CHAPTER 3: THE BASIC ACCOUNTING EQUATION AND

DOUBLE ENTRY SYSTEM

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1. EFFECT OF TRANSACTIONS ON THE BASIC ACCOUNTING EQUATION

A mathematical equation underlies the entire accounting process. Known as the basic
accounting equation, it states:

Assets = Equity + Liabilities

1.1. Every transaction affects at two of the elements of the BAE, and results in a change in
the financial position. However, the BAE must always stay balanced after each
transaction. The assets on the left-hand side [LHS] of the equation being equal to the
sum of the equity and liabilities on the right-hand side [RHS].

1.2. There are four different ways in which the BAE can change but remain balanced:

(a) Increase LHS with a corresponding increase RHS

(b) Decrease LHS with a corresponding increase RHS

(c) A corresponding increase and decrease on the LHS

(d) A corresponding increase and decrease on RHS

1.3. Thus BAE will remain balanced when;

(a) Transaction affect only.[one asset increases, the other asset decreases]
i. Buying assets with cash [asset:bank – asset:X +]
ii. Payments received from debtors [asset:bank + asset:debtors -]

(b) Transaction affect both assets and liabilities.

i. Buying assets on credit [ asset:Y + liability creditor:Xx +]
ii. Payments to creditors [ asset:bank - liability creditor:Yy -]
iii. Acquisition of loan [ asset:bank + liability loanL01 + ]

(c) Transaction affect assets and equity.

i. Drawings by owners [asset:bank – capital - ]
ii. Contribution by owners [ asset:Z + capital +]
iii. Income and expenses :
  Cash income
 Credit income
 Cash expenses

(d) Transactions affecting equity and liability

i. Expense made on credit

2. DOUBLE-ENTRY BOOKKEEPING
Bookkeeping practice employs a system called double-entry bookkeeping to record every
business transaction in view of both sides of the BAE.

2.1. The basis of this system is that the transactions which occur are entered in a set of
accounts within the accounting books. An account is a place where all the information
referring to a particular asset or liability, or to capital, is recorded.

2.2. A ledger is a book containing all the accounts of a practice. The accounts in a ledger
are also known as ledger accounts.

2.3. Ledge accounts are shown in the form of a capital T and are referred to as a T-account.

2.4. The left-hand side is the debit side and the right-hand side is the credit side. The terms
debit and credit refer to the side of the account and not to whether the account
increases or decreases.

2.5. Every transaction will have an effect on at least two accounts in the ledger; the amount
debited to an account must always equal the amount credited to another account. This
is to keep the BAE in balance.

2.6. The “giving” of a benefit is credited to the account of the “giver” [credit the giver];
the corresponding “receipt” appears as a debit in the account “receiving” the benefit.
[debit the receiver]

2.7. If the transactions are posted correctly, the total of the debit balances must equal the
total of the credit balances.

DR Name of Account CR
Mont Day Details Fol R Month Day Detail Fol R
h

Table 1: "T.Account" Format

2.8. There are five main groups of accounts, namely:

i. Asset accounts:
 - to increase an asset we make a DEBIT entry, to decrease an asset we make a
CREDIT entry. [Have to receive a benefit to increase]
- i.e Debit Balance

ii. Liability accounts:

- to increase an liability we make a CREDIT entry, to decrease a liability we
make a DEBIT entry. [Have to give a benefit to increase]
- i.e Credit balance

iii. Equity accounts: capital, drawings, income and expenses.

General to increase capital account we make a CREDIT entry. To decrease a
liability/capital account we make a DEBIT entry.

(a) Capital
- to increase Capital we make a CREDIT entry, to decrease Capital we make a
DEBIT entry. [Have to give a benefit to increase]
- i.e Credit balance.

(b) Drawings
- to increase Drawings we make a DEBIT entry, to decrease Drawings we make
a CREDIT entry. [Have to receive a benefit to increase]
- i.e Debit balance

(c) Income
- to increase Income we make a CREDIT entry, to decrease Income we make a
DEBIT entry. [Have to give a benefit to increase]
- i.e Credit balance

(c) Expenses
- to increase Expenses we make a DEBIT entry, to decrease Expenses. [Have to
receive a benefit to increase]
- i.e Debit balance

3. CALCULATION OF A LEDGER ACCOUNT BALANCE