2019-07-29 17:27:11Finance and Accounting: Finance and AccountingEnglishDouble Entry System of Accounting means every business transaction has an equal and opposite effect in minimum two different accounts.https://quickbooks.intuit.com/in/resources/in_qrc/uploads/2019/07/A-balance-sheet-revealing-the-double-entry-system-of-accounting.jpghttps://quickbooks.intuit.com/in/resources/finance-and-accounting-finance-and-accounting/double-entry-accounting-system/What is Double Entry Accounting System ?

What is Double Entry Accounting System ?

9 min read

Double entry system of accounting is based on the Dual Aspect Concept. Dual Aspect Concept is one of the fundamental accounting principles. All the business transactions recorded in the books of accounts are based on this principle of accounting.

According to the Dual Aspect Concept, each business transaction has a dual or a two way effect. This implies that a particular business transaction involves minimum two accounts when recorded in the books of accounts. This principle is the foundation of Double Entry System of accounting. So let’s understand what is Double Entry System of accounting given this in the backdrop.

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Double Entry System of Accounting

Double Entry System of Accounting means every business transaction involves at least two accounts. In other words, every business transaction has an equal and opposite effect in minimum two different accounts.

Thus, this system of accounting is based on the Dual Aspect Concept of accounting. Hence, it is first important to understand the Dual Aspect Concept in order to understand the double accounting system. Let’s consider an example.

Rajveer started a business by investing Rs 10,00,000. The amount invested by Rajveer will affect the business in following way taking the above business transaction into consideration:

  • Increase assets (cash) of the business by Rs 10,00,000
  • At the same time, increase capital by Rs 10,00,000

Further, Rajveer purchases goods amounting to Rs 5,00,000 on cash. The effect of this transaction is as follows:

  • Increase the asset (stock of goods) by Rs 5,00,000
  • At the same time, reduce another asset (cash) by Rs 5,00,000

Still further, Rajveer purchases machinery worth Rs 45,00,000 on credit from Kapoor Pvt Ltd. The effect of this transaction is as follows:

  • Increase the asset (plant and machinery) by Rs 45,00,000
  • At the same time, increase liabilities (creditors) by Rs 45,00,000

Thus, as can be seen, every transaction involves give and take effect. This effect is the basis of all business transactions and is known as the principle of duality. Principle of duality further is the basis of double entry system of accounting.

Accounting Equation

The principle of duality is expressed in the form of the fundamental accounting equation. This equation is represented as follows:

Assets = Liabilities + Capital

This accounting equation shows that assets of a business always equate the claims of owners and outsiders. This means that at any given point of time, the resources of a business are always equal to the claims of the stakeholders. These are the stakeholders who have provided funds for such resources. Such stakeholders include business owners and lenders (outsiders) who provide funds to the business.

Furthermore, the claim of owners on a business is called capital or owner’s equity. Whereas, the claim of lenders or outsiders on the business is called liability or outsider’s equity. Therefore, the dual effect of every business transaction impact in such a way that the asset side equals the liability plus capital side of the equation.

Furthermore, this equation is also known as balance sheet equation. This is because every item involved in the accounting equation forms a part of the balance sheet.

So, let’s consider an example in order to understand how this accounting equation remains balanced despite various business transactions having their impact.

Example

  • Rajveer started a business with Rs 10,00,000.
    • Effect of Transaction: Cash (asset) increases by Rs 10,00,000 and Capital (liability) increases by Rs 10,00,000.
  • Rajveer deposited Rs 10,00,000 in Bank of Baroda.
    • Effect of Transaction: Cash at Bank (asset) increases by Rs 10,00,000 and Cash (asset) decreases by Rs 10,00,000.
  • Purchased Furniture worth Rs 6,00,000 and in return a cheque is issued on the same day.
    • Effect of Transaction: Furniture (asset) increases by Rs 6,00,000 and the Bank (asset) decreases by Rs 6,00,000.
  • Purchased Machinery for Rs 2,00,000 and an advance of Rs 30,000 is paid in cash to M/s Singhania
    • Effect of Transaction: Machinery (asset) increases by Rs 2,00,000, Cash (asset) decreases by Rs 30,000 and Creditors (liability) increases by Rs 1,70,000.
  • Goods bought from M/s Khanna worth Rs 70,000.
    • Effect of Transaction: Goods increase by Rs 70,000 and the Creditors (liability) increases by Rs 70,000.
  • Goods worth Rs 50,000 sold to Bector Enterprises for Rs 60,000.
    • Effect of Transaction: Debtors (asset) increased by Rs 60,000, Goods (asset) decrease by Rs 50,000 and Capital (Profit) increases by Rs 10,000.

Now, the accounting equation Assets = Liabilities + Capital is put into balance in the following way:

LiabilityAmount (in Rs)AssetAmount (in Rs)
Creditors2,40,000Bank3,60,000
Capital10,10,000Cash 10,000
Furniture6,00,000
Plant and Machinery2,00,000
Stock20,000
Debtors60,000
12,50,00012,50,000

Therefore, as per the accounting equation:

Assets = Liabilities + Capital
12,50,000 = 2,40,000 + 10,10,000

Debit and Credit in Accounting

As mentioned above, business transactions are to be recorded in at least two accounts in double entry system of accounting. This is to say every amount debited in a transaction must be equal to every amount credited in that transaction. Thus, the terms debit and credit are used to record every business transaction in accounting. These basically indicate on what side of a particular account a business transaction needs to be recorded.

Every account in a business transaction takes the format of letter T. Hence, these accounts are referred to as T – Accounts. Such accounts have a left and a right side that record increase or decrease in the particular item. This is done to know where each item stands at the end of the accounting period.

For example, if it is the Capital Account of the owner, the Cash received is recorded on the right hand side. Whereas, the owner’s claim on the business is recorded on the left side of the Capital Account. As a result, the difference between the two sides, if any, reveals the amount owed by the business to the owner. The left side is called the debit side. Whereas, the right side is called the credit side of the T- Account.

Thus, recording an amount on the left side of the account means debiting the account. Whereas, recording the amount on the right side means crediting the account.

Rules For Debit and Credit

All accounts are divided into five categories in order to record transactions. Following are those categories:

  • Asset
  • Liability
  • Capital
  • Expenses/Losses
  • Income and Gains

Hence, two important rules are followed in order to record the changes in the above categories:

  1. Recording Changes in Assets or Expenses or Losses
    1. Debit all increase in assets and credit all decrease in assets
    2. Debit all increase in expenses or losses and credit all decrease in expenses or losses
  2. Record Changes in Liabilities or Capital or Revenues or Gains
    1. Credit all increase in liabilities and debit all decrease in liabilities
    2. Credit increase in capital and debit decrease in capital
    3. Credit all increase in revenue or gain and debit all decrease in revenue or gain

Let’s consider the transactions taken in the above examples and apply these rules to see the dual accounts involved in every transaction.

  • Rajveer started a business with Rs 10,00,000.
    • Effect of Transaction: Cash (asset) increases by Rs 10,00,000 and Capital (liability) increases by Rs 10,00,000.
Cash Account
Dr.Cr.
ParticularsAmountParticularsAmount
To Capital10,00,000
Capital Account
Dr.Cr.
ParticularsAmountParticularsAmount
By Cash10,00,000
  • Rajveer deposited Rs 9,60,000 in Bank of Baroda.
    • Effect of Transaction: Cash at Bank (asset) increases by Rs 9,60,000 and Cash (asset) decreases by Rs 9,60,000.
Cash Account
Dr.Cr.
ParticularsAmountParticularsAmount
By Bank9,60,000
Bank Account
Dr.Cr.
ParticularsAmountParticularsAmount
To Cash9,60,000
  • Purchased Furniture worth Rs 6,00,000 and in return a cheque is issued on the same day.
    • Effect of Transaction: Furniture (asset) increases by Rs 6,00,000 and the Bank (asset) decreases by Rs 6,00,000.
Furniture Account
Dr.Cr.
ParticularsAmountParticularsAmount
To Bank6,00,000
Bank Account
Dr.Cr.
ParticularsAmountParticularsAmount
By Furniture6,00,000
  • Purchased Machinery for Rs 2,00,000 and an advance of Rs 30,000 is paid in cash to M/s Singhania
    • Effect of Transaction: Machinery (asset) increases by Rs 2,00,000, Cash (asset) decreases by Rs 30,000 and Creditors (liability) increases by Rs 1,70,000.
Machinery Account
Dr.Cr.
ParticularsAmountParticularsAmount
To M/s Singhania1,70,000
To Cash30,000
Cash Account
Dr.Cr.
ParticularsAmountParticularsAmount
By Machinery30,000
Singhania Account
Dr.Cr.
ParticularsAmountParticularsAmount
By Machinery1,70,000
  • Goods bought from M/s Khanna worth Rs 70,000.
    • Effect of Transaction: Goods increase by Rs 70,000 and the Creditors (liability) increases by Rs 70,000.
Stock Account
Dr.Cr.
ParticularsAmountParticularsAmount
To Khanna70,000
M/s Khanna Account
Dr.Cr.
ParticularsAmountParticularsAmount
By Stock70,000
  • Goods worth Rs 50,000 sold to Bector Enterprises for Rs 60,000.
    • Effect of Transaction: Debtors (asset) increased by Rs 60,000, Goods (asset) decrease by Rs 50,000 and Capital (Profit) increases by Rs 10,000.
Stock Account
Dr.Cr.
ParticularsAmountParticularsAmount
By Bector Enterprises50,000
Bector Enterprises
Dr.Cr.
ParticularsAmountParticularsAmount
To Stock50,000
To Capital10,000
Capital Account
Dr.Cr.
ParticularsAmountParticularsAmount
By Bector Enterprises10,000
Information may be abridged and therefore incomplete. This document/information does not constitute, and should not be considered a substitute for, legal or financial advice. Each financial situation is different, the advice provided is intended to be general. Please contact your financial or legal advisors for information specific to your situation.

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