B1: 1.02 Double Entry Bookkeeping

Double-entry bookkeeping is used by almost all large organisations to record their financial transactions and keep track of how they are performing and what they own and owe. It has been used for more than five centuries and is the basis for the most popular types of bookkeeping software used across the world.

Many smaller businesses might not use the full double entry bookkeeping system but even these will use at least one of the books that we will cover on this course.

The purpose of double-entry bookkeeping

The purpose of double-entry bookkeeping is to enable a business to keep track of the value of its assets, liabilities and capital at particular points in time as well as the value of the income it has generated and the expenses it has incurred over an accounting period.

ASSETSAssets are resources that are owned/controlled by the business. Types of assets would include
i) property and equipment owned by the business
ii) money owed to the business from its customers
iii) inventories (or stock) owned by the business
iv) money held in the business’ bank accounts
LIABILITIESLiabilities are amounts of money, goods or services that are owed by the business to others. Types of liabilities would include bank loans and overdrafts, the amounts it owes to its suppliers as well as taxes owed to HM Revenue & Customs
CAPITALCapital is the amount of money the owners have tied up in the business. It includes any money the owners have invested as well as any profits made by the business less any money they have taken out of the business (known as drawings)
INCOMEIncome is the amount that the business makes from the sale of goods and services to customers (known as sales or sales revenue) as well as the money its generates from its savings and assets; e.g. rents charged to tenants or interest earned from money held in its bank accounts
EXPENSESExpenses are the costs incurred by the business. There are numerous types of expenses including the cost of making or buying the goods that it sells as well as the running costs of the business and costs of funding its activities
The five financial elements

There are a number of different stages in the double-entry bookkeeping system, as shown in the diagram below

When a financial transaction such as a sale or purchase takes place there is almost always a financial document associated with that transaction. A sale or purchase, for example, would be associated with an invoice or a till receipt. When a business makes a payment there would probably be a cheque or a remittance advice slip associated with the payment. In section 2 of this course we will look at some of the different types of financial documents used by bookkeepers.

Information from these financial transaction and documents will be recorded in the business’ Books of Prime Entry, so-called as they are the first place transactions are recorded.

In section 3 of this course we will look at eight of these books in detail, each of which is used to record particular types of transactions. For example, bank receipts and bank payments are recorded in a book of prime entry called the Cash Book.

Information from the books of prime entry is then transferred, or “posted” into another set of books called the Ledgers. [Whilst this might seem to be overly time consuming please remember that bookkeeping software are designed to complete these transfers or postings automatically]

There are three types of Ledgers, the General Ledger (also known as the Main or Nominal Ledger), the Sales Ledger and the Purchases Ledger. These are used to calculate keep track of the following important information:

General ledgerThe value of the business’ assets, liabilities and capital at a particular date as well as the value of its income and expenses over a period
Sales ledgerHow much each of the business’ credit customers owe the business
Purchases ledgerHow much the business owes to each of its credit suppliers
The three types of ledgers

In sections 4 and 5 of this course we will look at the ledgers and describe how information from the books of prime are entry are posted to them. Then in section 6 we shall look at how the ledgers are used to check the amounts owed by individual customers and the amounts owed to individual suppliers.

At the end of an accounting period such as a month or year, the values calculated in the General Ledger will be used to prepare a Trial Balance (this is a list of all the values of the assets, liabilities etc. recorded in the General Ledger). This will be examined in section 7 of this course.