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MGT101 - Financial Accounting - I - Lecture Handout 04

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SINGLE AND DOUBLE ENTRY RECORD KEEPING

Learning Objective

  • The objective of this lecture is to develop an understanding in the students about the basic concepts like:
    • The separate business entity
    • Single and double entry book-keeping
    • Debit and Credit
    • The dual aspect of a transaction
    • Accounting equation

Separate Entity Concept

In accounting, ‘The Business’ is treated independently from the persons who own it. This means, although anything owned by the business belongs to the owners of the business and anything owed by the business is payable by the owners but for accounting purposes, we assume that the business is independent from its owners. This means, if the business purchases a machine or piece of equipment, business will own and obtain benefit from that machine or equipment. Likewise, if the business borrows money from ‘someone’ it will have to repay the money. This ‘someone’ includes even the owner of the business.

This treatment of the business independently from its owners is called the

‘Separate Entity Concept’.

Single Entry Book-keeping

This is the conventional style of keeping records of financial transactions. In single entry book keeping system, as it is clear from the name, only one aspect of the transaction is recorded. This actually is not a system but is a procedure by which small business concerns, like retailers and small shopkeepers, keep record of their sale / income. In this system, there are usually two to three registers “Khata”. In one register cash received from customers is recorded, whereas the other one is a personwise record of goods sold on credit “Udhar Khata”. There may or may not be a register of suppliers to whom money is payable. That means, only one aspect of transaction i.e. either cash receipt or the fact that money is receivable from someone is recorded.

Double Entry Book-keeping

The concept of double entry is based on the fact that every transaction has two aspects i.e. receiving a benefit and giving a benefit. The accounting system that records both the aspects of transaction in books of accounts is called double entry system.
The account that receives the benefit is debited and the account that provides the benefit is credited. ‘Debit’ and ‘Credit’ are denoted by ‘Dr’ and ‘Cr’ respectively. The ultimate result of the system is that for every Debit (Dr) there is an equal Credit (Cr).

Single & Double Entry Book-keeping Distinguished

The double entry system is a more sophisticated, comprehensive and reliable form of single entry book keeping system.

  • Single entry system records only one aspect of the transaction such as:
    • Cash received from sale is recorded in cash register only,
    • Goods sold on credit are recorded in the individual’s account only,
    • When cash is received from the customer, to whom something was sold on credit, the receipt may just be recorded in the account of individual only.
  • Double entry system records both the aspects of the transaction;
    • When good are sold on cash the two aspects of the transaction are – the seller has sold goods and received cash against them. The goods sold are benefit transferred to the purchaser (Credit) whereas the cash received if the benefit against the goods sold (Debit).
    • When the goods are sold on credit the benefit given is the same i.e. goods sold but the benefit received is not cash but a right to receive cash from the customer. Therefore, in this case Debit is given to customer’s account (account receivable) instead of cash.
    • When cash is received from the customer the right to receive cash ceases. So, the benefit received is cash and benefit transferred is the right to receive cash. Here cash will be debited and customer will be credited.

      Adopting the double entry accounting system can, therefore, have following benefits:

    • Every transaction has equal Debit and Credit; hence the total of all Debit accounts will be equal to the total of all Credit accounts at any given time. This serves as a quick test of mathematical accuracy of book keeping.
    • Since all aspects of transactions are recorded, therefore, the books are more informative. In the above example of trader, if he keeps records under double entry system will know the exact figure of total sale, cash in hand and receivable from customers from their respective accounts at any desired time.

Debit and Credit

Debit and Credit are two Latin words and as such it is difficult to say what do these mean. But we can develop an understanding as to what does these terms stand for.

Debit

It signifies the receiving of benefit. In simple words it is the left hand side. DEBIT is a record of an indebtedness; specifically an entry on the left-hand side of an account constituting an addition to an expense or asset account or a deduction from a revenue, net worth, or liability account.

Credit

It signifies the providing of a benefit. In simple words it is the right hand side. CREDIT, in accounting, is an accounting entry system that either decreases assets or increases liabilities; in general, it is an arrangement for deferred payment for goods and services.

Dual Aspect of Transactions

For every debit there is an equal credit. This is also called the dual aspect of the transaction i.e. every transaction has two aspects, debit and credit and they are always equal. This means that every transaction should have two-sided effect. For example Mr. A starts his business and he initially invests Rupees 100,000/- in cash for his business. Out of this cash following items are purchased in cash;

  • A building for Rupees 50,000/-;
  • Furniture for Rupees 10,000/-; and
  • A vehicle for Rupees 15,000/-

This means that he has spent a total of Rupees 75,000/- and has left with Rupees 25,000 cash. We will apply the Dual Aspect Concept on these events from the viewpoint of business.

When Mr. A invested Rupees 100,000/-, the cash account benefited from him. The event will be recorded in the books of business as,

DebitCashRs.100, 000
CreditMr. ARs.100, 000

Analyse the transaction. The account that received the benefit, in this case is the cash account, and the account that provided the benefit is that of Mr. A.

• Building purchased – The building account benefited from cash account

DebitBuildingRs.50, 000
CreditCashRs.50, 000

• Furniture purchased – The furniture account benefited from cash account

DebitFurnitureRs.10, 000
CreditCashRs.10, 000

• Vehicle purchased – The vehicle account benefited from cash account

DebitVehicleRs.15, 000
CreditCashRs.15, 000

Basic Principle of Double Entry

We can devise the basic principle of double entry book-keeping from our discussion to this point “Every Debit has a Credit” which means that “All Debits are always equal to All Credits”.

Assets

Assets are the properties and possessions of the business.

Properties and possessions can be of two types:

  • Tangible Assets that have physical existence ( are further divided into Fixed Assets and Current Assets)
  • Intangible Assets that have no physical existence

Examples of both are as follows:

  • Tangible Assets – Furniture, Vehicle etc.
  • Intangible Assets – Right to receive money, Good will etc.

Accounting Equation

From the above example, if the debits and credits are added up, the situation will be as follows:

Debits

CashRs.100,000/-
Building50,000/-
Furniture10,000/-
Vehicle15,000/-

Credits

Mr. ARs.100, 000/-
Cash75,000/-

The total Equation becomes:

DEBITS=CREDITS
Cash + Building + Furniture + Vehicle=Cash + Mr. A
100000 + 50000 + 10000 + 15000=75000 + 75000

Cash on Left Hand Side is Rupees 100,000/- and on Right Hand Side it is Rs.75, 000/-. If it is gathered on the Left Hand Side it will give a positive figure of Rupees 25,000/- (which you will notice is our balance of cash in hand). Now the equation becomes:

DEBITS=CREDITS
Cash + Building + Furniture + Vehicle=Mr. A
25,000 + 50,000 + 10,000 + 15,000=100,000

Keeping the entity concept in mind we can see that the business owns the building, furniture, vehicle and cash and will obtain benefit from these things in future. Any thing that provides benefit to the business in future is called ‘Asset’. Similarly the business had obtained the money from Mr. A and this money will have to be returned in form of either cash or benefits. Any thing for which the business has to repay in any form is called ‘Liability’. So cash, building, furniture and vehicle are the assets of the business and the amount received from Mr. A for which the business will have to provide a return or benefit is the liability of the business. Therefore, our equation becomes:

Assets = Liabilities

The liabilities of the business can be classified into two major classes i.e. the amounts payable to ‘outsiders’ and those payable to the ‘owners’. The liability of the business towards its owners is called ‘Capital’ and amount payable to outsiders is called liability. Therefore, our accounting equation finally becomes:

Assets = Capital + Liabilities

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