Double Entry Bookkeeping

7 Step Guide To Processing

Business Accounts
Double entry bookkeeping is where the value from every
business transaction is entered twice into the system.

Learn the principles behind this system and your confidence

will grow in leaps and bounds whether keeping the books
manually or using software!
Understanding double entry bookkeeping will help you
understand journals. Journals are used for making manual
adjustments to the accounts without affecting the bank
account balances.

The Basic Steps Of Double Entry Bookkeeping:

1. Business transactions produce documents.

2. The information from the documents is recorded

into journals.

3. The data is taken from the journals and entered

into ledger books.

4. Each ledger book contains various accounts, listed

in the chart of accounts.
5. These accounts are totaled and balanced in line with
the accounting equation.

6. The accounts are balanced by using debits and credits,

which is the core foundation of double-entry bookkeeping.

7. A trial balance can be produced to ensure that the books

actually balance and that the debits and credits have been
posted correctly.

More details of each of these steps can be found below.

1. When A Business Carries Out An Activity A

Document Is Produced

Accounting Source Docs

One document example would be a sales invoice.

A business activity is the selling, buying, borrowing or loan of

items, cash, goods or services.

For example: a sales invoice would be raised when the

business sells a product.
The activity (in this case, a sale) is defined as a business
transaction.

The document is called an accounting or journal book.

2. The Transaction Starts Its Journey In The

Journal Books

Journals

The details of a business transaction as found on the source document

include:-

 the date
 the name of person or company
 a description of the transaction
 the amount

These details are recorded into books of original entry commonly called day
books or bookkeeping journals.

The journals describe in summary what the transaction was and what ledger
accounts are affected.

A transaction that has no value attached would not be recorded in the

accounts.

The mathematical principle for double entry bookkeeping is the Accounting

Equation.
If about now you want to run a mile because math isn’t your thing... don’t
worry! You don’t have to be a mathematical genius to do bookkeeping.

Bookkeeping is about organizing numbers into categories which are then

totaled.

You can use a calculator for that...!

...and the Accounting Equation is about classifying the values from business
transactions into separate bookkeeping accounts.

Each value is entered twice in such a way that keeps the equation balanced.

Here is the Accounting Equation:-

Assets = Liabilities + Equity

You can memorize it by shortening it to ALE.

A assets ............ are what the business owns.

L liabilities ......... are what the business owes.

E equity .. ......... represents the ownership of the business (the profits or

losses).

Lets break it down....

Equity

When starting a business the owner introduces assets such as cash and
office equipment used within the business to generate more assets... such as
cash and office equipment. 

Equity is the ownership of the assets of the business by the owner.

So the start of the accounting equation is :

assets = equity
Prepaid expenses represent expenditures that have not yet been recorded by
a company as an expense, but have been paid for in advance. In other
words, prepaid expenses are expenditures paid for in one accounting period,
but that will not be recognized until a later accounting period. Prepaid
expenses are initially recorded as assets, because they have future economic
benefits, and are expensed at the time when the benefits are realized
(the matching principle).

Alya Introduces Personal Cash To Her

 
Busines
If Alya contributes $600 of her personal cash to her business so
that it can operate, the entry in the accounting books would
change both the asset account and the equity account, increasing
each account by $600.

The asset account is the business part (the cash it now has in the
Bank Account) and the equity account is Alya's part (the personal
cash she has given to the business which is recorded in the
Capital account).

These two accounts are on the opposite side of the accounting

equation to each other so it keeps the ledgers balanced.

Alya may at any time introduce more cash in which case the
asset and equity accounts will equally increase, thus maintaining
the accounting equation balance.

Alya may also chose to withdraw cash for personal use in which
case assets and equity will decrease equally. 

Here are two diagrams to explain it a bit further.

1. Accounting Equation Starting

Balance
The first diagram shows our scale with no balances in it. It is in
balance because both sides have a nil balance ($0). 
2. The First Entry: Increasing The
Asset
This second diagram shows just the Asset entry, which is the
money in the business Bank Account. See what has happened
to the scale - it has tipped upward. This is the only entry so it is
out of balance, because in double-entry bookkeeping there should
be a second entry which will go on the other side of the equation
where the Equity is.
3. The Second Entry: Increasing The
Equity
Now we see what happens to the scale when we enter the $600
the second time on the other side of the accounting equation into
the Capital Account increasing this account. It now balances.
Now let's look at what happens if we introduce a Liability into the
equation.

Liabilities
The dictionary definition of liable is ‘responsible by law: legally
answerable’ (Oxford University Press).

A liability is a financial obligation. The business is legally

responsible for the financial obligation.

The obligation could be:-

 Money owed to suppliers/vendors for goods and services

purchased (accounts payable).
  A loan that the business is paying back. A loan that takes
more than a year to pay back is called a long term liability.

Alya Gets A Bank Loan

Let's see how the accounting equation is kept in balance if Alya
gets a loan from the bank of $2,000 so she can buy equipment.

The two accounts affected by this loan transaction are Bank

Account and Bank Loan.

The Bank Account is the Asset.

The Bank Loan is the Liability.

Because Assets and Liabilities are on different sides of the

equation to each other the books will balance when the values
are entered into the bookkeeping ledgers.

Here are the diagrams to demonstrate this.

1. The First Entry: Increasing The

Asset
Here we see what happens to the equation when Alya receives
the $2,000 cash loan into her business Bank Account from the
bank. However, it doesn't balance yet because we have only
made one entry. This is double-entry bookkeeping so we need to
make a second entry of the same amount.
2. The Second Entry: Increasing The
Liability
We make the second entry of $2,000 onto the other side of the
equation into the Liability account which increases it, which is
the Loan Account.

Now there is $2,600 on the left and $2,600 on the right, so the
ledgers balance.
Alya uses the cash loan from the bank to buy a computer for the
office. Let's see what happens next.

Assets
These are items that have a money value and belong to the
business.

What items can a business own?

There are five common divisions:-

1. Current Assets

Cash - in the cash box or the bank

Money owed to the business (accounts receivable) by its

customers
Short term investments such as a term deposit that matures
within a year.

Fixed Assets

These are all tangible assets that have a physical, touchable form
and can also be grouped under the heading plant:-

 Workshop equipment
 Buildings
 Land
 Vehicles
 Office equipment
 Furniture and fittings

Fixed assets are used in the operation of the business for more
than 12 months, and usually for several years.

3. Intangible Assets

These assets have a value to the owner but are not a physical or
touchable item. They include:     

 Trademarks
 Goodwill
 Copyrights
 Patents

4. Inventory
This represents the items in stock that you buy and sell. 

5. Long Term Investments

Typically money belonging to the business that is not used in the
running of the business but is invested elsewhere, and is not
expected to be converted to cash within a year. For example:-

 Stocks
 Bonds
 Investment in another business
Alya Gets A Computer
Alya uses the money in her Bank Account to buy a computer -
this is an Asset.

1. The First Entry: Decreasing The

Asset
Alya spends $1,100 from her business Bank Account; as this is
money going out of the bank, the Asset (Bank Account)
must decrease.

In this diagram you can see the amount entered in red with a
minus sign in front of it to show it is money leaving the Asset side
of the Equation - so the total is $1,500, which causes the
Accounting Equation to go out of balance because the other side
of it still has $2,600.
2. The Second Entry: Increaseing The
Asset
This is double entry bookkeeping! We must enter the $1,100 a
second time. But wait! Office equipment is also an Asset, so the
$1,100 will be entered again onto the Asset side but into a
different Account - the Office Equipment account. This takes the
total back up to $2,600 and brings the Equation back into
balance.

All we've done is shift the amount from one Account to another
Account on the same side of the Equation.
Revenue And Expenses
There are two other important bookkeeping accounts that
are not represented in the accounting equation because they
are temporary accounts:-

 the revenue account

 the expenses account

At the end of a financial year the difference between the revenue

and expenses will be assigned to the equity account. The
difference might be a profit or a loss.
 The revenue and expense accounts will then be cleared with a
special adjustment to start fresh with no balances in the new
financial year, which is why they are called temporary accounts.

The equity, assets and liability accounts are not cleared at the

end of a financial year and so are called permanent accounts.

However, the equity account will change as a result of the special

adjustment which moves the profit or loss into it.

The accounting equation is the basis upon which the financial

condition of a business is presented through means of a
bookkeeping balance sheet.

The accounting equation is a fundamental part of business

bookkeeping.

How Accounting Journal Entries Benefit

Small Business Owners
If you buy something for your business using personal money,
you can bring it into the books with a journal.

1. This by-passes the business bank account (because you

don't want the bank balance in the software to be affected when
you enter this transaction that comes from a completely different
source of funds).

2. You can ensure that when you spend money on your

business from your personal funds, you are accounting for these
expenses, which reduces your profit, which reduces how much
3. tax you have to pay to the government. It also gives a true
reflection of how much is being spent on business expenses.
The Details Of A Journal Entry
The journal transaction window will include:

 a narration where you can enter something like 'Business expense paid with
personal funds'

 a date - use either the date of the transaction or the last day of the month in
which the transaction occurred

 a debit account - select the account that reflects the type of expense, put a
description of the item purchased, and enter the cost into the debit field

 a credit account -  select Owner's Capital (also known as Funds

Introduced), put the same description, and enter the exact same cost into
the credit field

 the debit value and credit value must be the same; the software won't let

you close out if they don't balance

if you have to account for sales tax, make sure it is included on the expense,
but not the Capital (sales tax on Capital is not required) - your software will either
let you select the relevant sales tax, or you will have to enter two debit lines, one
for the expense cost before sales tax and one for the amount of sales tax.