Double entry, ledger accounts and the divisions of the ledger

Last time

Before we start: last time, in The cash book and the petty cash book, you learned these points. Here they are again on one card. Keep them in mind, because today builds on them.

Every transaction has two sides

When a business buys a machine for cash, two things change: it has a machine, and it has less cash. Accounting records both sides of every transaction. That is double entry, and everything else in this course is built on it.

The accounting equation

Assets are what the business owns. Liabilities are what it owes to others. Capital is what it owes to the owner. The accounting equation: assets equal capital plus liabilities. If assets are 12,000 dollars and liabilities 3,000, capital must be 9,000. Every transaction keeps the equation balanced.

The double-entry rule

Every transaction is recorded twice: once on the debit side of one account, and once on the credit side of another, for the same amount. Debit the account that receives the value; credit the account that gives the value. So total debits always equal total credits.

Debit or credit?

Here is the pattern for each type of account. An increase goes on one side; a decrease on the other.

Worked: buying a machine

The business buys a machine for 5,000 dollars, paying by cash. The machine account receives value, so it is debited 5,000. The cash account gives value, so it is credited 5,000.

Worked: a credit sale

The business sells goods for 800 dollars on credit to a customer, Ali. Ali now owes the business money, so his account, a trade receivable, is debited 800. The sales account is credited 800, because sales are income.

A ledger account

A ledger account has a debit side on the left and a credit side on the right, each with the date, the details, and the amount. Here is the cash account after two entries.

Balancing an account

Add up both sides. Put the difference on the smaller side as balance carried down, so both totals agree. Then bring the balance down on the opposite side, as balance brought down, to start the next period. A debit balance on cash means the business has cash. A credit balance on a supplier means it owes money.

Divisions of the ledger

The sales ledger holds the accounts of credit customers, the trade receivables. The purchases ledger holds the accounts of credit suppliers, the trade payables. The general, or nominal, ledger holds all other accounts: assets, expenses, income and capital. The cash book holds cash and bank.

The trial balance

A trial balance is a list of all the balances in the ledger on a date, debit balances in one column and credit balances in another. If double entry has been done correctly, the two totals agree. But agreement does not prove there are no errors, as you will see in chapter two.

Mistakes that lose marks

Mistake one: debiting the account that gives value. Debit the one that receives. Mistake two: entering a credit sale in the cash account. No cash has moved yet. Mistake three: putting the balance carried down on the larger side. The fix: name both accounts, decide which receives, then balance carefully.

The full-marks tip

The full-marks tip: for every transaction, name the two accounts first, then decide which is debited and which credited. When balancing, check that both totals are equal and the balance comes down on the right side.

On one card

So, on one card: double entry. Keep it for revision.