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Double Entry System, the

Ledger and the Trial Balance


LECTURE 2

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Common Terms used in accounting
Account payable (Creditor) : A person to whom money is owned for goods
is known in accounting language as a creditor.
Account receivable (Debtor) : A person who owes the business money is
known in accounting language as a debtor.
Inventory : Finished Goods to be sold that are stored within the business.

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The Accounting Process
This is the process of developing useful accounting information
which is relevant for decision making. This is an input output
process. Input is financial information. Process is accounting
functions and preparing financial statement is the output.

What we Record in Accounting

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Transactions
This is emphasis on the economic activities which involves an exchange of
goods, services or money from one party to another.
E.g. - Business Paid salaries of Rs.12,000
Business Sold goods worth Rs.125,000
The Elements of Transactions

• Have the monetary value

• Have the double entry

• Useful to decision making

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Events
These are internal & external events which are affected to the business.
We only record events that have a financial impact on the business.
Internal Events – The events can be control to the managers.
E.g. - Changes in productions
Staff Turnover

External Events – The events cannot be control to the managers.


E.g. - Changes in accounting environment (Introduction of new accounting standards)
Natural disasters

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Recording Transactions/Events
The accounting process starts by recognizing and recording the
transactions and events.
Each transaction will have two entries in accounting under Dual Aspect
Concept, also known as Duality Principle.

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Elements in Accounting
There are 5 major elements of accounting
where every transaction/event can be classified
into.
These are :
1. Assets
2. Liabilities
3. Equity / Capital
4. Income
5. Expenses

These terms are used widely in accounting so it


is necessary that we take a close look at each
element.
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Assets
Assets are the resources owned and controlled by the entity as a result of
past transactions and events, from which future economic benefits are
expected to flow to the entity. In simple terms, assets are properties or
rights owned by the business. They may be classified as current or non-
current.
 Current Assets – This is emphasis on the assets which are used within one year in
the operational cycle of the business.
E.g. – Inventories, Debtors, prepaid expenses & cash in hand.

 Non-Current Assets - This is emphasis on the assets which are not over within
one year in the operational cycle of the business. The assets are kept for long
term benefits (more than one year).
E.g. – Property, Plant & Equipment, Investments, & Intangible assets.
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Liabilities
The liability is a present obligation of the entity arising from past events,
the settlement of which is expected to result in an outflow of economic
benefits. This is emphasis on everything which is liable or entity has
obligation to pay to the external parties of the business. This can be divided
into two parts.
Current Liabilities – This is emphasis on the liabilities which are expected
to settle within one year.
E.g. – Accrued expenses, Creditors & Bank Overdraft.

Non-current Liabilities - This is emphasis on the liabilities which are


expected to settle within more than one year.
E.g. – Bank loans & Debentures.

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Equity (Capital)
This is emphasis on everything which belongs to the owner of the
business. This is a liability of the business because according to business
entity concept, the owner & the business are two parties.
E.g. - Capital, Net profit & Reserves
Capital
This is emphasis on everything which is provided to the business by the
owner. It may be an initial capital or extra capital. (Money & Property)
Drawings
This is emphasis on the things that the owner withdraws from the
business.

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Equity (Capital)

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Equity Vs Liabilities
The Similarities of Equity & Liability
Both of them give the resources to the business.
Both of them have the interest to the business.
Both of them belong to credit accounts of the business.
The Differences between Equity & Liability
Equity Liability
1
Obligation of the internal party of the business. Obligation to the external party of the business.
2
The Profit/Loss is the return. The Interest is the return.
3
Participates (Equity holders) in management of the Dose not Participate in management the business.
business.
4
After settling the debt holders liabilities, remained Debt holders have the priority to settle the
earnings, will be distributed among the equity liabilities in the event of liquidation of the
holders. business.

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The Basic Accounting Equation

Accounting equation shows the ways of getting the resources to the business & utilizing them.
Either the owner or an external party supplies the business with resources.

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The Basic Accounting Equation
The accounting equation is considered to be the foundation of the double-
entry accounting system. It is a mathematical representation of how the
business is funded with. The claim for assets by the owner or the external
parties is demonstrated.
All what business owns Provided by external parties Provided by Owner(s)

Debit Entries
Credit Entries
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The Basic Accounting Equation - Practice
1. The owner Introduced Rs.800,000 as Capital to the Business

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The Basic Accounting Equation - Practice
2. The owner obtained a bank loan of 200,000 for the business

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The Basic Accounting Equation - Practice
3. The Business opened a bank account for 100,000 in their name

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The Basic Accounting Equation - Practice
4. Purchased office equipment worth of 200,000 which 100,000 was
paid by cash and rest was agreed to be settled in two months
time

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The Basic Accounting Equation - Practice
5. The owner took 50,000 from the business to pay his medical bill

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The Basic Accounting Equation - Practice
Enter the following transactions to the Accounting equation.
6. Cash purchase of 10,000 worth goods
7. 30,000 worth good were bought on credit
8. 10,000 was paid to the creditors

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Extended Accounting Equation
It was mentioned earlier that the profit or the loss is received by the
owners of a business. The profit can be interpreted as follows. :
Profit(or Loss) = Total Income – Total Expenses
So the basic accounting equation can be modified as follows :
Assets = Capital + Profit/ Loss + Liabilities

(Income – Expense)

Expense + Assets = Capital + Liabilities + Income

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Income
This is emphasis on increase in economic benefits. Can be due to earnings
and cash inflows of the business. This can be divided in to two parts.
Operational Income - This is the earnings which arise from the day to day
operations of the business.
E.g. - Sales, Received commission, Received discounts.

Capital Income - This is the earnings which arise from long term liability or
fixed assets of the business.
E.g. - Revaluation profit, Profit on sale of fixed assets.

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Expenses
This is emphasis on decrease in economic benefits. Can be due to resource
consumption of a business. On the other words, the dedicated value of goods &
services for earning an income. This can be divided in to two parts.
Revenue Expenditure – This is emphasis on the expenditure which arises from
day to day operations of the business. This is clearly within one year.
E.g. – Purchases, Distribution cost & Financial cost.

Capital Expenditure - This is emphasis on the expenditure which spends for


acquiring the long term assets or benefits (more than one year).
E.g. – Purchasing the fixed assets.
The legal cost of land purchase

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Capital Expenditure Vs Revenue Expenditure

Capital Expenditure Revenue Expenditure


Spent for acquiring the long term Spent for short term benefits.
1
benefits.

Not Spent for continuing in daily business Spent for continuing in daily business
2
operation. operation.

Reduces parts by parts from the income Reduces whole expenditure from the
3
statement. income statement.

4 Helps to generate income at long term. Helps to generate income at short term.

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Double Entry System
Double entry system is a scientific way of presenting accounts. As such all
the Business concerns feel it convenient to prepare the accounts under
double entry system.
Under dual aspect concept the accountant deals with the two aspects of
business transaction i.e.,
1) Receiving Aspect and
2) Giving Aspect.
Receiving aspect is known as ‘Debit Aspect’ and giving aspect is known as
‘Credit Aspect’.

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Double Entry System
We discussed that every transaction has two entries. One of them is a
credit entry and one of them is a debit entry
Debit Side Credit Side

Expense + Assets = Capital + Liabilities + Income

• Increase in an element in the left • Increase in an element in the right side of the
side of the equation is a debit equation is a credit
• Decrease is a credit • Decrease is a debit

Debit Credit Credit Debit

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Ledger accounts
A ledger account contains a record of business transactions. It is a separate record that
is assigned to a specific asset, liability, equity item, revenue type, or expense type.
Examples of ledger accounts are:

◦ Cash Account Name


◦ Accounts receivable
◦ Inventory
◦ Fixed assets
◦ Accounts payable
◦ Bank Account
◦ Rent income
◦ Salaries and wages
◦ Office expenses
◦ Income tax expense

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Ledger Accounts
A Ledger account can be denoted by a T account. (Capital T- like illustration)

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Ledger Accounts – Balancing an account
 If the Debit entries are greater than Credit entries, the account will have a Debit balance
 If the Credit entries are greater than Debit entries, the account will have a Credit balance

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Ledger Accounts – Debit and Credit

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Exercise
Prepare Ledger Accounts (T accounts) for all the transactions performed
under the accounting equation.

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Trial Balance
A trial balance is a bookkeeping worksheet in which the balances of all
ledgers are compiled into debit and credit account column totals that are
equal. A company prepares a trial balance periodically, usually at the end
of every reporting period. The general purpose of producing a trial balance
is to ensure the entries in a company's bookkeeping system are
mathematically correct. i.e all the debits are equal to credits.
Importance of Trial Balance
 Helps to summarize the transactions
 Helps to prepare the financial statements
 Ensures the numerical accuracy of the accounting information

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Trial Balance
Structure of the Trial Balance

Description Debit Credit

Assets xxx
Expenditure xxx
Losses xxx

Liabilities xxx
Income xxx
Equity xxx
xxxxxx xxxxxx

The total of the Debit balances should be equal to the total Credit balances

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Exercise
Prepare the trial balance for the above prepared Ledger accounts

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Assignment 1
Refer the Following Transactions
1. Sarath decides to start a business and invests Rs. 150,000 and starts ‘Sarath Traders’
2. Business Purchased office equipment for Rs.70,000 cash
3. Sarath Traders purchase Rs.16,000 worth of goods on credit from Gunapala’s Business.
4. Rs.8,000 worth goods were sold for cash Rs.20,000 (on Profit)
5. ‘Sarath Traders’ receives a telephone bill of Rs. 2,500 but decides to pay it later.
6. Sells goods worth of Rs 5,000 to Sunil. Receives Rs.1,500 and rest to be received later
7. Business pays monthly expenses of Rent and Salaries in cash worth of Rs 5,000 and Rs.10,000
respectively
8. Pays it’s Telephone bill of Rs 2,500
9. Sunil Pays Rs. 2,000
10. Sarath takes Rs.2,000 worth goods to his home. Continued ………………

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Assignment 1
You are required to :
I. Enter all transactions to the accounting equation
II. Prepare Ledger accounts
III. Prepare the Trial balance

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END OF SESSION

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