Business entity, Single and double entry book-keeping, Debit and Credit

<< Cash Accounting and Accrual Accounting

Rules of Debit and Credit for Assets, Liabilities, Income and Expenses >>

Financial Accounting (Mgt-101)

Lesson-4

Learning Objective

The objective of this lecture is to develop an understanding in the students about the basic concepts

like:

o The separate business entity,

o Single and double entry book-keeping,

o Debit and Credit

o The dual aspect of a transaction,

o Accounting equation

Separate Entity Concept

In accounting, `The Business' is treated independently from the persons who own it.

This means, although anything owned by the business belongs to the owners of the business and

anything owed by the business is payable by the owners but for accounting purposes, we assume

that the business is independent from its owners.

This means, if the business purchases a machine or piece of equipment, business will own and

obtain benefit from that equipment. Likewise, if the business borrows money from `someone' it will

have to repay the money. This `someone' includes even the owner of the business.

This treatment of the business independently from its owners is called the `Separate Entity

Concept'. We will discuss this concept again in detail when we study the different types of business

entities.

Single Entry Book-Keeping

This is the conventional style of keeping records

In single entry book keeping system, as it is clear from the name, only one aspect of the

transaction is recorded.

This actually is not a system but is a procedure by which small business concerns, like retailers and

small shopkeepers, keep record of their sale / income.

In this system, there are usually two to three registers "Khata". In one register cash received from

customers is recorded, whereas the other one is a person-wise record of goods sold on credit "Udhar

Khata". There may or may not be a register of suppliers to whom money is payable.

That means, only one aspect of transaction i.e. either cash receipt or the fact that money is

receivable from someone is recorded.

Double Entry Book-Keeping

The concept of double entry is based on the fact that every transaction has two aspects i.e. receiving

a benefit and giving a benefit.

The accounting system that records both the aspects of transaction in books of accounts is called

double entry system.

The account that receives the benefit is debited and the account that provides the benefit is credited.

`Debit' and `Credit' are denoted by `Dr' and `Cr' respectively.

The ultimate result of the system is that for every Debit (Dr) there is an equal Credit (Cr).

Single & Double Entry Book-Keeping Distinguished

The double entry system is a more sophisticated, comprehensive and reliable form of single entry

book keeping system.

Single entry system records only one aspect of the transaction such as:

o Cash received from sale is recorded in cash register only,

Financial Accounting (Mgt-101)

Goods sold on credit are recorded in the individual's account only,

When cash is received from the customer, to whom something was sold on credit, the

receipt may just be recorded in the account of individual only.

Double entry system records both the aspects of the transaction;

o When good are sold on cash the two aspects of the transaction are the seller has sold

goods and received cash against them. The goods sold are benefit transferred to the

purchaser (Credit) whereas the cash against the goods is benefit received (Debit).

o When the goods are sold on credit the benefit given is the same i.e. goods sold but the

benefit received is not cash but a right to receive cash from the customer. Therefore, in this

case Debit is given to customer's account instead of cash.

o When cash is received from the customer the right to receive cash ceases. So, the benefit

received is cash and benefit transferred is the right to receive cash. Here cash will be debited

and customer will be credited.

Adopting the double entry accounting system can, therefore, have following benefits:

o Every transaction has equal Debit and Credit; hence the total of all Debit accounts will be

equal to the total of all Credit accounts at any given time. This serves as a quick test of

mathematical accuracy of book keeping.

o Since all aspects of transactions are recorded, therefore, the books are more informative. In

the example discussed, the trader, if he keeps double entry books, will know the exact figure

of total sale, cash in hand and receivable from customers from their respective accounts at

any desired time.

Debit and Credit

We have used two terms in our above discussion Debit and Credit. What do these terms mean?

Debit and Credit are two Latin words and as such it is difficult to say what do these mean.

But we can develop an understanding as to what does these terms stand for.

DEBIT

· It signifies the receiving of benefit. In simple words it is the left hand side.

CREDIT

· It signifies the providing of a benefit. In simple words it is the right hand side.

Debit and Credit will be explained in details and with examples in our future discussions.

Financial Accounting (Mgt-101)

Dual Aspect of Transactions

We have just said that for every debit there is an equal credit.

This is also called the dual aspect of the transaction i.e. every transaction has two aspects, debit and

credit and they are always equal.

This means that every transaction should have two-sided effect.

For example Mr. A starts his business and he initially invests Rupees 100,000/- in cash for his

business. Out of this cash following items are purchased in cash;

o A building for Rupees 50,000/-;

o Furniture for Rupees 10,000/-; and

o A vehicle for Rupees 15,000/-

This means that he has spent a total of Rupees 75,000/- and is left with Rupees 25,000 cash. We will

apply the Dual Aspect Concept on these events from the viewpoint of business.

When Mr. A invested Rupees 100,000/-, the cash account benefited from him. The event will be

recorded in the books of business as,

DEBIT

Cash

Rs.100, 000

CREDIT

Mr. A

Rs.100, 000

Analyse the transaction. The account that received the benefit, in this case is the cash account, and

the account that provided the benefit is that of Mr. A.

Building purchased The building account benefited from cash account

DEBIT

Building

Rs.50, 000

CREDIT

Cash

Rs.50, 000

Furniture purchased The furniture account benefited from cash account

DEBIT

Furniture

Rs.10, 000

CREDIT

Cash

Rs.10, 000

Vehicle purchased The vehicle account benefited from cash account

DEBIT

Vehicle

Rs.15, 000

CREDIT

Cash

Rs.15, 000

Basic Principle of Double Entry

We can devise the basic principle of double entry book-keeping from our discussion to this point.

"Every Debit has a Credit" which means that "All Debits are always equal to All Credits".

Assets

Assets are the properties and possessions of the business.

Properties and possessions can be of two types, one that have physical existence (called

tangible) and the other that have no physical existence (called intangible).

o Tangible Assets Furniture, Vehicle etc.

o Intangible Assets Right to receive money, Good will etc.

Financial Accounting (Mgt-101)

Accounting Equation

From the example that we just discussed, if the debits and credits are added up, the situation will be

as follows:

DEBITS

Cash

Rs.100, 000/-

Building

50,000/-

Furniture

10,000/-

Vehicle

15,000/-

CREDITS

Mr. A

Rs.100, 000/-

Cash

75,000/-

The total Equation becomes:

DEBITS

CREDITS

Cash + Building + Furniture + Vehicle

Cash + Mr. A

100000 + 50000 + 10000

+ 15000

75000 + 75000

Cash on Left Hand Side is Rupees 100,000/- and on Right Hand Side it is Rs.75, 000/-. If it is

gathered on the Left Hand Side it will give a positive figure of Rupees 25,000/- (which you will

notice is our balance of cash in hand). Now the equation becomes:

DEBITS

CREDITS

Cash

+ Building

+ Furniture+ Vehicle

Mr. A

25,000+ 50,000 + 10,000 + 15,000

100,000

Keeping the entity concept in mind we can see that the business owns the building, furniture,

vehicle and cash and will obtain benefit from these things in future. Any thing that provides benefit

to the business in future is called `Asset'.

Similarly the business had obtained the money from Mr. A and this money will have to be returned

in form of either cash or benefits. Any thing for which the business has to repay in any form is

called `Liability'.

So cash, building, furniture and vehicle are the assets of the business and the amount received from

Mr. A for which the business will have to provide a return or benefit is the liability of the business.

Therefore, our equation becomes:

Assets

Liabilities

The liabilities of the business can be classified into two major classes i.e. the amounts payable to

`outsiders' and those payable to the `owners'. The liability of the business towards its owners is

called `Capital' and amount payable to outsiders is called liability. Therefore, our accounting

equation finally becomes:

Assets

Capital

Liabilities

Table of Contents: