What is the DOUBLE ENTRY SYSTEM ?

What is Double entry system?

          This is a system through which transactions in a business involving money and money’s worth are recorded in the nominal ledger from the books of prime entry.

          According to this system each business transactions will have two sides which will be equal and opposite of each other; Debit side and a credit side. Every debit must be balanced to its credit.

Rules of double entry system

There are generally two sets of rules. You can follow the ones which you understand and find easy to remember the most.

1.   In this rule you need to keep in mind what a debit and a credit entry will do.

A debit entry will:-

n Increase an asset

n Increase an expense

n Decrease a liability

A credit entry will:-

n Decrease an asset

n Increase a liability

n Increase an income

So when you come across a transaction, you should keep in mind that:-

-         Each entry has two sides debit and credit

-         Check which all accounts that transactions will effect

-         Check what is increasing and what is increasing

-         Make your entry

A better way to understand the above rules is with the help of ledger accounts or the T accounts:-

 

Ø Asset account                                  

Debit increases

Credit decreases

 

Ø Liability account

Debit decreases

Credit increases

 

Ø Capital account

Debit decreases

Credit increases

 

Ø Income account

Debit decreases

Credit increases

 

Ø Expense account

Debit increases

Credit decreases

 

 

2.    In this type of method the accounts for double entry are classified into two

 

CLASSIFICATION OF ACCOUNTS

Personal accounts relate to an individual, firm or a company. For example: - accounts of State bank of India, accounts of a Gopal, accounts of Microsoft etc

 Rule for this type of account is:-

-         Debit the receiver (person who receives from the business)

-         Credit the giver (person who gives to the business)

Personal accounts can be classified into three:-

 

PERSONAL ACCOUNTS

a)    Natural personal accounts: - this is the accounts for human beings.

b)    Artificial personal accounts:- this is accounts for firm, company, bank etc. They do not have physical existence like human beings.

c)     Representative personal accounts: - when an account is a representative of individuals or groups, it becomes a representative personal account. For example, prepaid insurance account, accrued income account etc.

Impersonal accounts can be classified into two:-

 

IMPERSONAL ACCOUNTS

a)    Real account: - this is an account for everything whose value can be measured in terms of money. For example, cash account, goodwill account, building account etc.

Rule for this account is:-

-         Debit what comes in

-         Credit what goes out

Real account can be classified into two:-

o   Tangible real account- these are accounts which can be touched, felt, measured etc.

o   Intangible real account- these are accounts which can’t be touched, felt but its value can be measured in terms of money. For example, patent, trade mark etc.

b)    Nominal account: - these are the accounts for al incomes and expenses.

Rule for this account is:-

-         Debit all expenses and loses

-         Credit all incomes and gains

So the full chart will look like this:-

 

 

CLASSIFICATION OF ACCOUNTS

 

So as all systems have their advantages and disadvantages, double entry system is no different.

Advantages and disadvantages of double entry system

 

Advantages:-

-         Trial balance can be prepared with ease. Since all debit and credit balances should balance. It provides a check for arithmetic accuracy of the ledger accounts.

-         It is easy for business people to find the value of different accounts by just a glance. (By looking at the income statement, balance sheet).

-         This system is scientifically proven as it follows a certain rules.

-         This system is legally approved. Tax authorities relay on accounts prepared under this system.

-         It helps management to retrieve data quickly for decision making.

Disadvantages:-

-         It’s hard to find some types of errors (errors of principle, compensating errors etc).

-         Only the arithmetic accuracy of the accounts is checked with the trial balance.

-         Proper education and practical experience is required to understand and apply this system.

 

 

Conclusion

                    “Every business transaction has two fold effects and that it affects two accounts in opposite directions and if complete records were to be made of each transaction, it would be necessary to debit one account and credit another account. It is this recording of two fold effect of every transaction that has given rise to the term double entry system.”                                              

---- J.R. Batliboi

If you have any queries or suggestions, please comment below or you can email me.

For more contact details visit my contact page.