and increase trade payables by $3,000.

Thepurchases account is an expense account and the trade payables account isa liabilityaccount.

Bank Account

$ $

Capital 5,000 Purchases 1,200

Purchases Account

$ $

Bank1,000

Tradepayables3,000

Trade Payables Account

$ $

Purchases 3,000

www.knust.edu.gh

Total sales (income) are $6,000, and the sales result in an increase in total assetsof $6,000, consisting of cash ($2,000) and trade receivables ($4,000).

Bank Account

$ $


(3a) Sales 2,000

Receivables Account

$ $

(3b) Sales 4,000

2,000

Sales Account

$ $

(3a) Bank 2,000

(3b) Receivables 4,000

www.knust.edu.gh

This transaction adds to the non-current assets of the business, and reduces cash. An increase in one asset (equipment) is therefore matched by a reduction in another asset (cash).

Bank Account

$ $


Sales 2,000 (4) Equipment 3,000

Equipment Account

$ $

(4) Bank 3,000

www.knust.edu.gh

Therental cost adds to expenses and reduces cash.

BankAccount

$ $


Sales 2,000 Equipment 3,000

Rent 1,000

Rent Account

$ $

Bank 1,000 Purchases 1,000


Account balances and a trial balance

Atany time, the balance on an account can be established. The balance

onan accountis the difference between the total value of debit entries and

the totalvalue ofcreditentries.

• Iftotal debits exceed total credits, there is a debitbalance

• Iftotal credits exceed total debits there is a credit balance.

www.knust.edu.gh

Debit Balances $ Credit Balances $

Bank 2,000 Capital 5,000

Purchases 4,000 Trade Payables 3,000

Receivables 4,000 Sales 6,000

Equipment 3,000

Rent 1,000

14,000 14,000

Example

Total debit balances and total credit balances should always be equal. A list of the debit and credit balances in the main

ledger accounts is called atrial balance.

At any time, it should be possible to ‘extract’ a trial balance from the main ledger, and prepare a list of debit balances

and credit balances. If the accounts have been prepared correctly, total debit balances and total credit balances must be

equal.

www.knust.edu.gh

Atthe end of an accounting period, an account is closed off. On manyaccounts (particularlyasset, liability and capital accounts), there will be abalance.

• Balanceson expense accounts and income accounts are transferred to theincome statement.

• Balanceson the asset, liability and capital accounts are carried forwardas closingbalances at the end of the period, and become opening balances atthe beginningof the next period.

Toclose off an account, the closing balance is entered in the T account so thattotal debitsand total credits are equal. The debit and credit columns are then totalledand aline drawn underneath the entries. Below the line, the opening balance forthe beginningof the next period is entered.

Closing balance and opening balance

www.knust.edu.gh

Inthis example, there is a debit balance on the bank account at the end of theperiod. Theclosing balance to carry

forward is entered on the credit side, so that total debits and total credits add up to $7,000. The debit balance of

$2,000 is brought forward as the opening balance on the account at the beginning of the next period.Thisindicates

that the business has an asset (a debit balance) of cash in the bank account totalling $2,000.

Bank account

$ $


Sales 2,000 Equipment 3,000

Balance c/d 1,500 Rent 1,000

9,000 closing bal c/f 2,000

7,000 7,000

Opening balance b/f 2,000

www.knust.edu.gh

NOTEc/fstands for carried forward.

Youmight alsosee:

• c/fwd(for carried forward),or

• c/dfor ‘carried down’.

Similarly,b/fstands for brought forward.

Youmight also see:

• b/fwd(for brought forward),or

• b/dfor ‘brought down’.

Asimilar method of carrying forward the closing balance is used forliability accountssuch as trade payables, and the capital account. When the tradepayablesaccountbelow isbalancedthere is a closing balance of $1,500 indicating that $1,500is payableto suppliers in total – this is a credit balance as it is a liability.


Trade payables account

$ $



Balance c/d 1,500 Purchases 4,000

9,000 9,000

Balance b/d 1,500


ENDOF LECTURE

THANK YOU

THE ACCOUNTING EQUATION ANDDOUBLE-ENTRY BOOK-KEEPING · Book-keeping Book-keeping is the process of...

Documents

Transcript of THE ACCOUNTING EQUATION ANDDOUBLE-ENTRY BOOK-KEEPING · Book-keeping Book-keeping is the process of...