THE PROS AND CONS OF DOUBLE ENTRY

So far the records we have looked at have been the ‘single entry’ method (although the sales and purchase ledgers were the first steps towards double entry). The single entry method of bookkeeping, whilst adequate for many purposes, will be incomplete and have shortcomings if your business grows.

By contrast the double entry method of bookkeeping is a complete method. It overcomes the shortcomings, but it may be more than is needed by many small businesses.

Double entry bookkeeping has been around for many years; in fact the first known work on this subject was published in the reign of Henry VII in 1494. The modern system of double entry bookkeeping was first put into general use by Italian merchants at a time when Venice and other cities of northern Italy were Europe’s main trading centres.

Drawbacks of single entry

In the single entry method you only need to make one entry to record each transaction. This system has several shortcomings. A major one is that it is hard to tell how much was spent on a particular expense (for example, motor expenses) in a given year. One way partly to overcome this is to use an analysed cash book as described in Chapter 4, but even this does not fully deal with the problem. The analysed cash book doesn’t record the amounts owing at the beginning and end of the year, only those actually paid within the year.

For example, if at the beginning of the year £130 was owing for goods delivered in the last month of the previous year, then the payments that you make during the year will include this amount. Likewise if at the end of the year £165 is owing for goods this will not have been included in the payments made. To arrive at the correct figure of expenditure for the year the figure of payment therefore has to be adjusted.

Advantages of double entry

The advantages of a double entry bookkeeping system are:

• It provides a specific means of making these adjustments.
• It allows you to make an arithmetical check on your records since the total of the debit entries must equal the total of the credit entries.
• Using the personal ledgers, amounts owing by or to each person with whom you trade can be worked out easily.
• Double entry records form a stepping stone to producing annual accounts, and can help to save time and expense at the year end.
• The financial position of the business at any point in time can be stated definitely.
• It can reduce the risk of, and help detect, any errors and even fraud.

Making two entries each time

As its name implies, double entry bookkeeping needs two entries to be made each time a transaction is recorded. For each transaction you must record:

• the receiving of a benefit by one account (the debit)
• the giving of a benefit by some other account (the credit).

Example

Suppose you buy a photocopier for your business; the entries might be:

Debit	Machinery and Equipment Account (the account receiving the benefit of the new machine).
Credit	Bank Account (the credit – payments – side of the cashbook, the account giving the benefit in that money is flowing from it).

It’s worth noting that the cash book is really one of the accounts of the business: it has a debit and a credit just like any other account.

Confusion can sometimes arise from this. A person might say ‘I’m in credit at the bank’ meaning that they have money in their account. So they assume that the cash received by them should be entered on the credit side of the cash book – but this is wrong! The reason is that when you look at the bank statement you are looking at a copy of the account as recorded in the books of the bank. When you have money invested in the bank, then, from the bank’s point of view, they owe money to you. So the account has to record the fact that it has to give benefit and it is therefore a credit in the accounts of the bank. On the other hand in your own books it is an account receiving benefit, and so the money received has to be recorded on the debit (left) of your cash book.

If all this seems a little baffling then remember the following:

Debits (left)	Credits (right)
Cash receipts	Cash payments
Expenses	Income
Assets	Liabilities

When you have time, go back and see how this little table fits in with the rule stated above.

So how does the double entry system help?

There are several benefits in a double entry system:

Accuracy – ‘balancing the books’

Since every transaction has two aspects (one debit and one credit) it follows that if you add up all the debit entries and compare the total with that of all the credit entries, then the amounts should be exactly equal. If they are not, then you must have made a mistake somewhere! This idea of cross-checking is a vital part of the double entry system. In practice you will already have added up each individual account so you won’t need to add all the individual debit entries or all the individual credit entries; instead you can just work out the difference between the total debits and credits on each account. This difference is called the balance.

You then list your balances. If all is correct the total of all your debit balances will equal the total of all your credit balances. Such a listing is known as a trial balance (see Figure 29). If you have any friends or acquaintances who work in accounts departments, they might tell you: ‘My job is to get out a trial balance at the end of each month.’ They could probably share some experiences with you!

Useful summaries of information

Since all of the transactions relating to one type of expense (e.g. salaries and wages) are entered onto a single account for that expense, you will build up a summary of the total cost to the business for that expense for the year. In Figure 29 each type of expense has been given a code (e.g. 41 Telephone Charges). Similar comments also apply to income.

Personal and impersonal accounts

So far, as we have seen, all the transactions in double entry bookkeeping are recorded in accounts. These accounts can be of two sorts: personal accounts and impersonal accounts.

• Personal accounts

The first type are personal accounts – those relating to dealings with customers or suppliers, collected in the form of the sales ledger and the purchase ledger respectively.

• Impersonal accounts (nominal ledger)

These are for recording objects owned by the business, or its trading (overheads) expenses or income (such as interest earned) for the trading year. These impersonal accounts are normally grouped together in a single ledger called the nominal ledger. Strictly speaking, the cash book is one of the nominal ledger accounts, but for convenience, due to the large number of entries, this account is normally kept as a separate book.

YOUR DOUBLE ENTRY ACCOUNTS

So what accounts do I need?

The actual accounts you need to enter up in the nominal ledger will depend upon the nature of your business. In summary:

• 1.Sales accounts You may wish to distinguish between different types of sale, and so would need several ‘sales accounts’. Examples: Home Sales Accounts and Export Sales Accounts Head Office Sales Account and Representatives’ Sales Account (e.g. to work out commissions).

• 2.Sundry income accounts

You may want to keep track of odd items of income such as:

Interest earned from deposits in the bank

Commissions received

Any other special income or fees which you may receive.

• 3.Purchases of products and overhead expenses
  • (a)Purchases – raw materials or products for resale.
  • (b)Overhead expenses – for example:

Wages

Motor expenses

Telephone charges

Heating and lighting

Rent and rates

Bank charges and interest.

• 4.Current assets (more of this in Chapter 8) such as:

Trade debtors (money owed to you). Note: the accounts maintained in

the sales ledger are your trade debtors.

Bank account

Cash account

Stock and work-in-progress.

• 5.Current liabilities (more in Chapter 8) including: Trade creditors (money owed by you). Note: the accounts maintained in the purchase ledger are your trade creditors.
• 6.Fixed assets

Buildings

Motor vehicles

Plant and equipment (including office equipment).

• 7.Capital

This will depend on the kind of entity trading.

Limited companies:

Share capital

Profit and loss account

Capital reserve (in certain instances).

Sole traders and partnerships:

The proprietor’s capital account (with separate accounts for each partner if it is a partnership).

Do I have to write up all of these entries at the same time?

No. It is normal to write up one half of each entry as the transaction occurs and then to complete the double entry at a later date. The books in which you make the initial entries consist of:

The cash book

The purchase day book

The sales day book

The journal (see below). These books are collectively called the books of prime entry.

As we have seen, the cash book is really only one of the nominal ledger accounts, kept as a separate book for convenience.

Strictly speaking, the purchase day book and the sales day book don’t form part of the double entry. Suppose we want to post the purchase of goods for resale in a shop then:

Debit (left) – the purchases account in the nominal ledger.

Credit (right) – the supplier’s account in the purchase ledger.

However, the day books are used for two purposes:

• To form the initial entry where all the transactions of a certain type (either purchases or sales) can be summarised.
• By using analysed day books you can cut the number of entries needed in the nominal ledger accounts (and so save time). Chapter 4 looked at the analysed purchase day book; we saw how all the entries for one type of expense (e.g. motor expenses, or purchases) could be summarised to give a total for the month. Earlier in this chapter we saw that in double entry bookkeeping the total of the debit entries must equal the total of the credit entries. But there’s no reason why several credit entries cannot be balanced by a single debit entry or vice versa, provided that in total all the debits and credits agree. For example, instead of posting every single item of motor expenses individually in your motor expenses account in the nominal ledger, you can just post the monthly total from the day book. The day book is really a memorandum, linking the individual entries on, say, the purchase ledger to the summarised figures posted in the nominal ledger.

The journal

Like the purchase and sales day books, the journal does not form part of the double entry system as such. But it’s only found in double entry bookkeeping systems – it has no place within a single entry system. The journal is rather like the two day books, but whereas the day books are used to record all your day-to-day purchases or sales, the journal is used to record any other odd transactions and adjustments for which no other book of prime entry is available.

Example

Suppose you are unlucky enough to incur a bad debt. Your sales ledger

account might look like this:

		Broke Engineering Ltd
2002		Dr	Cr
5 April	Goods	493.72
17 May	Goods	151.05

There is a ledger balance of £644.77 that will remain on the ledger for evermore unless you do something about it. That something is to transfer the balance to a ‘Bad Debts’ account in the nominal ledger. This is how you do it:

• 1.Make an entry in the journal (book of prime entry) as follows:

JOURNAL	Dr	Cr
Bad Debts Account	644.77
Broke Engineering Ltd		644. 77

Being transfer of balance to Bad Debts account following liquidation of customer’s business.

Note: A brief note is added to record why you made the transfer.

• 2.You then debit the bad debts account in the nominal ledger with the same amount of £644.77.
• 3.Next, you credit the unfortunate customer’s account in the sales ledger with the same amount so that it no longer shows a balance outstanding.

We shall hope that you don’t have to post too many entries like this!

Note: The journal is just a memorandum. You are just using its debit and credit columns to record where the item is to be posted on the various accounts proper.

You will normally bring your books up to date each month and extract a trial balance to make sure they are in fact in balance.

HINTS ON FINDING ERRORS

So you have got to the end of extracting your trial balance and it doesn’t – balance that is! What do you do?

Well, after making a fresh cup of coffee, consider the following ideas which may help you find the error.

Is the difference an even amount?

If so it might be that you have posted an item to the wrong side of the ledger. Divide the difference by 2 and look to see if you can find an amount for that figure. Why divide by 2? Well, consider the following:

Telephone Charges Account	Dr	Cr
	£	£
Balance brought forward	340
Cheque payment		80
Balance		260
	_____	_____
	340	340
	_____	_____

The payment should of course be posted to the debit of the nominal ledger account but has been posted to the credit in error. Had the posting been made correctly the balance would be £420: a difference of £160 from the true figure. By dividing by 2 it is possible to isolate the true figure so that you can double check to make sure that all the postings of £80 are correct.

Is the difference a round number?

Differences of 1Op, £1 or £10, etc. are often errors in additions. So this is the best place to start looking.

Is the difference divisible by 9?

This is an odd one! The explanation is this. Consider a posting of £36 which has incorrectly been posted as £63: the numbers have been transposed. The difference is:

	63 -
	36
	_____
	27
	_____

and of course 27 is divisible by 9.

So if the difference is divisible by 9 it might be that you have transposed two figures. Try checking your postings.

Is the difference just a completely odd figure (e.g. £1, 042.37)?

If so then you have probably omitted a posting (or the extraction of a

balance).

It is not possible to forecast all the possible ways that errors can be made and the above suggestions can only be a general guide. Unfortunately if there are several errors they can be very difficult to find.

Console yourself with the thought that even qualified accountants don’t always balance first time but with practice your accuracy will improve and there will be fewer errors to look for.

At the end of the accounting year you may want to prepare or draft some annual accounts, and we’ll see how to do this in Chapter 8.

SUMMARY

This chapter has dealt with:

• the introduction of double entry bookkeeping
• the reasons for double entry bookkeeping
• debits and credits
• the nominal ledger
• the accounts that you will need
• the trial balance
• books of prime entry.