Principles of Double Entry In Accounting

What Is The Principle Of Double Entry Accounting?

The basic principle of double entry Bookkeeping states that for every debit entry, there must be a corresponding credit entry and for every credit entry, there must be a corresponding debit entry. It is the foundation of book keeping.

Accounting attempts to record both effects of a transaction or event on the entity's financial statements. This is the application of double entry concept. Without applying double entry concept, accounting records would only reflect a partial view of the company's affairs.

Imagine if an entity purchased a machine during a year, but the accounting records do not show whether the machine was purchased for cash or on credit. Perhaps the machine was bought in exchange of another machine. Such information can only be gained from accounting records if both effects of a transaction are accounted for.

Example Of Double Entry System Bookkeeping

Double entry bookkeeping is a system of accounting where every business transaction is recorded in two accounts: a debit entry to one account and a credit entry to another account. For example, if a company collects a loan of $5000, this is a decrease in assets and an increase in liabilities. Hence, asset account is credited with $5000 while liability is debited with $5000.

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Study has shown that many students failed accounts due to lack of indepth knowledge of the double entry principles. The principle operates on the basics that every financial transaction must have two aspects

Debit (DR) = Receiver (receiving account)

Credit (CR) = Giver (giving account)

Double entry also allows for the accounting equation (assets = liabilities + owner's equity) to always be in balance.

Importance of Double Entry System

1. The double entry system helps accountants and bookkeepers reduce mistakes, it also helps by providing a good check and balance benefit. 
2. The double-entry accounting system gives you more complete and comprehensive information about a transaction when compared to the single-entry method, since each transaction consists of both a destination and a source.
3. Before accounting software made double-entry system of recording transactions easier for small businesses, there might have been an argument for using single-entry and a cash book for very small and simple transactions.
4. Double-entry is the recommended method for most businesses because of the increased accuracy and efficiency when recording financial transactions.

Rules of Double Entry System

The Financial Accounting Standards Board (FASB) governs the generally accepted accounting principles (GAAP), which are the official rules for double entry bookkeeping.

Rules for Debits and Credits

Debits:

1. Recorded on the left of a ledger sheet
2. Increase an asset account
3. Decrease an equity or liability account
4. Decrease revenue 
5. Increase expense accounts

Credits:

1. Recorded on the right of a ledger sheet
2. Decrease an asset account
3. Increase an equity or liability account
4. Increase revenue 
5. Decrease expense accounts

Procedures For Double Entry

The following are the procedures for double entry practice:

1. The keeping of books of account.
2. The division of each book into separate accounts.
3. Each account is divided into two halves, left hand side (Dr) and right hand side (Cr)
4. All transactions must be recorded in two accounts, one account is debited and another account is credited.
5. The giver (giving account) is credited with and the value of whatever it receives  and the receiver (receiving account) is debited with the same amount.

ALSO READ: Meaning Of Assets: Fixed Assets And Current Assets

Cash And Credit Transactions

Financial transactions may be classified to cash and credit transactions

Cash Transactions

In this classification of transaction, the buyers pay for goods and services bought immediately. Here, no account will be opened in respect of a supplier or customer.

Steps In Recording Cash Transactions

• Prepare two accounts.
• Identify the "GIVING ACCOUNT" and the "RECEIVING ACCOUNT"
• Now apply the principle Cr (Giver), Dr (Receiver).

All cash transactions must pass through the cash book.

ALSO READ: Depreciation Of Fixed Assets: Causes Of Depreciation

Credit Transactions

The majority of commercial transactions are termed credit transactions, which means that the transfer of ownership takes place before payment to the supplier i.e settlement is deferred to a future date. Example: Mr John bought goods but he did not pay until 3 months later.

Steps In Recording Credit Transactions

• Prepare day books: Sales, Purchases, Returns, and Journal proper.
• Prepare two accounts.
• Identify the "GIVING ACCOUNT" and the "RECEIVING ACCOUNT"
• Apply the principle of double-entry.

Illustration of the principle of double-entry

1. January 1  Mr Frank started business with $1000 cash

EFFECT

Increase in capital: Capital account

Decrease in asset: Cash account

ACTION REQUIRED

Cr Capital account (Giver)

Dr Cash account (Receiver)

2. January 2   Paid $100 cash for rent

EFFECT

Increase in expenditure: Rent account

Decrease in asset: Cash account

ACTION REQUIRED

Cr Rent account (Giver)

Dr Cash account (Receiver)

3. January 3   Received refund for insurance $50 cash

EFFECT

Increase in assets: Cash account

Decrease in expenditure: Insurance account

ACTION REQUIRED

Cr Cash account (Giver)

Dr Insurance account (Receiver)

4. January 4    Bought motor vehicle $50 paying by cheque

EFFECT

Increase in assets: Motor vehicle account

Decrease in assets: Bank account

ACTION REQUIRED

Cr Vehicle account (Receiver)

Dr  Bank account (Giver)

5.  January 6    Cash sales $100

EFFECT

Increase in sales: Sales account

Increase in assets: Cash account

ACTION REQUIRED

Cr sales account (Giver)

Dr cash account (Receiver)

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6.  January 7     Cash purchases $100

EFFECT

Increase in purchases: Purchases account

Decrease in assets: Cash account

ACTION REQUIRED

Cr Cash account (Giver)

Dr Purchases account (Receiver)

7. January 9     Received loan $200 cash from Michael

EFFECT

Increase in assets: Cash account

Increase in liability: Loan account

ACTION REQUIRED

Cr Loan account (Giver)

Dr Cash account (Receiver)

8. January 10   Put cash $100 into the bank

EFFECT

Increase in assets: Bank account

Reduction in Asset: Cash account

ACTION REQUIRED

Cr Cash account (Giver)

Dr  Bank account (Receiver)

9. January 12   Sold goods $60 on credit to Samuel

EFFECT

Increase in assets: Samuel account

Increase in sales: Sales account

ACTION REQUIRED 

Cr Sales account (Giver)

Dr Samuel account (Receiver)