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Accounting Basics 1 | Double Entry Accountancy

Accounting Basics 1 | Double Entry Accountancy
Double entry accountancy basics explained

Debits and Credits – The Double Entry Accounting System

Modern day accounting may be done on computers and in The Cloud but the basics of the system have been around for centuries.

Luca Pacioli, a Fransican Monk, described the Double Entry accounting system in 1494 in his book on mathematics – “Summa de arithmetica, geometria, proportioni et proportionalità’.

Prior to this the earliest known records of Double Entry Bookkeeping date back the late 1200’s to a Florentine merchant Amatino Manucci who was an employee of the Farolfi firm. Farolfi’s ledger of 1299-1300 shows the double entry system being used.

The Accounting Equation

Assets – Liabilities = Equity

Equity consists of Capital +/- Accumulated Profits or Losses + Reserves
If a profit is achieved in an accounting period then Equity increases.
Conversely if a loss is incurred then Equity is reduced.

The Profit or Loss is determined (in the most basic terms) as
Income – Expenses = Profit or Loss

The modern Double Entry Accountancy System, Double Entry Accounting

Debits and Credits can be a “+” (plus) or a “–‘ (minus).

The sign of the Debit or Credit depends entirely on the category of account in which the transaction is occurring.

For example, if we receive money and put it in the bank then we will debit the bank account which will be a plus because it is an asset account which expects debit transactions.

If we have to cancel a sale then we will debit the sales account but this time it will act as a minus because the sales account is an income account where we are expecting credit transactions.

For every debit there must be an equivalent credit entry.
For example, in a Cash business where all sales receipts are banked our transaction would look like this: –
1- Sales for are $2650.36 and all this money is banked.
Bank Debit 2650.36 This increases our bank balance
Sales Credit 2650.36 This increases our sales income
2 – We spend money on supplies and wrapping paper from the bank.
Supplies Debit 1230.00 This increases our supplies expenses
Wrapping Debit 250.00  This increases our wrapping expenses
Bank Credit 1480.00 This decreases our bank account balance.

 

Black vs Red

You may have heard the expressions “To be in the Black” and “To be in the RED”.

To be in the BLACK is good.

To be in the RED is not good.

In days gone by when books of account were written by hand

  • Debit entries were written in Black and
  • Credit entries were written in Red

If you held more assets than liabilities then the total of the Debit balances (The Black entries) in your Balance Sheet was greater than the total of the Credit Balances and you were said to be in the Black.  The preferred position – ie Net Assets.

If you held more liabilities than assets  then the total of the Credit balances (The Red entries) in your Balance Sheet was greater than the total of the Debit Balances you were said to be in the Red.  A dangerous position – ie a Deficiency or Net Liabilities.

The General Ledger

The General Ledger is the prime book in the accountancy system and we recommend you read our upcoming pages of information on the Books of Account and the General Ledger to build your picture of this enduring system of accounting.

There are a number of subsidiary ledgers including Sales, Purchases, Accounts Receivable and Accounts Payable.  More about them in future posts.

In addition there are the two different accountancy methods to consider – Accrual Accounting (also known as the Non-Cash Method) and the Cash Accounting Method and we’ll cover these in other short essays and how they affect the reported results.

Good management requires a mix of Accrual Accounting and Cash accounting.

The Accountancy System The Most Important System

The accountancy system is without doubt one of the most, if not the most, important systems to get right in a business.
Why?
It is the feedback and reporting system and without up to date and reliable information your cannot manage your business and effectively work toward your goals (this assumes you have a business plan to manage).

Understand the Double Entry Accountancy system and how you can put it to great management use and you’ll see different results in your business in a short period of time.

ProfiTrain is here to help you understand your business performance.  Please contact us if you have any questions about this or a related business topic. Here is our Contact Form link.

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