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Introduction to Double Entry Accounting

Double-Entry Accounting
Double-entry Accounting requires at least two entries for every financial transaction. An entry is made when you assign an amount to an account. If you were to write a $100-00 cheque, the entry would look like this: Account Cheque Account Amount ⇓ (Credit) $100-00

However the entry reflects only one side of the transaction. It doesn't tell you what the money has paid. If this $100-00 is to pay for monthly advertising, the entry would look like this: Account Amount ⇑ (Debit)

Advertising $100-00 These two entries when put together, make up one double-entry that looks like this: Account Cheque Account Advertising $100-00 Debit Credit $100-00

As you can see, we now have a double entry system, reflecting where the money came from and where it went. This is the basic function of the double-entry system. The most important function however is that both the credits and the debits must equal! In simple diagram form the above cheque would be drawn thus:

From: Cheque Account

To: Advertising Expense Acc.

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Accounts
Double-entry accounting assigns dollar amounts to accounts. Accounts are the categories you use to organise your business. There are six basic account types: Assets, Liabilities, Equity, Income, Cost of Sales, and Expenses. Assets: All the things the business owns. Assets include your cheque account, inventory, furniture, etc. If someone owes you money (Accounts Receivable), the money they owe you is considered an asset. These accounts start with the 1-**** prefix in MYOB Liabilities: All the things the business owes. Liabilities include loans, credit cards, etc. If you owe someone money for the supply of goods or services (Accounts Payable), it is considered a liability. These accounts start with the 2-**** prefix in MYOB Equity: Equity is what's left over after subtracting the liabilities from the assets. It is what the owner has invested in the business. These accounts start with the 3-**** prefix in MYOB

The Accounting Equation
Just say that we won a $30,000 lottery. We placed the entire amount as capital to start up our business. From the business point of view, it now has $30,000 asset. It also has a liability: $30,000 debt to the owner. This is called capital or owner’s equity. Therefore: Cash at bank ($30,000) = Equity ($30,000) Assets = Equity In the case where the owner needs additional funding and has to borrow another $10,000. Then the business has $10,000 cash and a $10,000 loan from the bank Assets = Liabilities In a more complex scenario, our businessperson has $30,000 cash to invest in the business as capital (equity) he borrows another $10,000 from ACME Finance Co. With this $40,000 the business buys $10,000 worth of stock (inventory), $5,000 worth of furniture, $15,000 worth of premises, and leaves the remaining $10,000 in the bank. The Balance Sheet (The worth of the business) would look like this: Page 2

Pollin8 Assets Cash at Bank Inventory Furniture Premises Liabilities Loan from ACME Finance Equity Owner’s Equity $10,000 $10,000 $5,000 $15,000 $40,000 $10,000 $30,000 $40,000

Assets =Liabilities + Equity The relationship between the total assets, total liabilities and total equity is known as the accounting equation. The relationship always works and is always an equality. Here is a more complex example of a Balance Sheet:

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Pollin8 Notice that in the example above, total assets=total liabilities+ total equity or: Total assets – Total Liabilities = Total Equity The balance sheet is therefore a list of all the assets, liabilities and equity of an organisation at a particular point in time. The equation can also be expressed as: Assets-Liability=Equity (both sides must be equal) There are three other accounts (categories) which are also grouped together in an accounting software. They are Income, Cost of Sales and Expenses. They logically belong together because they