Financial accounting
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2.3.2 Double entry system Double entry bookkeeping, on the other hand, provides a more complete solution. It is based on the notion of a transaction. This is a change in the monetary state of the organization. A transaction can only occur between two entities; for example, a company and one of its employees in the case of a payroll transaction. To keep track of these transactions, all of the entities are given an account. In computerized systems, these accounts are given codes (normally called general ledger (GL) or nominal ledger codes). Each transaction has two parts:
Debit. This includes expenses, assets (including debt) and cash receipts. Credit. This includes income, liabilities (including debt) and cash payments.
It will be shown later that consolidation of these accounts allows the preparation of the financial statements. The double entry system is best explained by an example. Consider a company purchasing a service on credit from a particular supplier (in this example, designated 107). The work is completed on 15 November 2004 and the supplier raises an invoice for £100. This is represented by Table 2.2. Table 2.2
Credit purchase transaction Purchasing account – 9938
Debit
Credit
Supplier No. 107 account – 8759 Debit
15/11/2004 Sup. (107) £100 8759
Credit 15/11/2004 Pur. £100 9938
Because of concerns about the quality of the work undertaken, the company decides to pay only half of the invoice. This takes place on 17 December 2004. This means a transfer of funds from the company’s bank account to the supplier as shown in Table 2.3. At the end of an accounting period (31 December, in this case), the transactions associated with the supplier account are summarized in the trial balance. This is shown in Table 2.4. Table 2.3
Part payment
Supplier No. 107 account – 8759
Company bank account – 6757
Debit
Debit
17/12/2004 Bank A/C £50 6757
Credit
Credit 17/12/2004 Sup. (107) £50 8759