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ACCOUNTING MANUAL ON DOUBLE ENTRY SYSTEM OF ACCOUNTING FOR ICFRE 1 CONTENTS A) Bookkeeping 1) About Single Entry System and its disadvantages 2) About Bookkeeping and Accounting Process 3) About Double Accounting System and its advantages. 4) Classification of Accounts 5) Golden Rule of Debit and Credit 6) Abbreviations used in Accounts 7) Understanding Debits and Credits 8) Understanding Cash Book, Journal, General Ledger, Trial Balance, Income & Expenditure Account and Balance Sheet. 9) Double Entry Working Examples 10) Notes and References B) Main Manual 1) Books/ Documents to be maintained 2) Procedures to be followed to Convert the Single Entry System to Double Entry System 3) Notes and Suggestions 4) Performa of Debit/Credit note 5) Illustration for working 2 1. Single Entry Accounting System Single entry system of book keeping may be described as a loose and defective way of recording transactions, wherein some transactions are recorded in their two fold aspect, some are recorded in so far as they effect one aspect only, and few other are completely omitted to be recorded. Thus it can be seen that there is no system or method about single entry. Under this system a cash book and other ledger are maintained. Disadvantages of Single Entry System. Ø Since every debit does not have a corresponding credit, a Trial Balance can not be extracted to test the arithmetical accuracy of the entries. Ø In absence of proper records of any assets and of any allowances for depreciation or other losses of value, it is not possible to prepare a Balance Sheet. Ø It is too easy to perpetrate the errors and frauds and too difficult to detect them. 2. The book Keeping and Accounting Process In accountancy the Double Entry Bookkeeping (or double entry accounting) is the basis of the standard system used by businesses and other organizations to record financial transactions. The 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 Company A sell an item to Company B and Company B pay Company A by cheque then the book keeper of Company A credits the “Sales” and debits the “Bank”. Conversely the bookkeeper of Company B debits the account “Purchases” and credits the account “Bank”. 3 Historically the debit entries are recorded on the left side and credit values on the right hand side of the general ledger account and 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. Bookkeeping involves recording the details of all of these source documents into multi-column journals (also known as a book of first entry or daybooks.) After a certain period typically a month, the columns in each journal are totaled 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 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. 3. Double entry accounting system The system of double entry may be well compared to a scale which must have equal weight on both sides in order that the scale is balanced. Thus if the weight of one side of the scale is increased or decreased the same weight must be correspondingly added to or removed from, the other side. A more common expression of double entry book keeping system is the accounting equation. The total assets of a firm/ institution are equal of the equities. This reflects the fundamental equation of A= E, Where A denotes Assets and E denotes equity. Assets are the goods and properties which the institute owns as well as claims against outsiders which the institute has not yet collected. 4 Equities are the claims against the assets and indicate the source of assets. The source may be owners themselves or outsiders, e.g. owners invest funds in Organization and Creditors lend money in the Organization. Advantage of Double Entry System:Ø It is possible to keep a full record of dual aspect of each transaction. Ø Transactions are recorded in a scientific and systematic manner and thus the books of accounts provide the most reliable information for controlling the Organization efficiently and effectively. Ø Since the total debit under this system be equal to total Credit, arithmetical accuracy of the books can be tested by means of a trial balance. Ø An income and expenditure accounts can be prepared to know the excess income/ expenditure during a particular period and to know how such excess income/ expenditure has arisen Ø The financial position of the Organization can be readily ascertained by preparing a Balance Sheet. Ø Frauds are prevented, because alteration in accounts becomes difficult and discovery of irregularities is facilitated. 4. Classification of Accounts:• Personal Account:- when a transaction involved with a person known as personal account such as Mr. Roy, Bose& sons ABC Ltd. co. etc. • Nominal Account:- All recurring expenses/incomes are known as Nominal Account, such as salary, Rent, Interest etc. • Real Account:- Other than above two accounts all are fall under this category, such as Machinery, Furniture etc. 5 5. Golden Rule of Debit and Credit • In case of Personal Account - Debit the receiver and Credit the giver. • In case of Nominal Account- Debit all expenses and losses and Credit all income and liabilities. • In case of Real Accounts - Debit what comes in and credit what goes out. 6. Abbreviations used in bookkeeping • a/c – account • B/S – Balance Sheet • c/d – carried down • b/d – brought down • b/f – brought forward • Dr – Debit record • Cr – Credit record • G/L – General Ledger: (or N/L – Nominal Ledger) • P&L – Profit & Loss • TB – Trial Balance 7. Understanding Debits and Credits In a simpler way it can be explained as when an amount is entered on the left side of an account, it is a debit and the account is said to be debited. When an account is entered on the right side, it is a credit, and the account is said to be credited. Here are basic debit & credit rule: - 6 Assets & Expenses _________________ Dr Cr (Increases) (Decreases) Liabilities, Capital and Income ___________________________ Dr Cr (Decreases) (Increases) An account has a debit balance when the sum of its debits exceeds the sum of its credits: it has a credit balance when the sum of the credits is the greater. In doubleentry accounting, which is in almost universal use, there are equal debit and credit entries for every transaction. Where only two accounts are affected, the debit and credit amounts are equal. If more than two accounts are affected, the total of the debit entries must equal the total of the credit entries. 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 7 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) 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. 8. Understanding Cash Book, Journal, General Ledger, Trial Balance, Income & Expenditure A/c and Balance Sheet: Cash Book - All cash transactions are entered in the cash book straightway, and ledger accounts are prepared on the basis of such records. Hence, Cash Book is considered as a Subsidiary book. Cash book is again a ledger and a principal book since, it serves as cash account and book account, the balances of which are recorded in the trial balance via ledger directly. Cash book has debit and credit sides. All receipts are entered on the debit side and all payments are entered on the credit side. It is maintained under the Double entry principle. Feature of Cash Book: 1. All cash receipts and cash payments are entered chronologically in the cash book 8 2. It never shows a credit balance 3. It serves the functions of Journal also. Journal – A journal is a record that keeps accounting transactions in chronological order i.e. as they occur. All accounting transactions are recorded through journal entries that show account names, amounts, and whether those accounts are recorded in debit or credit side of accounts. A journal entry is called "balanced" when the sum of debit side amounts equals to the sum of credit side amounts. General Ledger – The complete set of accounts for a business entry is called a general ledger. It is the “reference book” of the accounting system and is used to classify and summarize transactions and to prepare data for financial statements. It is also a valuable source of information for managerial purposes, giving for example the amount of sales for the period or the cash balance at the end of the period. Trial Balance – As every transaction results in an equal amount of debits and credits in the ledger, the total of all debit entries in the ledger should equal the total of all credit entries. At the end of the accounting period, we check the equality by preparing a two-column schedule called a trial balance, which compares the total of all debit balances with the total of all credit balances. The procedure is as follows: 1. List account titles in numerical order. 2. Record balances of each account, entering debit balances in the left column and credit balances in the right column. 3. Add the columns and record the totals. 4. Compare the totals. They must be the same. 5. If the totals agree, the trial balance is in balance, indicating that debits and credits are equal for the hundreds or thousands of transactions entered in the 9 ledger. While the trial balance provides arithmetic proof of the accuracy of the records, it does not provide theoretical proof. Income & Expenditure A/c - A Income & Expenditure Account, shows the revenues from operations, expenses of operating the concern, and the resulting net profit or loss (Excess of Income over Expenditure/ Excess of expenditure over Income) of a organization over a specific period of time. In short Income & Expenditure Accounts is an account compiled at the end of an accounting period to Net results of operations i.e. (Excess of Income over Expenditure/ Excess of expenditure over Income). Balance Sheet - A balance sheet is a snapshot of a business’ financial condition at a specific moment in time, usually at the close of an accounting period. A balance sheet comprises assets, liabilities, and owners’ or stockholders’ equity. Assets and liabilities are divided into short- and long-term obligations including cash accounts such as checking, money market, or government securities. At any given time, assets must equal liabilities plus owners’ equity. An asset is anything the business owns that has monetary value. Liabilities are the claims of creditors against the assets of the business. A balance sheet helps a small business owner quickly get a handle on the financial strength and capabilities of the business. Is the business in a position to expand? Can the business easily handle the normal financial ebbs and flows of revenues and expenses? Or should the business take immediate steps to bolster cash reserves? Balance sheets can identify and analyze trends, particularly in the area of receivables and payables. Is the receivables cycle lengthening? Can receivables be collected more aggressively? Is some debt uncollectable? Has the business been slowing down payables to forestall an inevitable cash shortage? Balance sheets, along with income statements, are the most basic elements in providing financial reporting to potential lenders such as banks, investors, and vendors who are considering how much credit to grant the firm. 10