Definitions

# Double-entry bookkeeping system

In accountancy, the double-entry bookkeeping (or double-entry accounting) system is the basis of the standard system used by businesses and other organizations to record financial transactions. It was first described by the Italian mathematician Luca Pacioli, in his Summa de arithmetica, geometrica, proportioni et proportionalità (Venice, 1494). Its premise is that a business's (or other organization's) financial condition and results of operations are best recorded in accounts. Each account maintains a "history" of changes in monetary values about a particular aspect of the business.

This system is called double-entry because each transaction is recorded in at least two accounts. Each transaction results in at least one account being debited and at least one account being credited, with the total debits of the transaction equal to the total credits.

For example, if Business A sells an item to Business B and Business B pays Business A by cheque, the bookkeeper of the Business A would credit the account called "Sales" and debit the account called "Bank". Conversely, the bookkeeper of Business B would debit the account called "Purchases" and credit the account called "Bank".

Historically, debit entries have been recorded on the left hand side and credit values on the right hand side of a general ledger account. The ledger accounts are set up as T accounts so called because they resemble the letter T when the account is empty.

## History

The origins of a primitive double-entry system have been traced as far back as the 12th century. Some sources suggest that Giovanni di Bicci de' Medici first introduced this method for the Medici bank. The earliest extant records that follow the modern double-entry form are those of Amatino Manucci, a Florentine merchant at the end of the 13th century. By the end of the 15th century, the merchant venturers of Venice used this system widely. Luca Pacioli, a monk and collaborator of Leonardo da Vinci, first codified the system in a mathematics textbook of 1494. Pacioli is often called the "father of accounting" because he was the first to publish a detailed description of the double-entry system, thus enabling others to study and use it.

Double-entry bookkeeping was initially introduced in Japan during the Meiji period in the 1870s. The newly-established Japan Mint was the earliest Japanese government institution to begin using double-entry bookkeeping in its Osaka headquarters.

## The bookkeeping and accounting process

In the normal course of business, a document is produced each time a transaction occurs. Sales and purchases usually have invoices or receipts. Deposit slips are produced when lodgements (deposits) are made to a bank account. Cheques are written to pay money out of the account. Bookkeeping involves recording the details of all of these source documents into multi-column journals (also known as a books of first entry or daybooks). For example, all credit sales are recorded in the Sales Journal, all Cash Payments are recorded in the Cash Payments Journal. Columns in the journal normally correspond to an account. In the single entry system, each transaction is recorded only once. Most individuals who balance their cheque-book each month are using such a system, and most personal finance software follows this approach.

After a certain period, typically a month, the columns in each journal are each totalled to give a summary for the period. Using the rules of double entry, these journal summaries are then transferred to their respective accounts in the ledger, or book of accounts. The process of transferring summaries or individual transactions to the ledger is called Posting. Once the posting process is complete, accounts kept using the "T" format undergo balancing which is simply a process to arrive at the balance of the account.

To quickly check that the posting process was done correctly, a working document called an unadjusted trial balance is created. In its simplest form, this is a three column list. The first column contains the names of those accounts in the ledger which have a non-zero balance. If an account has a debit balance, the balance amount is copied into column two (the debit column). If an account has a credit balance, the amount is copied into column three (the credit column). The debit column is then totaled and then the credit column is totaled. The two totals must agree - this agreement is not by chance - it happens because under the double-entry rules, whenever there is a posting, the debits of the posting equal the credits of the posting. If the two totals do not agree therefore, an error has been made in either the journals or made during the posting process. The error(s) must be located and rectified and the totals of debit column and credit column re-calculated to check for agreement before any further processing can take place.

Once there are no errors, the accountant produces a number of adjustments and changes the balance amounts of some of the accounts. For example, the "Inventory" account and "Office Supplies" asset accounts are changed to bring them into line with the actual numbers counted during a stock take. At the same time, the expense accounts associated with usage of inventory and with the usage of office supplies are adjusted. Other refinements necessary to ensure that accounting principles are complied with are also done at this time. This results in a listing called, not surprisingly, the adjusted trial balance. It is the accounts in this list and their corresponding debit or credit balances that are used to prepare the financial statements.

Finally financial statements are drawn from the trial balance, which may include:

## Classification of accounts

Items in Accounts are classified into five broad groups, also known as the elements of the accounts:

## Abbreviations used in bookkeeping

• a/c - account
• B/S - Balance Sheet
• c/d - carried down
• b/d - brought down
• c/f - carried forward
• b/f - brought forward
• Dr - debit
• Cr - credit
• G/L - General Ledger; (or N/L - Nominal Ledger)
• P&L - Profit & Loss; (or I/S - Income Statement)
• PP&E - Property, Plant and Equipment
• TB - Trial Balance

## Debits and credits

Double-entry bookkeeping is governed by the accounting equation. If revenue equals expenses, the following (basic) equation must be true:

assets = liabilities + equity

At any point in time, revenue may not equal expenses. If so, the equation can be further expanded, so that the (extended) equation becomes:

assets = liabilities + equity + (revenue − expenses)

or

assets = liabilities + (capital − drawings) + (revenue − expenses)

A = L + C − D + R − E

Finally, the equation may be rearranged algebraically as follows:

A + E + D = L + R + C

This equation must be true, for any time period. If it is, then the accounts are said to be in balance. If the accounts are not in balance, an error has occurred.

For the accounts to remain in balance, a change in one account must be matched with a change in another account. These changes are made by debits and credits to the accounts. Note that the usage of these terms in accounting is not identical to their everyday usage. Whether one uses a debit or credit to increase or decrease an account depends on the normal balance of the account. Assets, Expenses, and Drawings accounts (on the left side of the equation) have a normal balance of debit. Liability, Revenue, and Capital accounts (on the right side of the equation) have a normal balance of credit. On a general ledger, debits are recorded on the left side and credits on the right side for each account. Since the accounts must always balance, for each transaction there will be a debit made to one or several accounts and a credit made to one or several accounts. The sum of all debits made in any transaction must equal the sum of all credits made. After a series of transactions, therefore, the sum of all the accounts with a debit balance will equal the sum of all the accounts with a credit balance.

Debits and credits are then defined as follows:

• debit: an increase in one of the accounts with a normal balance of debit or a decrease in one of the accounts with a normal balance of credit. A debit is recorded on the left hand side of a T account
• credit: an increase in one of the accounts with a normal balance of credit or a decrease in one of the accounts with a normal balance of debit. A credit balance is recorded on the right hand side of a 'T' account
• Debit accounts = Asset and Expenses (also debit money received into bank accounts)
• Credit accounts = Gains (income) and Liabilities (also credit money paid out of bank accounts)

The following accounts have a normal balance of debit:

• Assets
• Accounts receivable: debts promised by other entities but not yet paid
• Drawings by the owners on equity
• Expenses

The following accounts have a normal balance of credit:

• Liabilities
• Accounts payable and taxes, notes or loans payable: debts promised to outsiders but not yet paid
• Revenue
• Capital

Credit and debit items are summarized at the end of a recording period in a trial balance which is a list of all the debit and credit balances. The trial balance acts as a self checking mechanism for the correctness of entries in the individual accounts and also as a starting point for the preparation of the Final Account which is made up of the balance sheet and the trading, profit and loss account.

### Examples of debits and credits

Purchase of a Computer

Debit Computer account (Fixed asset account) is increased.
Credit Creditors account (Liability account) is increased.

Paying supplier for the computer

Debit Creditors account (Liability account) is reduced.
Credit Bank account (Asset account) is reduced.

The following table summarizes how debits and credits affect the different elements of the accounts.

Debit/credit
Account Debit Credit
Assets
Expenses
Liabilities
Shareholder Equity
Revenue

## Double-entry working examples

### Example 1

In this example the following will be used:

Books of prime entry (Books of original entry)

• Sales Invoice Daybook (records customer Invoice Daybook)
• Bank Receipts Daybook (records customer & non customer receipts)
• Purchase Invoice Daybook (records supplier Invoice Daybook)
• Bank Payments Daybook (records supplier & non supplier payments)

The books of prime entry are where transactions are first recorded. They are not part of the Double-entry system.

Ledger Cards

• Customer Ledger Cards
• Supplier Ledger Cards
• General Ledger (Nominal Ledger)
• Bank Account Ledger

From the above we will create:

• Trial Balance
• Profit and Loss Statement (Dr & Cr Formatting, classic format)
• Profit and Loss Statement (List Format, Modern version used today)
• Balance Sheet (Dr & Cr Formatting, classic format)
• Balance Sheet (List Format, Modern version used today)

#### Purchases/creditors

##### Purchase invoice daybook
Purchase Invoice Daybook
Date Supplier Name Reference Amount Electricity Widgets
10 July 2006 Electricity Company PI1 1000 1000
12 July 2006 Widget Company PI2 1600   1600
------- ------- -------
Total 2600 1000 1600
==== ==== ====
Credit Debit Debit
Creditors G/L G/L
control a/c a/c a/c
Each individual line is posted as follows:

• The amount value is posted as a credit to the individual supplier's ledger a/c
• The analysis amount is posted a debit to the relevant general ledger a/c

From example above:

• Line 1 - Amount value 1000 is posted as a credit to the Supplier's ledger a/c ELE01-Electricity Company
• Line 2 - Amount value 1600 is posted as a credit to the Supplier's ledger a/c WID01-Widget Company

The totals of each column are posted as follows:

• Amount total value 2600 posted as a credit to the Trade creditors control a/c
• Electricity total value 1000 posted as a debit to the Electricity General Ledger a/c
• Widget total value 1600 posted as a debit to the Widgets General Ledger a/c

Double-entry has been observed because Dr = 2600 and Cr = 2600.

##### Bank payments daybook
The payments book is not part of the double-entry system.
Bank Payments Daybook
Date Supplier Name Reference Amount Trade Creditors Other
17 July 2006 Electricity Company BP701 1000 1000
19 July 2006 Widget Company BP702 900 900
28 July 2006 Owner's Wages BP703 400 400
------- ------- -------
Total 2300 1900 400
==== ==== ====
Credit Debit Debit
Account Creditors control a/c
control a/c
Keys: PI = Purchase Invoice, BP = Bank Payment

Each individual line is posted as follows:

• The amount value is posted as a debit to the individual supplier's ledger a/c.
• The analysis amount is posted as a credit to the relevant general ledger a/c.

From example above:

• Line 1 - Amount value 1000 is posted as a debit to the Supplier's ledger a/c ELE01-Electricity Company.
• Line 2 - Amount value 900 is posted as a debit to the Supplier's ledger a/c WID01-Widget Company.

The totals of each column are posted as follows:

• Amount total value 2300 posted as a credit to the Bank Account.
• Trade Creditors total value 1900 posted as a debit to the Trade creditors control a/c.
• Other total value 400 posted as a debit to the Wages control a/c.

Double-entry has been observed because Dr = 2300 and Cr = 2300.

The daybooks are the key documents (books) to the double entry system. From these daybooks we create the ledger accounts. Each transaction will be recorded in at least two ledger accounts.

##### Supplier ledger cards
Supplier Ledger Cards
A/c Code: ELE01 - Electricity Company
Date Details Reference Amount Date Details Reference Amount
17 July 2006 Bank Payments Daybook BP701 1000 10 July 2006 Invoice PI1 1000
Balance c/f 0
------- -------
1000 1000
==== ====
Balance b/f 0
A/c Code: WID01 - Widget Company
Date Details Reference Amount Date Details Reference Amount
19 July 2006 Bank Payments Daybook BP702 900 12 July 2006 Invoice PI2 1600
Balance c/f 700
------- -------
1600 1600
==== ====
Balance b/f 700

#### Sales/customers

##### Sales daybook
Sales Invoice Daybook
Date Customer Name Reference Amount Parts Service
2 July 2006 JJ Manufacturing SI1 2500 2500
29 July 2006 JJ Manufacturing SI2 3200   3200
------- ------- -------
Total 5700 2500 3200
==== ==== ====
Debit Credit Credit
debtors Parts Service
control a/c a/c a/c
Each individual line is posted as follows:

• The amount value is posted as a debit to the individual customer's ledger a/c.
• The analysis amount is posted as a credit to the relevant general ledger a/c.

From example above:

• Line 1 - Amount value 2500 is posted as a debit to the Customer's ledger a/c JJM01-JJ Manufacturing.
• Line 2 - Amount value 3200 is posted as a debit to the Customer's ledger a/c JJM01-JJ Manufacturing.

The totals of each column are posted as follows:

• Amount total value 5700 posted as a debit to the Trade debtors control a/c.
• Sales-parts total value 2500 posted as a credit to the Sales parts a/c.
• Sales-service total value 3200 posted as a credit to the Sales service a/c.

Double-entry has been observed because Dr = 5700 and Cr = 5700.

##### Bank receipts daybook
The receipts book is not part of the double-entry system
Bank Receipts Daybook
Date Customer Name Reference Amount Customers Others
20 July 2006 JJ Manufacturing BR1 2500 2500 0
------- ------- -------
Total 2500 2500 0
==== ==== ====
Debit Credit Credit
control a/c Debtors control a/c
control a/c
Keys: SI = Sales Invoice, BR = Bank Receipt

Each individual line is posted as follows:

• The amount value is posted as a credit to the individual customer's ledger a/c.
• The analysis amount is posted as a debit to the relevant general ledger a/c.

From example above:

• Line 1 - Amount value 2500 is posted as a credit to the Customer's ledger a/c JJM01 - JJ Manufacturing.

The totals of each column are posted as follows:

• Amount total value 2500 posted as a credit to the Trade debtors control a/c.
• Customers total value 2500 posted as a debit to the Bank a/c.

Double-entry has been observed because Dr = 2500 and Cr = 2500.

The daybooks are the key documents (books) to the double entry system. From these daybooks we create the ledger accounts. Each transaction will be recorded in at least two ledger accounts.

##### Customer ledger cards
Customer Ledger cards are not part of the Double-entry system. They are for memorandum purposes only. They allow you to know the total amount an individual customer owes you.
CUSTOMER LEDGER CARDS
A/c Code: JJM01 - JJ Manufacturing
Date Details Reference Amount Date Details Reference Amount
2 July 2006 Sales invoice daybook SI1 2500 20 July 2006 Bank receipts daybook BR1 2500
29 July 2006 Sales invoice daybook SI2 3200 31 July 2006 balance c/f 3200
------- -------
5700 5700
==== ====
1 August 2006 Balance b/f 3200

#### General/Nominal ledger

##### General/Nominal ledger

GENERAL/NOMINAL LEDGER
Sales parts
Date Details Reference Amount Date Details Reference Amount
31 July 2006 Balance c/d 2500 2 July 2006 Sales invoice daybook SI1 2500
------- -------
2500 2500
==== ====
1 August 2006 Balance b/d 2500
Sales service
Date Details Reference Amount Date Details Reference Amount
31 July 2006 Balance c/d 3200 29 July 2006 Sales invoice daybook SI2 3200
------- -------
3200 3200
==== ====
1 August 2006 Balance b/d 3200
Electricity
Date Details Reference Amount Date Details Reference Amount
10 July 2006 Electricity Co. PI1 1000 31 July 2006 Balance c/d 1000
------- -------
1000 1000
==== ====
1 August 2006 Balance b/d 1000
Widgets
Date Details Reference Amount Date Details Reference Amount
12 July 2006 Widget Co. PI2 1600 31 July 2006 Balance c/d 1600
------- -------
1600 1600
==== ====
1 August 2006 Balance b/d 1600
Other a/c
Date Details Reference Amount Date Details Reference Amount
28 July 2006 Owner's Wages BP703 400 31 July 2006 Balance c/d 400
------- -------
400 400
==== ====
1 August 2006 Balance b/d 400
Bank Control A/c
Date Details Reference Amount Date Details Reference Amount
31 July 2006 Bank receipts daybook BR-Jul 2500 31 July 2006 Bank payments daybook BP-Jul 2300
31 July 2006 Balance c/d 200
------- -------
2500 2500
==== ====
1 August 2006 Balance b/d 200
Date Details Reference Amount Date Details Reference Amount
1 July 2006 Balance b/d 0 31 July 2006 Bank receipts daybook BR-Jul 2500
31 July 2006 Sales Invoice Daybook SI-Jul 5700 31 July 2006 Balance c/d 3200
------- -------
5700 5700
==== ====
1 August 2006 Balance b/d 3200
Date Details Reference Amount Date Details Reference Amount
31 July 2006 Bank Payments Daybook BP-Jul 1900 1 July 2006 Balance b/d 0
31 July 2006 Balance c/d 700 31 July 2006 Purchase Daybook PI-Jul 2600
------- -------
2600 2600
==== ====
1 August 2006 Balance b/d 700
The customers ledger cards shows the breakdown of how the trade debtors control a/c is made up. The trade debtors control a/c is the total of outstanding debtors and the customer ledger cards shows the amount due for each individual customer. The total of each individual customer account added together should equal the total in the trade debtors control a/c.

The supplier ledger cards shows the breakdown of how the trade creditors control a/c is made up. The trade creditors control a/c is the total of outstanding creditors and the suppliers ledger cards shows the amount due for each individual supplier. The total of each individual supplier account added together should equal the total in the trade creditors control a/c.

Each Bank a/c shows all the money in and out through a bank. If you have more than one bank account for your company you will have to maintain separate bank account ledger in order to complete bank reconciliation statements and be able to see how much is left in each account.

##### Bank account
Bank A/c
Date Details Reference Amount Date Details Reference Amount
1 July 2006 Balance b/d 0 17 July 2006 Bank Payments Daybook BP701 1000
20 July 2006 Bank Receipts Daybook BR1 2500 19 July 2006 Bank Payments Daybook BP702 900
28 July 2006 Bank Payments Daybook BP703 400
31 July 2006 Balance c/d 200
------- -------
2500 2500
==== ====
1 August 2006 Balance b/d 200
Trial balance as at 31 July 2006
A/c description Debit Credit
Sales-parts 2500
Sales-service 3200
Widgets 1600
Electricity 1000
Other 400
Bank 200
------- -------
6400 6400
===== =====
Both sides must have the same overall total
Debits = Credits.
The individual customer accounts are not to be listed in the trial balance, as the Trade debtors control a/c is the summary of each individual customer a/c.

The individual supplier accounts are not to be listed in the trial balance, as the Trade creditors control a/c is the summary of each individual supplier a/c.

Important note: this example is designed to show double entry. There are methods of creating a trial balance that significantly reduce the time it takes to record entries in the general ledger and trial balance.

##### Profit-and-loss statement and balance sheet

Profit and loss statement
for the month ending 31 July 2007
Dr
x Sales
x Sales-parts 250000
x Sales-service 320000
x -------
x 570000
x Widgets 160000
x -------
x Gross Profit 410000
x Less expenses
x Electricity 100000
x Other 40000
x -------
x 140000
x -------
x Net Profit 270000
x ====
Balance sheet
as at 31 July 2007
Dr
x Current Assets
x Bank A/c 20000
x -------
x 340000
x Current Liabilities
x -------
x 70000
x -------
x Net Current Assets 270000
x ====
x Capital & Reserves
x Revenue Reserves a/c 270000
x -------
x 270000
x ====

### Example 2

#### Transactions

XYZ Company is closing its books for the end of the month. Each of the daily journals has been summarized and the amounts are ready to be transferred to the general ledger. The amounts to be transferred are:

• Purchase raw materials on trade credit: \$500,000
• Pay workers from cash in bank to make goods: \$1,500,000
• Pay sales force from cash in bank to sell goods: \$1,000,000
• Sell goods for cash: \$3,500,000

To close the books for the month, we will adjust expenses and revenue to be zero by appropriately crediting and debiting the income summary and then closing the income summary to retained earnings (part of equity).

These items are entered in the ledger below; each matching credit and debit have been numbered to make finding them in the ledger easier.

#### Ledgers

General Ledger (in 000s)
Transaction Debit Credit Balance
Expenses
Balance forward     -
1 Raw materials \$ 500   \$ 500
2 Labor \$ 1500   \$ 2000
3 Sales costs \$ 1000   \$ 3000
5 Income summary   \$ 3000 -
Total \$ 3000 \$ 3000
Revenue
Balance forward     -
4 Revenue from sales   \$ 3500 \$ 3500
6 Income summary \$ 3500   -
Total \$ 3500 \$ 3500
Cash
Balance forward     \$11000
2 Labor   \$ 1500 \$ 9500
3 Sales costs   \$ 1000 \$ 8500
4 Revenue from sales \$ 3500   \$12000
Total \$ 3500 \$ 2500
Accounts Payable
Balance forward     \$ 1000
1 Raw materials   \$ 500 \$ 1500
Total - \$ 500
Income summary
Balance forward     -
5 Expense \$ 3000   \$ 3000
6 Revenue   \$ 3500 \$ 500
7 Retained earnings \$ 500   -
Total \$ 3500 \$ 3500
Retained earnings
Balance forward     \$10000
7 Income summary   \$ 500 \$10500
Total - \$ 500
Total all accounts: \$13500 \$13500

The amount in equity (in the form of retained earnings) has changed with a net credit of \$500,000. Since equity has a normal balance of credit, this means there is now \$500,000 more in equity than at the beginning of the month.