Time Tracer Ltd - Publishing

ACCOUNTING INSIGHT

2nd Edition by Edwin Olima FCCA

ISBN 0-9543820-1-3

 

 

 

 

 

 

 

 

 

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The dual nature of transactions

By now you will have began to appreciate that every transaction has two aspects to it:

1.        The value of what flows into the business (debits) and,

2.        The value of what flows out of the business (credits).

 

This duality arises as a natural result of entering into a transaction and can be represented diagrammatically as follows:

 

 

Figure 1: The Point of Transaction illustrating the dual nature of transactions

 

This reality of business transactions  is reflected in accounting by the use of the double-entry system  of keeping records. This system was invented in the 16th century by an Italian monk by name of  Fra Luca Bartolomeo Pacioli.

 

Double-entries are what you have been doing since Chapter 1 where you started by listing the following:

1)       Gross debtors  (expected cash flows into the business - debits) and

2)       Net sales , and vat thereon (value of goods  and tax thereon that flow out of the business - credits).

All arising out of the sales transactions  with your customers .

 

Most people tend to think of the direction of cash flow mainly. In accounting however one must also look at what the cash was exchanged for and record this as well.

 

Accountants tend to use two columns to list the two directions of flows. Debits on the left and Credits on the right. Every account that is used to list out transactions  will also follow this format – debits on the left and credits on the right. So to account for the first sales invoice an accountant would make the following entries in the books (color is used for illustration only):

DEBTORS ACCOUNT – JOHN SMITH

Date

Details

Debit £’s

Date

Details

Credit £’s

15-1-3000

Sales invoice number  1001

4,700.00

 

 

 

 

 

 

 

 

 

 

SALES ACCOUNT            

Date

Details

Debit £’s

Date

Details

Credit £’s

 

 

 

15-1-3000

Sales invoice number  1001

4,000.00

 

 

 

 

 

 

 

VAT  ACCOUNT 

Date

Details

Debit £’s

Date

Details

Credit £’s

 

 

 

15-1-3000

Sales invoice number  1001

700.00

 

 

 

 

 

 

 

The above system may not be intuitive at first sight, however it is reliable and flexible where there are many accounts and transactions  over the period of accounting. There are three entries since the VAT  needs to go to separate account.

 

You could for the sake of illustrating the double-entry system  split the first entry in John Smith’s Account into net sales  of £4,000 and VAT  of £700.00. Thus getting the full illustration of the double- entry system with two debit entries mirrored by two credit entries exactly (four entries in total). The main point in either case being that the value of debits equals the value of credits.

 

Compare the three entries above with the first line entry that you made in the sales invoice list (Chapter 1 ) and note how the line entry is also a double-entry but is also more intuitive:

Gross  Debtors   =   VAT   +   Net Sales.

 

 

Formats of accounts used in accounting

 

The above type of accounts are called “T-accounts” because of the way the debits and credit sides are split down the middle by the main border.  The complete T-account for John Smith in the debtors ledger could be closed off at the end of January (or indeed at the end of any period of accounting that your company is using) as follows:

 

DEBTORS ACCOUNT – JOHN SMITH

Date

Details

Debit £’s

Date

Details

Credit £’s

15-1-3000

Sales invoice number  1001

4,700.00

30-1-3000

Cheque received

4,700.00

 

 

31-1-3000

Balance carried down

0.00

 

 

4,700.00

 

 

4,700.00

1-2-3000

Balance brought down

0.00

 

 

 

 

 

 

 

 

 

 

 

If however John Smiths cheque of the 30th Jan 3000 was only for £1,000.00, then balance carried down would have been £3,700.00 as shown below below.

 

DEBTORS ACCOUNT – JOHN SMITH

 (if only £1,000 was received)

Date

Details

Debit £’s

Date

Details

Credit £’s

15-1-3000

Sales invoice number  1001

4,700.00

30-1-3000

Cheque received (say)

1,000.00

 

 

 

31-1-3000

Balance carried down

3,700.00

 

 

4,700.00

 

 

4,700.00

1-2-3000

Balance brought down

3,700.00

 

 

 

 

 

 

 

 

 

 

 

There are other formats for presenting accounts and one used a lot by computer programs is a variation of the above together with a running balance as shown below:

 

DEBTORS ACCOUNT – JOHN SMITH

Date

Details

Debit £’s

Credit £’s

Balance

15-1-3000

Sales invoice number  1001

4,700.00

 

4,700.00

30-1-3000

Cheque received

 

4,700.00

0.00

 

 

 

 

 

31-1-3000

Totals

4,700.00

4,700.00

0.00

 

 

A further format uses just one column of values but shows debits as positive numbers and credits as negative numbers. Using this format John Smiths Account would look like this:

 

DEBTORS ACCOUNT – JOHN SMITH

Date

Details

Amount £’s

15-1-3000

Sales invoice number  1001

4,700.00

30-1-3000

Cheque received

(4,700.00)

31-1-3000

Balance

0.00

 

As you can see all formats present the same information and arrive at the same result.

 

The Full Set of Double-Entry Accounts for The Company Ltd

 

After you have completed the exercises in this book you can review the full set of double-entry T-Accounts for The Company Ltd (APPENDIX F ). These accounts are all kept in one book called the Nominal Ledger.

 

Exercise for later: On finishing the book, you can practice doing double-entry accounts  by creating your own set of T-Accounts from the source documents in the work pack and comparing your T-Accounts with the solution in APPENDIX F . This exercise will increase your abilities in double-entry accounting. A blank set of T-Accounts is included for you to photocopy and practice with.


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