The Double Entry System

Introduction:

This note will explain the double entry system, the rationale behind it, which is the dual aspect of business transactions, and how transactions are recorded using the double entry system.

What is the Double Entry System:

This is a system of bookkeeping where every business transaction is recorded twice. It will be remembered that in a previous note, we discussed bookkeeping as “the aspect of recording financial data in the cash book and ledgers.” In recording financial data in the ledgers, the double entry system, which is simply a system of bookkeeping, requires that the recording be done twice.

Rationale behind the Double Entry System:

The double-entry system of bookkeeping is based on the principle that every business transaction has a dual aspect. Consider the following common transactions in business and notice their dual aspect:

A: Sale of Goods for Cash:

1. Cash is received.
2. Goods are given out.

B. Sale of Goods on Credit:

1. Goods are given out.
2. The recipient of the goods becomes a debtor (as he would eventually have to pay for the goods).

C. Purchase of Goods for Cash:

1. Cash is given out to supplier.
2. Goods are received.

D. Purchase of Goods on Credit:

1. The supplier of the goods becomes a creditor (as the business would eventually have to pay for the goods).
2. Goods are received.

Recording Transactions Using the Double Entry System:

A. What Recording Twice Does Not Mean:

In discussing the double entry system of bookkeeping, it was merely said that every transaction is recorded twice. Does this mean we simply describe the transaction and the amount involved, and simply redo this, such as follows:

Is the above double recording of the sale of goods to Kofi in accordance with the double entry system of recording transactions? The answer is no.

B. What Recording Twice Entails:

To ensure that the recording of a transaction is done in accordance with the double entry system of recording transactions, we must do the following:

1. Identify the two accounts that are affected by each transaction.
2. Record each transaction in the two separate ledger accounts .
3. In recording in the two separate accounts, one account is debited and the other account is credited . It is often said thatfor every debit entry, there must be a corresponding credit entry and for every credit entry, there must be a corresponding debit entry(This principle forms the core of the double-entry bookkeeping system). If this rule is strictly complied with, the sum of all the debit entries will equal the sum of all credit entries.
4. Based on the nature of the transaction, identify the right account to be debited and the right account to be credited .
5. The amount debited must always equal the amount credited.

All the above will be more comprehensible after we explain what is informally known as the T-Account, which is used to portray a ledger account, and how and when the T-account is credited or debited.

C. Understanding the T-Account:

The T-account represents a ledger account, which is simply a record of all transactions affecting a particular account. Remember that in the note on the accounting cycle, it was discussed that after entries are made in the day books (e.g. purchases daybook, sales daybook, return inwards and return outwards daybook), the next step is to post those entries into ledger accounts in the general ledger. In practice, each ledger account in the general ledger is in the form of a T, hence the unofficial name “T-account.” Consequently, it is often said that the T-account is the graphical representation of a ledger account.

Below is a sample of a T-account (a graphical representation of what is formally known as a ledger account):

From the above, each ledger has the following:

1. A Title: This is simply the name of the account. For example, if the account is for dealing with capital, it will be called “Capital Account.” If it is for dealing with cash, it will be called “Cash Account.” If it is for dealing with sales, it is called “Sales Account.” If it is for a particular type of asset, say the purchase of a computer, it may simply be called “Computers Account.” Essentially, the title of an account is chosen to ensure it clearly represents the nature of the transactions recorded in it, making it easy to understand at a glance.

2. A Left and a Right Side, known as Debit and Credit Respectively: Every ledger account is divided into two sides by a vertical line in the middle, as seen above. The left side of the divide is called the debit side , which is abbreviated as Dr. When a transaction is recorded at the debit side of the divide, the ledger account is said to have been debited. The right side of the divide is called the credit side, abbreviated as Cr. Similarly, when a transaction is recorded at the credit side of the divide, the ledger account (or T-account) is said to have been credited.

3. Date, Particulars and Amount on Both the Debit Side and the Credit Side: Both the debit side and the credit side of a ledger account typically have three separate columns, a date column, a particulars column, and an amount column. The date column is used to record the date of a transaction. The particulars column is used to record the name of the ledger affected by the transaction. The amount column is used to record the amount involved in the transaction.

D. Crediting and Debiting the T-Account:

Now that we understand the format of the T-account, the essential question is when do we enter a transaction on the debit side of an account (described as debiting the account), and when do we enter a transaction on the credit side of an account (described as crediting the account)?

To guide you on when to debit an account and when to credit it, the following cardinal principles or maxims have been developed:

1. Maxim 1: Recording Assets: To increase an asset, debit it; to decrease an asset, credit it.
2. Maxim 2: Recording Liabilities: To increase a liability, credit it; to decrease a liability, debit it.
3. A General Rule on Double Entry Recording: Debit the receiver, credit the giver or Debit what comes in Credit what goes out.

We shall now take each of these maxims and discuss them into detail.

1. Recording Assets: To Increase an Asset, Debit It; To Decrease an Asset, Credit It:

Assets are the resources owned by a business such as cash, goods (inventory), immovable property, movable property, or any other resource. Once it is established that the accounts involved in a transaction are asset accounts, the maxim ‘to increase an asset, debit it; to decrease an asset, credit it’ applies. Thus,

1. An increase in the value of the asset is recorded by debiting the asset account.
2. A decrease in the value of the asset is recorded by crediting the asset account.

To illustrate, let us say you operate a business and you have Ghc 100, 000 in the bank and Ghc 20, 000 cash. On 1 ^st January, 2025, you decided to withdraw Ghc 30, 000 from the bank to add to your cash. The affected accounts will be:

1. Bank Account.
2. Cash Account.

As both the money at the bank and the cash in hand are assets of your business, the maxim “to increase an asset, debit it and to decrease an asset, credit it” will apply. In the present case, the transaction has the following effect on the two accounts:

1. Bank Account: The balance in the bank will decrease by GHS 30,000 due to the withdrawal.
2. Cash Account: The cash in hand will increase by GHS 30,000 due to the same withdrawal.

To record the above transactions in the cash and bank ledgers (T-accounts), the following entries will be made:

1. Debit the Cash Account to reflect the increase in cash.
2. Credit the Bank Account to reflect the decrease in the bank balance.

The entries will look as follows:

From the above, notice that the date of the transaction was captured under the date column of the credit side of the bank account, the name of the account to which the transaction relates (cash) was captured under the particulars column, and the amount involved in the transaction was captured under the Ghc, which is the amount column.

If we were to take our illustration further and say that furniture worth Ghc 10, 000 was purchased on 2 ^nd January and was paid for by cash, our accounts will now look as follows:

In these revised accounts, the value of cash is decreasing by Ghc 10, 000 following the purchase of furniture for that amount. So, in line with the maxim that decreases in asset are credited, we credited the cash account to reflect this decrease. In satisfaction of the double-entry rule, we simultaneously debited the Furniture Account because the value of furniture, which is an asset, has increased.

Recording Liabilities: To Increase a Liability, Credit It; To Decrease a Liability, Debit It:

A liability is a debt or obligation that a business owes to a third party. For example, if a business obtains a loan of GHS 100,000 from ABC Microfinance Ltd. on 10 ^th January, 2025, the loan is classified as a liability.

Once it is established that an account is a liability account, the following rules apply:

1. An increase in the value of the liability is recorded by crediting the liability account.
2. A decrease in the value of the liability is recorded by debiting the liability account.

The combined effect of maxim 1 (recording assets) and maxim 2 (the present maxim) is that the loan of Ghc 100, 000 from ABC Microfinance Ltd. will have the following effect:

1. Credit the amount of Ghc 100, 000 to the account of ABC Microfinance Ltd. to show that the amount of liability has increased (so we now owe ABC Microfinance Ltd. Ghc 100, 000).
2. Debit the amount of Ghc 100, 000 to the Bank Account or Cash Account, depending on whether the amount was received via a bank transfer or in cash. Let us assume it was received in cash. Also, note that maxim one still applies here because the value of the cash account, an asset account, has increased by the value of Ghc 100, 000 (the loan amount), so we debit it to record the increase.

Our accounts will now look as follows:

Let us say on 25 ^th January, 2025, the business decides to repay Ghc 50, 000 of the loan from ABC Microfinance Ltd via cheque. This transaction will affect the Bank Account and the account of ABC Microfinance Ltd. by reducing the bank balance and also reducing the liability of the business towards ABC Microfinance Ltd. To record this transaction, we do the following:

1. Credit the Bank Account: Remember that the Bank Account is an asset account and, therefore, a reduction in its value, pursuant to maxim one, is recorded by crediting it.
2. Debit the account of ABC Microfinance Ltd.: Remember that the account of ABC Microfinance Ltd. is a liability account and, therefore, a reduction in its value, pursuant to the present maxim, is recorded by debiting it.

The books will now look as follows:

3. A General Rule on Double Entry Recording: Debit the Receiver, Credit the Giver or Debit What Comes in Credit What Goes Out:

In recording transactions affecting asset accounts and liability accounts, what we have been simply doing is debiting an account that is receiving value and crediting an account that is giving value.

Applying this maxim, we may analyse all the above transactions as follows:

A. Transfer from Bank to Cash Account
When GHS 30,000 was transferred from the bank account to the cash account:

1. The bank account was giving value (value goes out), so we credited the bank account.
2. The cash account was receiving value (value comes in), so we debited the cash account.

B. Purchase of Furniture with Cash
When GHS 10,000 cash was used to purchase furniture:

1. The cash account was giving value (value goes out), so we credited the cash account.
2. The furniture account was receiving value (value comes in), so we debited the furniture account.

C. Loan from ABC Microfinance Ltd.
When ABC Microfinance Ltd. advanced a loan of GHS 100,000 cash to the business:

1. The account of ABC Microfinance Ltd. was giving value (value goes out), so we credited the liability account for ABC Microfinance Ltd.
2. The cash account was receiving value (value comes in), so we debited the cash account.

D. Partial Loan Repayment
When GHS 50,000 was paid to ABC Microfinance Ltd. as partial repayment of the loan:

1. The bank account was giving value (value goes out), so we credited the bank account.
2. The account of ABC Microfinance Ltd. was receiving value (value comes in), so we debited the liability account for ABC Microfinance Ltd.

Summarily, the rules on double entry in accounting stem from this basic rule: Debit the Receiver, Credit the Giver. When unsure about whether an account is an asset account or a liability account, for which reason you may not be able to apply the specific rules on recording assets and liabilities, you may fall back on this general rule after analysing the transaction to see which account gives value and which account receives the value given.