Friday, 30 May 2014

Bookkeeping- A Look at the Double Entry System & Golden Rules of Accounting

As already mentioned in my previous articles, there are two methods of Bookkeeping:-Single Entry System and Double Entry System.

Single Entry system is applicable only for small shop owners and vendors who simply enter either purchases and sales or income entries with no corresponding debit or credit.

Introduction to Double Entry System

Double Entry System is the genuine system of accounting mandatory for all firms and companies. It is based on the method of entering each transaction in two different accounts and on the principle that each transaction affects two persons or two different types of accounts. 

When some person receives something, it is inherent that some other is giving it to you. So whenever you make a transaction, you will be entering the same monetary value of it in two places or two different types of accounts. One entry in the receiving head and the other entry in the giving head. One account gets debited and the other account gets credited with the same amount. Thus two accounts always get affected by each transaction under this double entry system of accounting.

How to make entries or How to differentiate Debit and Credit

There are three accounting principles or rules to be followed while making entries of transactions. But before that, you should have a clear knowledge of What is Debit and What is Credit.

Under double entry system of accounting, all receipts are entered on the Debit side and all payments in the Credit side. Similarly, expenses are debited and incomes are credited. So a debit balance in your book shows that either you have a stock balance or you have incurred so much expenditure on your business. 

As I said, debit side shows your assets and credit side your liabilities. Debit is an asset for the business and credit is the liability. 

Here, be clear that you alienate yourself from the business and look from the viewpoint of your business firm. Business is to be treated as a separate entity. Only that much of amount invested by you in business is its Capital. And its assets and liabilities are different from yours. 

When a business receives funds from you it credits you in its books and shows that you are a Creditor for the business firm. It has borrowed money from you and it ought to return you that money. It received cash or cheques from you. So it debits the Cash account or if deposited in a bank, the Bank account.

In the same manner, you should analyze every transaction and know which account to be debited and which account to be credited.

Three following Golden Rules of Accounting help us in identifying all debits and credits.

Three Golden Rules of Accounting

The three Golden Rules of Accounting and Bookkeeping are as follows:
  1. Debit what comes In and Credit what goes Out
  2. Debit the Receiver and Credit the Giver
  3. Debit Expenses and Credit Incomes
Now, let us examine each of these rules.

Debit what comes in
All that comes into the business should be debited by its value. Suppose you purchase some items for reselling them or Assets for company use. Here you are receiving Stock or Asset like Furniture, Computer, etc. So you Debit either Stock A/c or Furniture A/c or Computer A/c.

Credit what goes out
In the above purchases, you will be paying the cost of items purchased. You may pay by cash or through cheque/draft. So either Cash goes out or a Cheque from your Bank a/c goes out. So you will credit either Cash a/c or the concerned Bank a/c with the amount paid.

Debit the receiver
Suppose you sell something from Stock to say A. In this case A will be receiving some goods and paying its value to you at a later date. So you will have to Debit the a/c of "A" with the value of stock sold (and since the value of that stock is to be reduced, you credit the Stock a/c.) 

Credit the giver 
In above example, you have credited Stock a/c as it is giving the item for sale. 
Next, when you receive money from "A", (you will Debit the Cash a/c or Bank a/c which receives the amount and) Credit will be given to "A" as he is giving the amount.

Debit all expenses
During your course of business, you will be incurring many kinds of expenses like stationery, courier, printing, advertising, traveling, and cartage etc. Now all these expenditure items are to be debited to their respective heads. When you total up all these heads at the month ending or year ending, it will give you the total expenditure incurred for running your business. (When you debit the expenditure heads, the corresponding credits will be given to either cash or bank account as per mode of payment)

Credit all incomes
Whenever you receive any income such as interest from banks on your company's deposits or any other income by way of scrap sales, etc., the relevant heads will be credited with those amounts. (The
corresponding debit entries for these incomes will be given either to the Cash or Bank a/c as the money is received in those accounts.)

So, from the above explanations of Double Entry System and Golden Rules of Accounting, I hope you are able to understand the complete process of Bookkeeping and the Double Entry System of accounting.

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