dbs3024 biz trx week 2 double entry system

The Double Entry SystemThe Double Entry SystemThe Double Entry SystemThe Double Entry System

DBS3024 BUSINESS TRANSACTIONDBS3024 BUSINESS TRANSACTION

byStephen Ong

Visiting Fellow, Birmingham City University Business School

Visiting Professor, Shenzhen University

Today’s Overview Today’s Overview

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11The double entry system for The double entry system for assets, liabilities and capitalassets, liabilities and capital

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Learning objectivesLearning objectives

After you have studied this chapter, you After you have studied this chapter, you should be able to:should be able to:

Explain what is meant by ‘double entry’Explain what is meant by ‘double entry’ Explain how the double entry system Explain how the double entry system

follows the rules of the accounting follows the rules of the accounting equationequation

Explain why each transaction is recorded Explain why each transaction is recorded into individual accountsinto individual accounts

Describe the layout of a ‘T-account’Describe the layout of a ‘T-account’

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Learning objectives Learning objectives (Continued)(Continued)

Explain what is meant by the terms Explain what is meant by the terms debit and creditdebit and credit

Explain the phrase ‘debit the receiver Explain the phrase ‘debit the receiver and credit the giver’and credit the giver’

Prepare a table showing how to record Prepare a table showing how to record increases and decreases of assets, increases and decreases of assets, liabilities and capital in the accountsliabilities and capital in the accounts

Enter a series of transactions into Enter a series of transactions into T-accountsT-accounts

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The double entry systemThe double entry system

Every transaction affects two items.Every transaction affects two items.

These effects need to be shown in the These effects need to be shown in the accounting books.accounting books.

This is double entry bookkeeping.This is double entry bookkeeping.

Exhibit 4.1

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A double entry accountA double entry account

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How recording in an accountHow recording in an accountaffects itemsaffects items

Exhibit 4.2

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Or, to see this in the accountsOr, to see this in the accounts

Exhibit 4.3

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ActivityActivity

The owner starts the business with The owner starts the business with RM10,000 in cash on 1 August 2012.RM10,000 in cash on 1 August 2012.

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Activity (Continued)Activity (Continued)

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A van is bought for RM4,500 in cash on A van is bought for RM4,500 in cash on 2 August 2012.2 August 2012.

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Fixtures (e.g. shelves) are bought on Fixtures (e.g. shelves) are bought on credit from Shop Fitters for RM1,250 on credit from Shop Fitters for RM1,250 on 3 August 2008.3 August 2008.

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Paid the amount owning to Shop Fitters Paid the amount owning to Shop Fitters in cash on 17 August 2012.in cash on 17 August 2012.

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Combining all four of these transactions, Combining all four of these transactions, the accounts now contain:the accounts now contain:

Exhibit 4.4

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ActivityActivity

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Activity (Continued)

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Activity (Continued)

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Learning outcomesLearning outcomes

You should have now learnt:You should have now learnt:

1.1. That double entry follows the rules of That double entry follows the rules of the accounting equationthe accounting equation

2.2. That double entry maintains the That double entry maintains the principle that every debit has a principle that every debit has a corresponding credit entrycorresponding credit entry

3.3. That double entries are made in That double entries are made in accounts in the accounting booksaccounts in the accounting books

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Learning outcomes Learning outcomes (Continued)(Continued)

4.4. Why each transaction is entered into Why each transaction is entered into accounts rather than directly into the accounts rather than directly into the statement of financial positionstatement of financial position

5.5. How transactions cause increases and How transactions cause increases and decreases in asset, liability and capital decreases in asset, liability and capital accountsaccounts

6.6. How to record transactions in T-accountsHow to record transactions in T-accounts

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2The double entry system for

asset of stock/inventory

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Explain why it is inappropriate to use Explain why it is inappropriate to use an inventory account to record an inventory account to record increases and decreases in inventoryincreases and decreases in inventory

Describe the two causes of inventory Describe the two causes of inventory increasingincreasing

Describe the two causes of inventory Describe the two causes of inventory decreasingdecreasing

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Explain the difference between a purchase Explain the difference between a purchase account and a return inwards accountaccount and a return inwards account

Explain the difference between a sales Explain the difference between a sales account and a return outwards accountaccount and a return outwards account

Explain how to record increases and Explain how to record increases and decreases of inventory in the appropriate decreases of inventory in the appropriate accountsaccounts

Explain the meanings of the terms Explain the meanings of the terms ‘purchases’ and ‘sales’ as used in‘purchases’ and ‘sales’ as used inaccountingaccounting

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Explain the differences in recording Explain the differences in recording purchases on credit as compared to purchases on credit as compared to recording purchases that are paid for recording purchases that are paid for immediately in cashimmediately in cash

Explain the differences in recording sales Explain the differences in recording sales on credit as compared to recording sales on credit as compared to recording sales that are paid for immediately in cashthat are paid for immediately in cash

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Inventory (Stock)Inventory (Stock)

Normally, goods and services are sold Normally, goods and services are sold aboveabove

cost price, the difference being profit. As cost price, the difference being profit. As

you know, when goods and services are you know, when goods and services are

sold for less than their cost, the sold for less than their cost, the difference difference

is a loss.is a loss.

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An increase in inventoryAn increase in inventory

An increase in inventory can be due to An increase in inventory can be due to one of two causes:one of two causes:

The purchase of additional goods.The purchase of additional goods. The return in to the business of goods The return in to the business of goods

previously sold.previously sold.

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An increase in inventory An increase in inventory (Continued)(Continued)

To distinguish the two aspects of the To distinguish the two aspects of the increase of inventory, two accounts are increase of inventory, two accounts are opened:opened:

A purchases account, in which A purchases account, in which purchases of goods are entered.purchases of goods are entered.

A return inwards account, in which A return inwards account, in which goods being returned into the business goods being returned into the business are entered.are entered.

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A decrease in inventoryA decrease in inventory

A decrease in inventory can be due to A decrease in inventory can be due to one of two causes:one of two causes:

The sale of goods.The sale of goods. Goods previously bought by the Goods previously bought by the

business now being returned to the business now being returned to the supplier.supplier.

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A decrease in inventory A decrease in inventory (Continued)(Continued)

To distinguish the two aspects of the To distinguish the two aspects of the decrease of inventory, two accounts are decrease of inventory, two accounts are opened:opened:

A sales account, in which sales of A sales account, in which sales of goods are entered.goods are entered.

A return outwards account, in which A return outwards account, in which goods being returned out to a supplier goods being returned out to a supplier are entered.are entered.

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ActivityActivity

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Purchase of inventory on Purchase of inventory on creditcredit

On 1 August 2012, goods costing RM165 On 1 August 2012, goods costing RM165 are bought on credit from D. Henry.are bought on credit from D. Henry.

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Purchase of inventory for Purchase of inventory for cashcash

On 2 August 2012, goods costing RM310 On 2 August 2012, goods costing RM310 are bought, cash being paid for them are bought, cash being paid for them immediately at the time of purchase.immediately at the time of purchase.

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Sales of inventory on creditSales of inventory on credit

On 3 August 2012, goods were sold on On 3 August 2012, goods were sold on credit for RM375 to J. Lee.credit for RM375 to J. Lee.

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Sales of inventory for cashSales of inventory for cash

On 4 August 2012, goods are sold for On 4 August 2012, goods are sold for RM55, cash being received immediately RM55, cash being received immediately at the time of sale.at the time of sale.

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Returns inwardsReturns inwards

On 5 August 2012, goods which had On 5 August 2012, goods which had been previously sold to F. Lower for been previously sold to F. Lower for RM29 are now returned to the business.RM29 are now returned to the business.

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Returns outwardsReturns outwards

On 6 August 2012, goods previously On 6 August 2012, goods previously bought for RM96 are returned by the bought for RM96 are returned by the business to K. Howe.business to K. Howe.

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Special meaning of ‘sales’ and Special meaning of ‘sales’ and ‘purchases’‘purchases’

Both ‘sales’ and ‘purchases’ have a Both ‘sales’ and ‘purchases’ have a special meaning in accounting.special meaning in accounting.

PurchasesPurchases means the purchase of means the purchase of those goods which the business buys those goods which the business buys with the sole intention of selling.with the sole intention of selling.

SalesSales means the sale of those goods in means the sale of those goods in which the business normally deals and which the business normally deals and which were bought with the prime which were bought with the prime intention of resale.intention of resale.

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You should have now learnt:You should have now learnt: That it is not appropriate to use an That it is not appropriate to use an

inventory account to record increases and inventory account to record increases and decreases in inventory because inventory decreases in inventory because inventory is normally sold at a price greater than its is normally sold at a price greater than its costcost

That inventory increases either because That inventory increases either because some inventory has been purchases or some inventory has been purchases or because the inventory that was sold has because the inventory that was sold has been returned by the buyerbeen returned by the buyer

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That inventory decreases either That inventory decreases either because some inventory has been sold because some inventory has been sold or because inventory previously or because inventory previously purchased has been returned to the purchased has been returned to the suppliersupplier

That a purchase account is used to That a purchase account is used to record purchases of inventory (as debit record purchases of inventory (as debit entries in the account) and that a return entries in the account) and that a return inwards account is used to record inwards account is used to record inventory returned by customers (as inventory returned by customers (as debit entries in the account)debit entries in the account)

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That a sales account is used to record That a sales account is used to record sales of inventory (as credit entries in sales of inventory (as credit entries in the account) and that a return outwards the account) and that a return outwards account is used to record inventory account is used to record inventory returned to suppliers (as credit entries returned to suppliers (as credit entries in the account)in the account)

How to record increases and decreases How to record increases and decreases of inventory in the appropriate accountsof inventory in the appropriate accounts

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That in accounting, the term ‘purchases’ That in accounting, the term ‘purchases’ refers to purchases of inventory. refers to purchases of inventory. Acquisitions of any other assets, such as Acquisitions of any other assets, such as vans, equipment and buildings, are vans, equipment and buildings, are nevernever described as purchasesdescribed as purchases

That in accounting, the term ‘sales’ refers That in accounting, the term ‘sales’ refers to sales of inventory. Disposals of any to sales of inventory. Disposals of any other assets, such as vans, equipment other assets, such as vans, equipment and buildings, are and buildings, are nevernever described as described as salessales

That purchases for cash are That purchases for cash are nevernever entered entered in the supplier’s accountin the supplier’s account

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That purchases on credit are That purchases on credit are alwaysalways entered in the supplier’s (creditor’s) entered in the supplier’s (creditor’s) accountaccount

That sales for cash are That sales for cash are nevernever entered in entered in the customer’s accountthe customer’s account

That sales on credit are That sales on credit are alwaysalways entered entered in the customer’s (debtor’s) accountin the customer’s (debtor’s) account

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33The double entry The double entry

system for expenses and system for expenses and revenuesrevenues

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Calculate profit by comparing revenue Calculate profit by comparing revenue with expenseswith expenses

Explain how the accounting equation is Explain how the accounting equation is used to show the effects of changes in used to show the effects of changes in assets and liabilities upon capital after assets and liabilities upon capital after goods or services have been tradedgoods or services have been traded

Explain why separate accounts are used Explain why separate accounts are used for each type of expense and revenuefor each type of expense and revenue

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Explain why an expense is entered as a debit Explain why an expense is entered as a debit in the appropriate expense accountin the appropriate expense account

Explain why an item of revenue is entered as a Explain why an item of revenue is entered as a credit in the appropriate revenue accountcredit in the appropriate revenue account

Enter a series of expense and revenue Enter a series of expense and revenue transactions into the appropriate T-accountstransactions into the appropriate T-accounts

Explain how the use of business cash and Explain how the use of business cash and business goods for the owner’s own purposes business goods for the owner’s own purposes are dealt with in the accounting recordsare dealt with in the accounting records

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The nature of profit or lossThe nature of profit or loss

Profit means the amount by which Profit means the amount by which revenue is greater than expenses for a revenue is greater than expenses for a set of transactions, where:set of transactions, where:

Revenue means the sales value of Revenue means the sales value of goods and services that have been goods and services that have been supplied to customers.supplied to customers.

Expenses means the cost value of all Expenses means the cost value of all the assets that have been used up to the assets that have been used up to obtain these revenues.obtain these revenues.

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Calculating profitCalculating profit

If we supplied goods and services valued for sale If we supplied goods and services valued for sale at £100,000 to customers, and the expenses at £100,000 to customers, and the expenses incurred by us in order to supply those goods and incurred by us in order to supply those goods and services amounted to RM70,000, the result would services amounted to RM70,000, the result would be a profit of RM30,000:be a profit of RM30,000:

RevenueRevenue RM100,000 RM100,000

LessLess expenses expenses (RM70,000)(RM70,000)

ProfitProfit RM30,000RM30,000

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The effect of profit and loss on The effect of profit and loss on capitalcapital

The accounting equation we have used The accounting equation we have used is:is:

Capital = Assets Capital = Assets −− Liabilities Liabilities

When profit has been earned, this When profit has been earned, this increases capital:increases capital:

Old capital + Profit = New capitalOld capital + Profit = New capital Or when a loss has been earned, the Or when a loss has been earned, the

capital figure decreases:capital figure decreases:

Old capital Old capital −− Loss = New capital Loss = New capital

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Recording expensesRecording expenses

In order to calculate profit, expenses In order to calculate profit, expenses must be entered into appropriate must be entered into appropriate accounts. A accounts. A separate account separate account is is opened for each type of expense:opened for each type of expense:

Bank interest accountBank interest account Subscriptions accountSubscriptions account Rent accountRent account

Overdraft interest Overdraft interest accountaccount

Motor expenses Motor expenses accountaccount

Postages Postages accountaccount

Audit fees accountAudit fees account Telephone accountTelephone account Stationery Stationery accountaccount

Insurance accountInsurance account General expenses General expenses accountaccount

Wages accountWages account

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Debit or creditDebit or credit

Assets and expenses involve Assets and expenses involve expenditure by the business and are expenditure by the business and are shown as shown as debit entries debit entries because they because they must ultimately be paid for.must ultimately be paid for.

Revenue is the opposite of expenses Revenue is the opposite of expenses and therefore revenue entries appear on and therefore revenue entries appear on the the credit side credit side of the revenue accounts.of the revenue accounts.

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Debit or credit (Continued)Debit or credit (Continued)

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Double entries for expenses and Double entries for expenses and revenuesrevenues

Rent of RM200 is paid in cash:Rent of RM200 is paid in cash:

Debit the rent account with RM200Debit the rent account with RM200

Credit the cash account with RM200Credit the cash account with RM200

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Double entries for expenses and Double entries for expenses and revenues (Continued)revenues (Continued)

Motor expenses of RM355 are paid by Motor expenses of RM355 are paid by cheque:cheque:

Debit the motor expenses account with Debit the motor expenses account with RM355RM355

Credit the bank account with RM355Credit the bank account with RM355

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Double entries for expenses and Double entries for expenses and revenues (Continued)revenues (Continued)

RM60 cash is received for commission RM60 cash is received for commission

earned by the business:earned by the business:

Debit the cash account with RM60Debit the cash account with RM60

Credit the commissions received account Credit the commissions received account with RM60with RM60

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ActivityActivity

June 1 – Paid for postage stamps by cash June 1 – Paid for postage stamps by cash RM50RM50

June 2 – Paid for electricity by cheque RM229June 2 – Paid for electricity by cheque RM229

June 3 – Received rent in cash RM138June 3 – Received rent in cash RM138

June 4 – Paid insurance by cheque RM142June 4 – Paid insurance by cheque RM142

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Exhibit 6.1

More ExamplesMore Examples

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DrawingsDrawings

Money that the owner takes from the Money that the owner takes from the business for private use is called business for private use is called drawings.drawings.

Drawings reduces capital – they are never Drawings reduces capital – they are never an expense of the business.an expense of the business.

An increase in drawings is a debit entry in An increase in drawings is a debit entry in the drawings account.the drawings account.

The credit entry is against cash or bank if The credit entry is against cash or bank if money was taken from the business, or money was taken from the business, or purchases if stock was taken.purchases if stock was taken.

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Recording drawingsRecording drawings

On 25 August, the owner takes RM50 cash On 25 August, the owner takes RM50 cash out of the business for his own use:out of the business for his own use:

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Recording drawings Recording drawings (Continued)(Continued)

On 28 August, the owner takes RM400 of On 28 August, the owner takes RM400 of goods out of the business for his own use: goods out of the business for his own use:

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You should have now learnt:You should have now learnt:1.1. How to calculate profit by comparing How to calculate profit by comparing

revenue with expensesrevenue with expenses2.2. That the accounting equation is central That the accounting equation is central

to any explanation of the effect of to any explanation of the effect of trading upon capitaltrading upon capital

3.3. Why every different type of expense is Why every different type of expense is shown in a separate expense accountshown in a separate expense account

4.4. Why every different type of revenue is Why every different type of revenue is shown in a separate revenue accountshown in a separate revenue account

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5.5. Why an expense is shown as a debit Why an expense is shown as a debit entry in the appropriate expense entry in the appropriate expense accountaccount

6.6. Why revenue is shown as a credit entry Why revenue is shown as a credit entry in the appropriate revenue accountin the appropriate revenue account

7.7. How to enter a series of expense and How to enter a series of expense and revenue transactions into the revenue transactions into the appropriate T-accountsappropriate T-accounts

8.8. What is meant by the term ‘drawings’What is meant by the term ‘drawings’

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9.9. That drawings are That drawings are alwaysalways a reduction a reduction in capital and in capital and nevernever an expense of a an expense of a businessbusiness

10.10. How to record drawings of cash in the How to record drawings of cash in the accounting booksaccounting books

11.11. How to record drawings of goods in How to record drawings of goods in the accounting booksthe accounting books

Resources : Core ReadingResources : Core Reading

Wood, Frank and Robinson, Sheila Wood, Frank and Robinson, Sheila (2009) (2009) Bookkeeping and Accounts Bookkeeping and Accounts ,7,7thth Edition, Pearson/ FT Prentice HallEdition, Pearson/ FT Prentice Hall

Wood, Frank and Sangster, Alan (2012) Business Accounting ,12th Edition, Pearson/ FT Prentice Hall

Fortes, Hilary (2011) Accounting Simplified , Pearson/ FT Prentice Hall

QUESTIONS?QUESTIONS?

dbs3024 biz trx week 2 double entry system

Economy & Finance