Double Entry Bookkeeping, Journal Entries and Ledger Accounts

The accounting equation says that assets equal capital plus liabilities. Double entry is the method that keeps it true every time a transaction is recorded. Each transaction is entered twice, once as a debit in one account and once as a credit in another, and the two entries are always equal.

This topic teaches the rules for choosing the accounts, the journal that records and explains an entry, the ledger that collects the entries, the chart of accounts that organises the ledger, and the entries that close the books at the year end.

This is the most heavily examined skill in the first half of the paper. In the 20 diets reviewed, a full Section B question that asks for journals, ledger accounts or a trial balance from a list of transactions appears in about one diet in three, usually for 10 to 20 marks. Section A adds items on the debit and credit rules, the purpose of the journal and the chart of accounts.

Read the topic on the accounting equation and business transactions first, because double entry is that equation in action. The next topic covers balancing the accounts and the trial balance.

The rules of debit and credit

Two rules govern the main ledger, which is also called the nominal ledger or general ledger. First, every transaction is recorded twice, as a debit entry in one account and a credit entry in another. Second, total debits and total credits are always equal, which maintains the accounting equation. It helps to draw each account as a T account, with the account name on top.

By convention, debit entries go on the left-hand side and credit entries on the right-hand side. “Debit” and “credit” are shortened to Dr and Cr. Accounts can also be kept in columns, but a debit in a credit-balance account is then shown as a deduction, so mistakes are easier. This course uses T accounts.

The main ledger has accounts for assets, liabilities, equity, income and expenses. The rules follow from the accounting equation.

You need to know these by heart. A useful way to hold them: Assets and expenses are debit-balance accounts, and Liabilities, capital and income are credit-balance accounts. Each type increases on its normal side and decreases on the other.

Example. A purchase invoice arrives for electricity of ₦46,000. Electricity is an expense and the amount owed is a liability. So the entry is Dr Electricity expense ₦46,000 and Cr Expense payables ₦46,000. Written this way, a debit and credit entry is a Journal entry.

Cash, bank and the common transactions

An entity usually keeps separate accounts for cash in hand and cash at bank. Both are assets. Receipts add to cash, so they are debits to the cash or bank account. Payments reduce cash, so they are credits.

The matching entry for a receipt might be a credit to sales for a cash sale, to trade receivables for money from a credit customer, or to capital for new money paid in by the owner.

The matching entry for a payment might be a debit to an expense, to trade payables for a payment to a supplier, to drawings for the owner’s withdrawals, or to an asset account for a purchase.

This topic uses a Periodic approach to inventory in these early chapters. Goods bought for resale are recorded in a Purchases account, which is treated as an expense. Inventory is not recorded as an asset until the end of the period, when the closing inventory is counted and valued. Goods taken by the owner reduce purchases, because some of the purchases were not for the business. The full treatment of inventory comes in the inventory topics.

Ledger accounts and posting

The general ledger contains all the individual accounts used to record a business’s double entries. It may be a book or a software application. Recording an entry in an account is called Posting. Beside each entry, write the name of the account that holds the matching entry, so any entry can be traced.

At the end of a period the balances on the accounts are extracted as a trial balance, the foundation for the financial statements.

The journal

The general journal is a book of prime entry that records transactions not recorded in any other book of original entry. It records and explains postings from other books of prime entry, year-end adjustments, corrections of errors and any other adjustment. Each entry names the account to be debited, then the account to be credited, the amounts, and a short narration beginning “Being”.

Not every transaction goes through a journal in practice, but any transaction can be journalised. A question that says “prepare journal entries” simply asks you to show the debit and credit for each transaction, without T accounts.

Take the purchase of a van for ₦2,400,000, paid by cheque:

Where one transaction has two parts, such as borrowing money and then spending it, write two journals or a single compound entry. A compound entry can have more than one debit or more than one credit, but the total debits must still equal the total credits.

The chart of accounts

A chart of accounts is a list of the accounts a business uses to organise its transactions into categories of assets, liabilities, income and expenses. Each ledger account has a unique code and heading. The list is usually arranged in the order in which the accounts appear in the financial statements, statement of financial position accounts first and statement of profit or loss accounts after.

Its purpose is consistent posting: staff are told which account to use for each kind of transaction. A company can design its own chart within the rules of accounting, and in some countries the government issues a general chart from which a business selects what it needs.

Within non-current assets, for instance, land might be 110, office buildings 120, warehouses 130 and factories 140.

Closing the books at the year end

There is no profit figure in the ledger until the trial balance has been extracted, because profit is represented by all the balances on the income and expense accounts. At the year end the year-end exercise has five steps.

1. Record the year-end adjustments by double entry in the ledger.
2. Transfer all the income and expense account balances to a Profit or loss account.
3. Close off the profit or loss account. Its balance is the profit or loss for the period.
4. Transfer that balance to the capital account.
5. Transfer the drawings account to the capital account and close off the capital account.

Income accounts such as sales are debited and the profit or loss account credited. Expense accounts are credited and the profit or loss account debited. Closing inventory is debited to an inventory asset account and credited to the profit or loss account, which reduces the cost of sales. A profit is then debited to the profit or loss account and credited to capital.

A loss goes the other way. Drawings are debited to capital and credited to the drawings account.

The ideas in more depth

Debit and credit are only sides

In ordinary speech credit sounds good and debit sounds bad. In bookkeeping they only mean left and right. An increase in an asset is a debit and an increase in a liability is a credit, so neither word has a built-in meaning of good or bad.

Why the entries balance

Assets and expenses are on the debit side of the equation and liabilities, capital and income on the credit side. Any event that raises one side must raise the other or lower another item on the same side. Equal debits and credits keep the equation in balance.

The journal is a record of explanation

The ledger shows the effect of each transaction on an account. The journal shows the reason for it. That is why the journal is used for entries that have no other source document, such as corrections and adjustments.

Drawings of goods

When an owner takes goods, the business has bought less for resale than it records, so purchases are credited. The alternative of crediting sales would suggest a sale that never took place.

Personal accounts and nominal accounts

Accounts for customers and suppliers are personal accounts. Accounts for assets, expenses and income are impersonal. The rules of this topic apply to all of them, and the next topics show how the accounts of customers and suppliers are controlled.

Sources and references

Worked example: a bakery in Kaduna

1. Journals. (1) Dr Bank, Cr Capital 800,000. (2) Dr Oven, Cr Bank 350,000. (3) Dr Purchases, Cr Trade payables (Musa) 200,000. (4) Dr Bank, Cr Sales 260,000. (5) Dr Trade receivables (Hotel Rayfield), Cr Sales 180,000. (6) Dr Trade payables (Musa), Cr Bank 120,000. (7) Dr Bank, Cr Trade receivables (Hotel Rayfield) 100,000. (8) Dr Wages, Cr Bank 70,000. (9) Dr Drawings, Cr Bank 50,000. Each carries a narration beginning “Being”.
2. Bank account.
   Debits: capital 800,000 + sales 260,000 + receivables 100,000 = 1,160,000.
   Credits: oven 350,000 + Musa 120,000 + wages 70,000 + drawings 50,000 = 590,000.
   Balance brought down: debit 570,000.
3. Other balances. Trade payables (Musa): credit 200,000 less debit 120,000 = credit 80,000. Trade receivables: debit 180,000 less credit 100,000 = debit 80,000. Sales: credit 440,000. Purchases 200,000, oven 350,000, wages 70,000 and drawings 50,000 are debits. Capital is a credit of 800,000.
4. Trial balance.
   Debits: bank 570,000 + oven 350,000 + purchases 200,000 + receivables 80,000 + wages 70,000 + drawings 50,000 = 1,320,000.
   Credits: capital 800,000 + payables 80,000 + sales 440,000 = 1,320,000.
   The two totals agree.
5. Profit or loss account.
   Debits: purchases 200,000 + wages 70,000 = 270,000.
   Credits: sales 440,000 + closing inventory 40,000 = 480,000.
   The balancing figure is a profit of 480,000 − 270,000 = 210,000.
6. Capital account.
   Credits: 800,000 + profit 210,000 = 1,010,000.
   Debit: drawings 50,000.
   Balance carried down: 960,000.
7. Check with the equation.
   Assets: bank 570,000 + oven 350,000 + receivables 80,000 + inventory 40,000 = 1,040,000.
   Liabilities 80,000 + capital 960,000 = 1,040,000.
   It balances.

All the ledger accounts after posting

This table shows every account in the bakery example after the nine transactions are posted. Each entry names the account that holds the other side of the double entry.

Each transaction is entered as a debit in one account and a credit in another, so the debit entries and the credit entries each total ₦2,130,000. Check: 800,000 + 350,000 + 200,000 + 260,000 + 180,000 + 120,000 + 100,000 + 70,000 + 50,000 = 2,130,000. Counting the entries in the table gives the same total on each side: debit entries 1,160,000 + 350,000 + 200,000 + 120,000 + 180,000 + 70,000 + 50,000, and credit entries 590,000 + 800,000 + 200,000 + 440,000 + 100,000.

Common mistakes in the exam

• Debiting an account that should be credited, usually when the transaction involves the bank. Receipts are debits to bank, payments are credits.
• Posting only one side of a transaction, which makes the trial balance fail.
• Crediting bank for a credit purchase. A credit purchase credits trade payables, and bank is used only when cash moves.
• Journalising without a narration, or with debit and credit in the wrong order. The debit is written first.
• Recording drawings of goods as sales. They are a debit to drawings and a credit to purchases.
• Forgetting to name the opposite account beside each ledger entry.
• Treating a loan received as income. It is a credit to a loan account.

Quick revision

• Every transaction: one debit and one credit of equal amounts.
• Debit: increase in assets and expenses, decrease in liabilities, capital and income. Credit: the reverse.
• Cash and bank are assets: receipts debit, payments credit.
• Journal: debit first, credit second, narration beginning “Being”.
• General ledger holds all accounts. The chart of accounts gives each a code, arranged as in the financial statements.
• Year end: close income and expenses to the profit or loss account, move the profit to capital, then drawings to capital.
• Goods taken by the owner: debit drawings, credit purchases.

Practice questions

These are original questions written in the style of the Institute of Chartered Accountants of Nigeria (ICAN) exam. Try each one before you open the answer.

Section A style: multiple choice

Section B style: written questions

A further written question

Model answers

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