You will take about one hour to study this 4th unit of this course. In this unit, you will study the double entry system of accounting, in which the following points will be covered.
- Double aspect of a business transaction
- Double effect of a business transaction and
- The essential rule of double entry system.
The above points will lead us to the treatment of the already mentioned three types of ledger accounts, in unit one i.e. Personal accounts, Real accounts and Nominal accounts.
At the end of this unit, you should be able to:
- identify in a business transaction the double entries
- understand the double effect of a business transaction upon the finances of any party to it
- apply the essential rule of double-entry system of accounting in identifying the account to be credited in the two accounts involved in a business transaction.
Double-Entry System of Accounting
Double-Entry system is the system in Accounting whereby every transaction that has to be recorded gives rise to two entries, the first one a debit entry and the other a credit entry. It is in this double entry system that the Golden Rule of Double Entry System is used.
Double Aspect of Transaction
Every business transaction involves two persons, one who parts with something and one who receives it. For example, in every sales, a seller and buyer are involved. The seller parts with that which is sold, and the buyer receives it. Similarly, when money is paid one person parts with it and another receives it. No matter what transaction is taken as an example it is always found that there are two parties, one who parts with something and one who receives it. For this reason it is said that every transaction has a double aspect; the aspect of one party parting with something and the aspect of the other receiving it.
Double Effect of a Transaction
Apart from the double aspect of a business transaction, what is more important still is that we should understand that every transaction has a double effect upon the finances of any single business which is a party to it.
Thus, if money is loaned to a business, an asset of a business, i.e. cash, is increased and the liabilities, i.e. the amounts owing by the business, are also increased. When property for use in the business is bought on credit, both an asset, e.g. buildings and the liabilities of the business are increased. When the property is paid for an asset, i.e. cash, and the liabilities of the business are both reduced. When goods or services are bought on credit, the expenditure of the business and its liabilities are both increased. When the goods and services are paid for, an asset of the business i.e. cash, and its liabilities are both reduced. Also, when goods or services are sold on credit, the income of the business Is increased and an asset, i.e. debts owing by customers, is also increased.
When the customer pays for the goods or asset, i.e. debts owing by customers, is reduced. Thus, in any business every transaction in which the business is involved has a double effect upon its finances. You should note that double-entry system of accounting is designed to record thus double effect.
Now, you should consider the follow examples:
S/N. Transaction One Effect Another Effect
- Society bought Its expenditure Its debt increases books for resale on increases credit
- A cooperative Its assets-cash Its debt decreases Society pays for decreases books bought
- Cooperative society Its income increases Amount owed to sold cocoa on credit it increases
- Cooperative society Its assets (cash) receives money for increases cocoa sold
Apart from the above examples, no matter the example given, you will be able to state the double effect of the business transaction upon the finances of each of the parties to it.
Golden Rules of Double-Entry
In a double-entry system of accounting one aspect or effect of a transaction is always recorded by a debit posting to a ledger account, and the other aspect or effect is always recorded by a credit posting to another ledger account.
Thus, when a person parts with anything which is received by the business, the account for that person in.the books of the business must be credited and some other account in the books of the business must be debited. The account to be debited depends upon the nature of that which the business receives. When a person receives anything, with which the business has parted, the account of that person in the books of the business must be debited, and some other account in the books of the business must be credited. Again, the account to be credited depends upon the nature of that with which the business parts.
There are separate rules of the double entry system in respect of Personal Accounts, Real Accounts and Nominal Accounts which are discussed below:
As discussed earlier, these accounts record a business’s dealing with persons or firms. The person receiving something is given debit and the person giving something is given credit. For example, if John sells goods to James on credit, James’s Account will be debited (in John’s book) as he is the receiver of goods and John’s account will be credited (in James’s book) as he is the giver of goods. When James makes the payment for these goods, John’s Account will be debited in James’s book as he is the receiver of the cash and James account will be credited in John’s books as he is the giver of cash.
These are the accounts of Assets. Assets entering the business is given debit and assets leaving the business is given credit. For example, when goods are sold for cash, Cash Account will be debited as cash comes in and Goods Accounts will be credited as goods goes out. So, the rule is debit what comes in and credit what goes out.
These accounts deal with expenses, incomes, profits and losses. Account of expenses and losses are debited and accounts of incomes and gains are credited. For examples, when rent is paid to the landlord, Rent account will be debited as it is an expenses and cash account (real account) will be credited as it goes out.
Similarly, when commission is received, cash account will be debited as cash is received and commission account will be credited as it is an income.
Thus, the rule is: debit all expenses and losses and credit all incomes and gains.
For more explanation, the rules of double entry system of accounting are shown in the following chart:
Rules of Double Entry
From the above chart, you will be able to identify accounts to be debited and those to be credited without any problem.
1. Briefly explain:
a. double entry system of accounting.
b. double effect of a transaction upon the finances or assets of each
of the parties to it.
2. Show the separate rules of the double entry System of accounting
in respect of Personal, Real and Nominal Accounts.