infosheet Double Entry Book-keeping      Return to menu
     
   An Introduction to double entry
book-keeping		    The first point to make, is that double entry book-keeping is a very simple set of rules that has evolved over many centuries. The same principles apply even today in the age of computerised accounting systems.

All businesses are required by law to keep a written record of their day-to-day business transactions. The purpose of double entry book-keeping is to ensure that the records prepared under this convention, can be universally understood by anyone with the authority to read them.

Book-keeping is a set of rules that define how each kind of business transaction should be written up into the accounting records. The best way of coming to grips with the process is to follow a few simple transactions as they are recorded in a set of manual daybooks.

Double entry is one of those odd subjects you meet in life, where you will never understand the individual parts until you have looked at the whole process. Many people get very frustrated when they first try to learn the system. Their mistake is to try to get to know all about each part of the system, before moving onto the next.

Save yourself of lot of time and unnecessary anguish. If you do not understand one aspect of an individual process, don't waste time by reading it again and again in the hope that eventually the penny will drop. Press on to the next section. The explanation you are looking for will nearly always be found further down the page.

Another tip is to just accept that many of the rules have been formulated because there is simply a need to define a convention for everyone to follow. You can waste many hours of trying to understand why a bank payment should always be recorded as a credit entry in the right-hand column of the bank ledger, instead of just accepting that it is just the way it is always done.

If everyone makes the entry this way, then (in theory at least) those accounts should be understood by any other book-keeper. Why do the British drive on the left-hand side of the road? Answer - by convention of course as it avoids a lot of unnecessary accidents.

In both cases, it could so easily have been the other way around.
   The Basic Rules    By convention all accounting records are kept in ledgers (a term derived from the time when accounts were written up into large books called ledgers) that consist of pages of analysis columns used for recording details of individual business transactions that occur over a given period.

By convention:

  • Every transaction will always require two equal and opposite entries in the ledgers.


  • The two main number columns in the ledger, are called the Debit and Credit columns.


  • The Debit column is on the left, and the Credit column is on the right.



    • Figure 1 - This is the typical format of a ledger page
       Sample Limited    In order to explain how the system works, we are going to examine how Andrew and Barbara Crane record a few typical transactions through their accounting records, using double entry principles.

    Mr and Mrs Crane run a small graphic design business trading under the name of Samples Limited.

    Needless to say, all references to the people and businesses in this document are purely fictitious. Any reference to any existing business or actual person is incidental and unintentional.
       Entering your first double entry transaction    Mr Crane buys some stationery from Mr Smith's Stationers for £100. Mr Crane must make two equal and opposite entries somewhere is the Company's accounting ledgers to record this transaction.

    One entry will be recorded in the Debit column. The other in the Credit column.

    As a point of interest, the fact that each transaction requires two entries to be made in the ledgers, gave rise to the term 'double-entry'.

    If we follow through on the payment of £100, then the Company's ledger will be completed in the following way:

    Figure 2 - Recording the first cash transaction:


       Balancing the books    The term balancing the books comes from the need to ensure that the total of the Debit column always equal the total of the Credit column. When they do, it is reasonable to assume that the ledgers have been correctly written up with the correct counterbalancing entries.

    If the two columns do not add up to the same amount, the reviewer knows an error has been made. The possible errors could be:

  • A simple addition error has been made in one, or both of the columns;
  • The wrong amount has been recorded in one, or more places; or
  • One or more entries have been entered in the wrong column


    • The value of the double entry book-keeping system, and the reason why it has lasted all these years, is the elegant way it highlights that an error has been made. If the columns don't agree, then the error(s) must be found by someone going back through the transaction history. The accounting records can only be relied upon once the error causing the imbalance has been found and corrected.

    It is a common mistake to assume that if the columns don't agree by a small amount, then the problem is insignificant and not worth resolving. What's a few pence between friends.

    A little thought on your part will quickly lead you to realise that a difference of a single penny between the Debit and Credit column totals, could represent an error of £1m one way, and a £1m less a penny the other.
       Attention to detail creates an informative history    A review of Figure 2 shows that the ledger conveys very little useful information. All it tells us is that a payment has been made to Mr Smith. We need to record from which bank account the payment came from, and also reflect that stock has been purchased.

    If you think about this transaction, the net effect of the payment would be to reduce the funds in the bank account by £100. And increase our level of stationery stock by the same amount.

    These more useful pieces of information could be recorded in Mr Crane's ledger as follows:

    Figure 3 - The completed double-entry:


    Ignore for the moment why we choose to credit the 'bank' and debit 'stationery', and not the other way around. The important point to note is that if we continue to record other transactions in the same manner, by the end of the day, we will have created a meaningful written history of the day's business.
       A day's trading    After a day's trading at Samples Ltd, the same ledger, may look something like this:

    Figure 4 - The Day's Ledger:


    Although the Cranes's have only enacted four transactions, it has taken eight entries in the ledger to reflect the day's business.

    The two sales transactions need to record the sales have taken place, and that cash has been received into the till.

    Likewise, the purchase of milk has been recorded, and the bank entry shows a payment has been made to the milkman.

    With so few transactions, you do not have to be an accountant to extract some meaningful trading information from the ledger. It would appear that today we have sold £750 worth of goods (£250+£500). Samples Ltd's cash register now has £750 extra cash or cheques in the till tray. The Crane's have also paid out a total of £110 (£100+£10) to suppliers from the bank account.

    From this simple ledger we can also calculate the profit made for the day. By extracting the sales (£750), and deducting the day's expenditure on stationery and milk (£110) it is easy to calculate the profit for the day would be £640 (£750-£110). This would only be correct, however, if we had consumed all of the day's purchases in completing the sales for the day. Let us assume that we had. This the profit and loss account for the day.

    You should also be able to see that although our bank account has reduced by the £110 payments made to suppliers, the funds in our till have also increased by £750 sales receipts. Take one from another to arrive at the increase in net assets of the business of £640. This is the balance sheet for the end of the day.

    It is no coincidence that the increase of net assets of £640 in the balance sheet, equals the profits for the day of £640 in the profit and loss account. See the next section for an explanation of this relationship.
       Different types
    of ledgers    		    In practice, the summary ledger we created in Figure 4 is referred to as the Nominal Ledger (or the General Ledger) and forms the central backbone of every accounting system.

    The extraction of the sales, purchases and cash movements from the Nominal Ledger in the last section, presented no problems because there were so few transactions. The number of transactions that are likely to be entered into the Nominal Ledger of even a small business will be much greater. In these circumstances it will not be so easy to extract these useful trading figures and results. It could of course be done, but the process would be very tedious.

    To help make the process more efficient, it makes sense to group and record individual transactions of the same type into their own separate ledgers. Sales, purchases, cash and stock are typical examples that are handled in this way.

    It is all very well keeping separate ledgers so that we can easily extract the sales to date, or how much money has come in, or has been paid out. But what happens to the Nominal Ledger? You will be pleased to learn that you do not have to write up the same set of transactions twice. Once in the separate ledger and once again in the Nominal Ledger. It is normal practice to write-up the detailed records in the separate ledgers, and then just record a single-line total in the Nominal Ledger to keep it balanced. This approach also serves to keep the volume of data stored in the Nominal Ledger down to a manageable level.

    Take 'sales' for example. The Sales Ledger would look like this:

    Figure 5 - The Sales Ledger (full transactions history):


    By summarising the sales transaction in this way, we can instantly draw down a total for the day's takings, matched by the cash received.

    Figure 6 - The Nominal Ledger (containing just a single-line summary of the sales and cash received):


    The saving of two lines in the Nominal Ledger may not be much in this example. It will be a different matter when there are several hundred sales transactions a day. To write up all of those individual transactions twice would be a monumental waste of time and effort.