The financial statements are produced at the end of the period as it will be silly and impracticable to produce a financial statement each time a transaction is made. However, every transaction must be recorded and is recorded as they take place.
The recording usually starts from the journal entry, then the ledger, then all the way to the preparation of the final account.
What is accounting equation?
The accounting equation is the equilibrium statement of logic relating to a company’s Assets, Liabilities and Owners’ equity. This is to say that an organization’s total assets equal the combined values of liabilities and equities. Accountants generally use the trial balance to test this equality before preparing the financial statements.
What is double entry accounting?
To make the above claims about accounting equation true, the double entry procedures must be fully observed each time a business transaction is posted. You will agree with me that one of the importance of accounting is to keep accurate useful records of all business transactions.
Double entry ensures that the effects of both ends of a business transaction on a company are fully recorded. Every transaction is entered as a debit entry in one account (or more) and a credit entry in another account (or more) – these effects must be equal and opposite.
Oxford Dictionary of Accounting defines double entry accounting as ‘a method of recording the transactions of a business in a set of accounts, such that every transaction has a dual aspect and therefore needs to be recorded in at least two accounts. Double entry keeps the account balanced and relational. This entry principle was invented by a monk called Luca Pacioli (1447 -1517)
Double entry procedure with examples
It is best to use examples to explain the double entry procedures. We are going to use ‘T’ accounts for this purpose.
Double entry procedure example
The following are few transactions of Hybrid Accountants trading business during the first month of trading. (Not that our transactions are this few, just for illustration, am sure you get the idea)
|1-May-22||Starts business with capital||$5,000.00|
|5-May-22||Bought a car for cash||$1,000.00|
|14-May-22||Bought goods for resale cash (purchases)||$500.00|
|15-May-22||Bought mores goods for resale on credit||$600.00|
|22-May-22||Paid rent for cash||$250.00|
|29-May-22||Sold half of the goods on credit||$900.00|
|31-May-22||Sold the other half of goods for cash||$800.00|
Double entries for the above transactions using ‘T’ Accounts. Please note that all that you are about to learn in this section are now done by computers using accounting software. However, please do read carefully as the knowledge gained here are key to your successful accounting career that would be built on solid understanding of debit and credit.
The first transaction has effects on Capital Account and Cash Account as follows:
Image (1) Capital Account after the first transaction
Image (2) Cash Account after the first transaction
The two effects of the first transaction in our baby example are fully captured in the above two double entries demonstrated.
Image (3) Car Account after the second transaction
Image (4) Cash Account after the second transaction
Again, notice the dual effects of the second transactions ‘car account’ and ‘cash account’.
Image (5) Purchase Account after the third transaction
Image (6) Cash Account after the third transaction
Image (7) Purchase Account after the fourth transaction
Image (8) Payables Account after the fourth transaction
Image (9) Rent Account after the fifth transaction
Image (10) Cash Account after the fifth transaction
Image (11) Receivables Account after the sixth transaction
Image (12) Sales Account after the sixth transaction
Image (13) Cash Account after the seventh transaction
Image (14) Sales Account after the seventh transaction
Golden rule of double entry and 8 general rules of double entries
The golden rule of double entry hinges on the popular phrase ‘for every debit entry, there must be a corresponding credit entry’. The other rules are:
- Increase in Assets are debit entries
- Increase in expense accounts are debited
- Decrease in Liabilities are debit entries
- Increase in liabilities are credit entries
- Decrease in assets accounts are credit entries
- Income accounts are credited (sales and capital accounts are good examples)
- Debit the accounts that receives value (not necessarily money) – reemphasizing all the debit entry rules
- Credit accounts that gives value (not necessarily money) – reemphasizing all the credit entry rules
At the end of the month, accounting adjustments are made to properly close the accounts that require closing before preparing the final account.