Double Entry System assignment help 

Double Entry System is a scientific technique of accounting in which every transaction has two-fold aspects- debit and credit, and both of the aspects are recorded in the books of accounts.

E,g. 1) For every purchase transaction made by the business, inventory will increase and cash will decrease or creditors will increase by the same amount.

2) If payment is received from the debtors, then cash goes up and receivables goes down by the same amount.

Why this system is called Double entry system is quiet by its name. This technique has been proven very useful and systematic for businesses because it recognizes and records both the aspects of the transaction which makes the books of account balanced.

Here are some advantages of a double entry system accounting-

a. Through the use of Trial Balance, this system ensures accuracy of the accounting work performed throughout the period

b. The profit or loss during the period can be ascertained in detail with the help of Profit and Loss account

c. The financial position of the firm can be well derived and presented at the period end through Balance Sheet

d. Results of one year can be compared with those of the previous years and reasons for the change can be ascertained. Corrective measures can be taken on the basis of this comparison

e. This technique requires accounts to be kept in as much detail as necessary, so all the significant information can be presented to the users to the financial statement

Debit and Credit

The whole system of double entry accounting system (debit and credit) is based on the following equation-

Assets = Liabilities + Capital

Or, Assets – Liabilities = Capital

Now, first let us have a brief introduction to what do assets, liabilities and capital mean for a business entity.

Assets are economic resources, tangible or intangible, which have value and are owned by a business enterprise to produce positive economic outcomes/values. They are valuable resources that an entity uses to generate income and meet its debts & commitments.

All the assets are recorded at their monetary value on the left side of the Balance Sheet.

Liabilities are obligations that the company is bound to pay as a result of the past transactions like purchase of goods/services on credit or borrowing money, the settlement of which may result in decrease in assets of the entity.

All the liabilities are recorded at their original book value on the right side of the Balance Sheet.

Capital/ Owners’ equity is the account that’s shows the stake or equity of owners in the business. 

An entity is separate from its owners and hence any capital invested by the owners/ shareholders in the business and any profit earned thereon are all liabilities upon the business to pay to its stakeholders.

Capital also shows that how much of the company’s assets are owned by the owners/shareholders of the company and not by its creditors.

Capital/ Owners’ equity is recorded on the right side of the Balance Sheet along with the liabilities.

Under the double entry accounting system, two approaches are followed to record the transactions in the books, which are- 

1) Accounting Equation Approach

We know that any transaction that takes place in an enterprise have an equalizing effect on the equation, i.e. it should affect assets, liabilities or capital in a way that they agree to this equation.

E.g.Started the business with cash $20,000.

A = C + L

20,000 = 0 + 20,000

Now the above example shows you the effect of any transaction on the assets, liabilities and capital using the “+” and “-“signs but this is not how transactions are recorded in the books of accounts. (We will study about this approach in detail later under the topic “Accounting Equation”)

As there are a lot of transactions taking place in the day-to-day operations of the business, separate “T-shaped” accounts are prepared for each items e.g. cash account, Owners’ equity account, creditors account, debtors account, inventory account, income account, expense account, etc. 

All the transactions/events or items increases the asset of the company or decreases its obligations/liabilities is debited in the books of account. All the transactions which increase the liability/obligation (internal liability- owners’ capital and external liability- creditors) or decreases the assets is credited in the books of accounts.

Note:- The left side of the “T-shaped” account is called the Debit side and the right side is called the credit side. 

To elaborate more, let’s make separate accounts for assets, liabilities and capital for some of the transactions-

1. Started the business with cash $20,000

2. Purchased inventory worth $14,000 on credit

3. Loan repaid to the bank for $8,000

4. Withdrew cash from the business for personal use $3,000

5. Borrowed $5,500 from a moneylender

As we can see in the above transactions that all the transactions which increased the assets and decreased the obligations (creditors and capital) are debited and transactions which had an opposite affect were credited.

Also please note that all the transactions above have an equal debit as well credit side to it.

2) Traditional Approach 

For the purpose of recording, the transactions are classified in three separate accounts as per the traditional approach of accounting-

(i) Personal account (debtors, creditors, capital accounts)

(ii) Real account (assets like cash, buildings, investments, deposits, etc.)

(iii) Nominal account (expenses, incomes, gains and losses)

All the above accounts have two rules, one related to debit and another related to credit, for recording transactions under the double entry system.

1. For Personal account: 

Debit the receiver

Credit the giver

2. For Real account:

Debit what comes in

Credit what goes out

3. For Nominal account:

Debit all the expenses and losses

Credit all the incomes and gains                    

Let’s discuss some of these transactions in details with the help of examples-

1. Sale of inventory for $2,000 (cost $1,500)

Cash Account                   Dr.                         $2,000

To Sales Account                      Cr.                        $2,000

Sales Account                   Dr.                         $2,000

To Inventory Account              Cr.                        $1,000

To Profit & Loss Account         Cr.                        $ 500

Conclusion:  Increase in assets (cash) is debited. (Real account - Debit what comes in)

Sales increases the income/revenue of the firm, hence credited. (Nominal Account- Credit all the incomes and gains)

Further, sales Account is adjusted showing its effect on the inventory and Profit & Loss account. Every sale transaction decreases the inventory so it is credited. (Real account - Debit what comes in)

In this case, the sale price of the stock is more than its cost price, so it a profitable sale for the entity. This increases the profit of the firm or reduces the loss, which in turn increases the capital, hence credited. (Nominal Account- Credit all the incomes and gains)

2. Purchase of inventory with cash for $3,100

Purchases Account                   Dr.                         $3,100

To Cash Account                 Cr.                        $3,100

 Conclusion: Purchase a/c is debited because purchase is an expense for the firm hence it reduces the profit or increases the loss, which in turn decreases the capital, hence debited. (Nominal Account- Debit all the expenses and losses). Purchase of inventory implies increase in stock

Decrease in assets (cash) is credited. (Real account - Credit what goes out)

3. Sale of old machinery for $15,500 (Cost $17,500 after charging depreciation)

Cash Account                   Dr.                         $15,500

Profit & Loss Account     Dr.                         $2,000

To Machine Account                 Cr.                        $17,500

Conclusion: Sale of machinery implies increase in cash/debtors by sale price, hence debited. (Real account - Debit what comes in)

As, this is a case of loss, so, the loss will be the excess of cost price over sale price. The capital will decrease with the same amount as it decreases the firm’s liability to pay to its owners, hence the Profit & loss account is debited. (Nominal Account- Debit all the expenses and losses)

On the other hand, it also implies the reduction in the value of machinery by book value, i.e. cost less depreciation, hence machinery account is credited. (Real account - Credit what goes out)

4. Payment received from a debtor in cash for $5,000

Cash Account                   Dr.                         $5,000

To Debtors Account                      Cr.                        $5,000

Conclusion: Payment received implies increase in cash. Hence, cash account is debited. (Real account - Debit what comes in, Credit what goes out) 

It also implies decrease in debtors by the same amount. Hence, debtors account is credited. (Personal account - Credit the giver)

5. Administration expenses for the year $4,000 paid in cash

Admin Exp. Account                   Dr.                         $3,100

To Cash Account                 Cr.                        $3,100

Profit & Loss Account                   Dr.                         $3,100

To Admin Exp. Account         Cr.                        $ 3,100

Conclusion: AdministrationExpenses paid decreases the profit of the entity. (Nominal Account- Debit all the expenses and losses)

As, in this case expenses are paid in cash, it will decrease the cash of the entity. So, cash account is credited. (Real account -Credit what goes out)

As expenses decreases the profit and increases the loss, it also decreases the liability of the business to pay to its stakeholders. So, the Profit and Loss account is debited because of the increase in loss. (Nominal Account- Debit all the expenses and losses)

6. Outstanding expenses of $4,600 due for the year

Expenses Account                   Dr.                         $4,600

To Outstanding expenses Account                 Cr.                        $4,600

Profit & Loss Account                   Dr.                         $4,600

To Expenses Account         Cr.                        $ 4,600

Conclusion:  Expenses decreases the profit of the entity, even if it’s not paid in the same year, it is always charged in the same year. (Nominal Account- Debit all the expenses and losses)

As, in this case expenses are yet to be paid and it’s due for the year, it will create a creditor account in the name of Outstanding expenses which increases the firm’s liability to pay, hence credited. (Personal account- Credit the giver)

As expenses decreases the profit and increases the loss, it also decreases the liability of the business to pay to its stakeholders. So, the Profit and Loss account is debited because of the increase in loss. (Nominal Account- Debit all the expenses and losses)

7. Outstanding rent of $1,600 received from the tenants 

Cash Account                   Dr.                         $1,600

To Outstanding Rent Account                 Cr.                        $1,600

Conclusion:  Rent is received in cash, so cash account is debited. (Real account - Debit what comes in)

As the rent income belongs to the previous year but it is received in the current year, it won’t have any effect on the Profit and Loss account of the entity for the current period. The period to which the income belongs, the rent income would have increased the profit of that period. Also, as the rent wasn’t received in that period, a receivable/debtor account would have been created and shown on the asset side of the Balance Sheet.

Since the rent is received in the current period, hence the Outstanding Rent account has to be decreased with the amount received, hence credited. (Personal account:Credit the giver)

8. Withdrawal of $9,200 cash from the business for personal use

Capital                  Dr.                         $4,600

To Cash               Cr.                        $ 4,600

Conclusion:  Withdrawal of Capital decreases the firm’s liability to pay to the owner/ shareholders, hence debited. (Personal account:Debit the receiver)

As, in this case, withdrawal of capital is done by cash, so it will decrease the cash of the entity. Hence cash account is credited. (Real account -Credit what goes out)