Debits and credits

Double-entry bookkeeping is governed by the accounting equation. If revenue equals expenses, the following (basic) equation must be true:assets = liabilities + equity

For the accounts to remain in balance, a change in one account must be matched with a change in another account. These changes are made by debits and credits to the accounts. Note that the usage of these terms in accounting is not identical to their everyday usage. Whether one uses a debit or credit to increase or decrease an account depends on the normal balance of the account. Assets, Expenses, and Drawings accounts (on the left side of the equation) have a normal balance of debit. Liability, Revenue, and Capital accounts (on the right side of the equation) have a normal balance of credit. On a general ledger, debits are recorded on the left side and credits on the right side for each account. Since the accounts must always balance, for each transaction there will be a debit made to one or several accounts and a credit made to one or several accounts. The sum of all debits made in each day’s transactions must equal the sum of all credits in those transactions. After a series of transactions, therefore, the sum of all the accounts with a debit balance will equal the sum of all the accounts with a credit balance.

Debits and credits are numbers recorded as follows:

  • Debits are recorded on the left side of a T account in a ledger. Debits increase balances in asset accounts and expense accounts and decrease balances in liability accounts, revenue accounts, and capital accounts.
  • Credits are recorded on the right side of a T account in a ledger. Credits increase balances in liability accounts, revenue accounts, and capital accounts, and decrease balances in asset accounts and expense accounts.
  • Debit accounts are asset and expense accounts that usually have debit balances, i.e. the total debits usually exceed the total credits in each debit account.
  • Credit accounts are revenue (income, gains) accounts and liability accounts that usually have credit balances.

The mnemonic DEADCLIC is used to help remember the effect of debit or credit transactions on the relevant accounts. DEADDebit to increase Expense, Asset and Drawing accounts and CLICCredit to increase Liability, Income and Capital accounts.

The account types are related as follows:
current equity = sum of equity changes across time (increases on the left side are debits, and increases on the right side are credits, and vice versa for decreases)
current equity = Assets – Liabilities
sum of equity changes across time = owner’s investment (Capital above) + Revenues – Expenses

Books of accounts

Each financial transaction is recorded in at least two different nominal ledger accounts within the financial accounting system, so that the total debits equals the total credits in the general ledger, i.e. the accounts balance. This is a partial check that each and every transaction has been correctly recorded. The transaction is recorded as a “debit entry” (Dr) in one account, and a “credit entry” (Cr) in a second account. The debit entry will be recorded on the debit side (left-hand side) of a general ledger account, and the credit entry will be recorded on the credit side (right-hand side) of a general ledger account. If the total of the entries on the debit side of one account is greater than the total on the credit side of the same nominal account, that account is said to have a debit balance.

Double entry is used only in nominal ledgers. It is not used in daybooks (journals), which normally do not form part of the nominal ledger system. The information from the daybooks will be used in the nominal ledger and it is the nominal ledgers that will ensure the integrity of the resulting financial information created from the daybooks (provided that the information recorded in the daybooks is correct).

The reason for this is to limit the number of entries in the nominal ledger: entries in the daybooks can be totalled before they are entered in the nominal ledger. If there are only a relatively small number of transactions it may be simpler instead to treat the daybooks as an integral part of the nominal ledger and thus of the double-entry system.

However, as can be seen from the examples of daybooks shown below, it is still necessary to check, within each daybook, that the postings from the daybook balance.

The double entry system uses nominal ledger accounts. From these nominal ledger accounts a trial balance can be created. The trial balance lists all the nominal ledger account balances. The list is split into two columns, with debit balances placed in the left hand column and credit balances placed in the right hand column. Another column will contain the name of the nominal ledger account describing what each value is for. The total of the debit column must equal the total of the credit column.

Journals & Ledgers

Journals

Journals are recorded in the general journal daybook. A journal is a formal and chronological record of financial transactions before their values are accounted for in the general ledger as debits and credits. A company can maintain one journal for all transactions, or keep several journals based on similar activity (e.g., sales, cash receipts, revenue, etc.), making transactions easier to summarize and reference later. For every debit journal entry recorded, there must be an equivalent credit journal entry to maintain a balanced accounting equation.

Ledgers

ledger is a record of accounts.The ledger is a permanent summary of all amounts entered in supporting Journals which list individual transactions by date. These accounts are recorded separately, showing their beginning/ending balance. A journal lists financial transactions in chronological order, without showing their balance but showing how much is going to be charged in each account. A ledger takes each financial transaction from the journal and records it into the corresponding account for every transaction listed. The ledger also sums up the total of every account, which is transferred into the balance sheet and the income statement. There are three different kinds of ledgers that deal with book-keeping:

  • Sales ledger, which deals mostly with the accounts receivable account. This ledger consists of the records of the financial transactions made by customers to the business.
  • Purchase ledger is the record of the purchasing transactions a company does; it goes hand in hand with the Accounts Payable account.

Daybooks & Petty cash book

Daybooks

daybook is a descriptive and chronological (diary-like) record of day-to-day financial transactions; it is also called a book of original entry. The daybook’s details must be transcribed formally into journals to enable posting to ledgers. Daybooks include:

  • Sales daybook, for recording sales invoices.
  • Sales credits daybook, for recording sales credit notes.
  • Purchases daybook, for recording purchase invoices.
  • Purchases debits daybook, for recording purchase debit notes.
  • Cash daybook, usually known as the cash book, for recording all monies received and all monies paid out. It may be split into two daybooks: a receipts daybook documenting every money-amount received, and a payments daybook recording every payment made.
  • General Journal daybook, for recording journal entries.

Petty cash book

petty cash book is a record of small-value purchases before they are later transferred to the ledger and final accounts; it is maintained by a petty or junior cashier. This type of cash book usually uses the imprest system: a certain amount of money is provided to the petty cashier by the senior cashier. This money is to cater for minor expenditures (hospitality, minor stationery, casual postage, and so on) and is reimbursed periodically on satisfactory explanation of how it was spent.

Double-entry bookkeeping system

Double-entry bookkeeping, in accounting, is a system of bookkeeping so named because every entry to an account requires a corresponding and opposite entry to a different account. The double entry has two equal and corresponding sides known as debit and credit. The left-hand side is debit and right-hand side is credit. For instance, recording a sale of $100 might require two entries: a debit of $100 to an account named “Cash” and a credit of $100 to an account named “Revenue.”

The accounting equation

{\displaystyle {\text{Assets}}={\text{Equity}}+{\text{Liabilities}}}

is an error detection tool; if at any point the sum of debits for all accounts does not equal the corresponding sum of credits for all accounts, an error has occurred. However, satisfying the equation does not guarantee that there are no errors; the ledger may still “balance” even if the wrong ledger accounts have been debited or credited.

Double-entry bookkeeping was pioneered in the Jewish community of the early-medieval Middle East. Jewish bankers in Old Cairo, for example, used a double-entry bookkeeping system which predated the known usage of such a form in Italy, and whose records remain from the 11th century AD. It has been hypothesized that Italian merchants likely learned the method from their interaction with medieval Jewish merchants from the Middle East, but this question remains an area for further research. The oldest European record of a complete double-entry system is the Messari (Italian: Treasurer’s) accounts of the Republic of Genoa in 1340. The Messari accounts contain debits and credits journalised in a bilateral form, and include balances carried forward from the preceding year, and therefore enjoy general recognition as a double-entry system. By the end of the 15th century, the bankers and merchants of Florence, Genoa, Venice and Lübeck used this system widely.

However, the double-entry accounting method was said to be developed independently earlier in Korea during the Goryeo dynasty (918–1392) when Kaesong was a center of trade and industry at that time. The Four-element bookkeeping system was said to be originated in the 11th or 12th century.

The earliest extant accounting records that follow the modern double-entry system in Europe come from Amatino Manucci, a Florentine merchant at the end of the 13th century. Manucci was employed by the Farolfi firm and the firm’s ledger of 1299-1300 evidences full double-entry bookkeeping. Giovannino Farolfi & Company, a firm of Florentine merchants headquartered in Nîmes, acted as moneylenders to the Archbishop of Arles, their most important customer. Some sources suggest that Giovanni di Bicci de’ Medici introduced this method for the Medici bank in the 14th century.

Ragusan economist Benedetto Cotrugli’s 1458 treatise Della mercatura e del mercante perfetto contained the earliest known description of a double-entry bookkeeping system, but his manuscript was not officially published until 1573.

Luca Pacioli, a Franciscan friar and collaborator of Leonardo da Vinci, first codified the system in his mathematics textbook Summa de arithmetica, geometria, proportioni et proportionalitàpublished in Venice in 1494. Pacioli is often called the “father of accounting” because he was the first to publish a detailed description of the double-entry system, thus enabling others to study and use it.

In pre-modern Europe, double-entry bookkeeping had theological and cosmological connotations, recalling “both the scales of justice and the symmetry of God’s world”.

Single-entry bookkeeping system

single-entry bookkeeping system or single-entry accounting system is a method of bookkeeping relying on a one sided accounting entry to maintain financial information.

Overview

Most businesses maintain a record of all transactions based on the double-entry bookkeeping system. However, many smaller businesses maintain only a single-entry system that records the “bare-essentials.” In some cases, only records of cash, accounts receivable, accounts payable and taxes paid may be maintained.

This type of accounting system with additional information can typically be compiled into an income statement and statement of affairs by a professional accountant.

Advantages

Single-entry systems are used in the interest of simplicity. If a double-entry system is needed, then the services of a trained person are often required.

According to the U.S.A. Internal Revenue Service: A single-entry system is based on the income statement (profit or loss statement). It can be a simple and practical system if you are starting a small business.

Additionally, in the U.S.A. stated:

  1. The single entry system of record keeping does not include equal debit and credit to the balance sheet and income statement accounts. A single-entry accounting system is not self-balancing. Mathematical errors in the account totals are thus common. Reconciliation of the books and records to the return is an important audit step.
  2. A single-entry system may consist only of transactions posted in a notebook, daybook, or journal. However, it may include a complete set of journals and a ledger providing accounts for all important items.
  3. A single-entry system for a small and ledgers showing debit and credit balances.

Disadvantages

  1. Data may not be available to management for effectively planning and controlling the business.
  2. Lack of systematic and precise bookkeeping may lead to inefficient administration and reduced control over the affairs of the business.
  3. Single-entry record administration of those assets may occur.
  4. Theft and other losses are less likely to be detected.

Entry systems Of Bookkeeping

Two bookkeeping methods in most common use today are the single-entry bookkeeping system and the double-entry bookkeeping system. Single-entry bookkeeping is adequate for many small businesses; it uses only income and expense accounts recorded primarily in a revenue and expense journal. In the double-entry system, at least two accounting entries are required to properly document each financial transaction. These entries may be recorded to asset, liability, equity, expense, or revenue accounts.

Single-entry system

The primary bookkeeping record in single-entry bookkeeping is the cash book, which is similar to a checking account register (in UK: cheque account, current account), except all entries are allocated among several categories of income and expense accounts. Separate account records are maintained for petty cash, accounts payable and receivable, and other relevant transactions such as inventory and travel expenses. To save time and avoid the errors of manual calculations, single-entry bookkeeping can be done today with do-it-yourself bookkeeping software.

Double-entry system

double-entry bookkeeping system is a set of rules for recording financial information in a financial accounting system in which every transaction or event changes at least two different nominal ledger accounts.

Process Of Bookkeeping

The bookkeeping process primarily records the financial effects of transactions. An important difference between a manual and an electronic accounting system is the former’s latency between the recording of a financial transaction and its posting in the relevant account. This delay, which is absent in electronic accounting systems due to nearly instantaneous posting to relevant accounts, is characteristic of manual systems, and gave rise to the primary books of accounts—cash book, purchase book, sales book, etc.—for immediately documenting a financial transaction.

In the normal course of business, a document is produced each time a transaction occurs. Sales and purchases usually have invoices or receipts. Deposit slips are produced when lodgements (deposits) are made to a bank account. Checks (spelled “cheques” in the UK and several other countries) are written to pay money out of the account. Bookkeeping first involves recording the details of all of these source documents into multi-column journals (also known as books of first entry or daybooks). For example, all credit sales are recorded in the sales journal; all cash payments are recorded in the cash payments journal. Each column in a journal normally corresponds to an account. In the single entry system, each transaction is recorded only once. Most individuals who balance their check-book each month are using such a system, and most personal-finance software follows this approach.

After a certain period, typically a month, each column in each journal is totalled to give a summary for that period. Using the rules of double-entry, these journal summaries are then transferred to their respective accounts in the ledger, or account book. For example, the entries in the Sales Journal are taken and a debit entry is made in each customer’s account (showing that the customer now owes us money), and a credit entry might be made in the account for “Sale of class 2 widgets” (showing that this activity has generated revenue for us). This process of transferring summaries or individual transactions to the ledger is called posting. Once the posting process is complete, accounts kept using the “T” format undergo balancing, which is simply a process to arrive at the balance of the account.

As a partial check that the posting process was done correctly, a working document called an unadjusted trial balance is created. In its simplest form, this is a three-column list. Column One contains the names of those accounts in the ledger which have a non-zero balance. If an account has a debit balance, the balance amount is copied into Column Two (the debit column); if an account has a credit balance, the amount is copied into Column Three (the credit column). The debit column is then totalled, and then the credit column is totalled. The two totals must agree—which is not by chance—because under the double-entry rules, whenever there is a posting, the debits of the posting equal the credits of the posting. If the two totals do not agree, an error has been made, either in the journals or during the posting process. The error must be located and rectified, and the totals of the debit column and the credit column recalculated to check for agreement before any further processing can take place.

Once the accounts balance, the accountant makes a number of adjustments and changes the balance amounts of some of the accounts. These adjustments must still obey the double-entry rule: for example, the inventory account and asset account might be changed to bring them into line with the actual numbers counted during a stocktake. At the same time, the expense account associated with usage of inventory is adjusted by an equal and opposite amount. Other adjustments such as posting depreciation and prepayments are also done at this time. This results in a listing called the adjusted trial balance. It is the accounts in this list, and their corresponding debit or credit balances, that are used to prepare the financial statements.

Finally financial statements are drawn from the trial balance, which may include:

  • the income statement, also known as the statement of financial resultsprofit and loss account, or P&L
  • the balance sheet, also known as the statement of financial position
  • the cash flow statement
  • the statement of changes in equity, also known as the statement of total recognised gains and losses

What is Bookkeeping ?

Bookkeeping is the recording of financial transactions, and is part of the process of accounting in business. Transactions include purchases, sales, receipts, and payments by an individual person or an organization/corporation. There are several standard methods of bookkeeping, including the single-entry and double-entry bookkeeping systems. While these may be viewed as “real” bookkeeping, any process for recording financial transactions is a bookkeeping process.

Bookkeeping is the work of a bookkeeper (or book-keeper), who records the day-to-day financial transactions of a business. They usually write the daybooks (which contain records of sales, purchases, receipts, and payments), and document each financial transaction, whether cash or credit, into the correct daybook—that is, petty cash book, suppliers ledger, customer ledger, etc.—and the general ledger. Thereafter, an accountant can create financial reports from the information recorded by the bookkeeper.

Bookkeeping refers mainly to the record-keeping aspects of financial accounting, and involves preparing source documents for all transactions, operations, and other events of a business.

The bookkeeper brings the books to the trial balance stage: an accountant may prepare the income statement and balance sheet using the trial balance and ledgers prepared by the bookkeeper.

History

The origin of book-keeping is lost in obscurity, but recent researches indicate that methods of keeping accounts have existed from the remotest times of human life in cities. Babylonian records written with styli on small slabs of clay have been found dating to 2600 BCE. The term “waste book” was used in colonial America, referring to the documenting of daily transactions of receipts and expenditures. Records were made in chronological order, and for temporary use only. Daily records were then transferred to a daybook or account ledger to balance the accounts and to create a permanent journal; then the waste book could be discarded, hence the name.