Notes · AccountingUK · A-Levels

The double entry model

This is the engine room of the whole subject. It builds the accounting equation and the dual effect, sets out the rules of debit and credit, follows a transaction from its source document through the books of prime entry into the ledger, shows how accounts are balanced and gathered into a trial balance, and covers discounts, irrecoverable debts and the disposal of non-current assets. Every later financial statement rests on getting this model exactly right.

4 sections~18 min reading time4 competenciesLevel Foundation 1 · Standard 2 · Advanced 1

T·0333 / 18

Exam profile

AO1 · Understand the accounting equation, the dual effect and the rules of debit and creditAO2 · Record transactions in the books of prime entry, post to the ledgers, balance accounts and prepare a trial balanceAO2 · Account for trade and settlement discounts, irrecoverable debts and the disposal of non-current assetsAO3 · Analyse the effect of transactions on the accounting equation and evaluate the integrity of the records

Operators:preparerecordcalculateexplainshow thatbalanceanalyse

basic level

AS-Level expects confident double entry: recording transactions, balancing accounts and preparing a trial balance, including discounts and irrecoverable debts.

higher level

The full A-Level adds the disposal of non-current assets, the recovery of debts previously written off, and the analysis of how transactions affect the accounting equation and the integrity of the records.

Depth

Text

Contents · 4 sections

The double entry model

The accounting equation and the dual effect#

FoundationAQA 7127 3.3

The accounting cycle

Fig. 1The accounting cycle: transactions flow from source documents through the books of prime entry and the ledgers to the trial balance, and after adjustments into the financial statements.

The whole of double-entry bookkeeping rests on one identity, the accounting equation: assets equal capital plus liabilities. Assets are the resources the business owns or controls (premises, machinery, inventory, receivables, cash); liabilities are what it owes to outsiders (payables, loans, overdrafts); and capital is what the business owes to its owner - the owner's stake, or the residual claim on the assets after the liabilities have been met. Rearranged, the equation says capital equals assets minus liabilities, which is why capital is often called the net assets or the owner's equity. The equation must hold at every instant, and keeping it in balance is the discipline that makes the records reliable.

Every transaction has a dual effect - it affects at least two items in the equation, and it affects them in a way that keeps the equation balanced. This dual aspect is not an accounting convention imposed on reality; it reflects the fact that every exchange has two sides. If the owner pays £20,000 into the business bank account, the asset 'bank' rises by £20,000 and the capital rises by £20,000 - both sides of the equation increase equally. If the business buys a £8,000 machine by cheque, the asset 'machinery' rises by £8,000 while the asset 'bank' falls by £8,000 - one asset is exchanged for another and the totals are unchanged. If it buys goods on credit, an asset (inventory or purchases) rises and a liability (the payable) rises by the same amount. In every case the equation stays in balance.

It is worth tracing a few transactions through the equation to see the pattern, because this is what double entry mechanises. Introducing capital increases an asset and increases capital; taking drawings decreases an asset and decreases capital; making a profit increases net assets and increases capital (profit belongs to the owner), while a loss reduces both; buying an asset for cash swaps one asset for another; borrowing increases an asset and increases a liability; repaying a loan decreases an asset and decreases a liability. Because capital is affected by profit and drawings, the equation can be written in expanded form, and this expanded view links the double-entry records directly to the income statement and the statement of financial position that summarise them.

The reason the dual effect matters so much is that it provides a built-in check on accuracy. Because every transaction is recorded twice - once as a debit and once as a credit of equal value - the total of all debits must always equal the total of all credits, and the accounting equation must always balance. If it does not, an error has been made. This self-checking property is the genius of double entry and the foundation of the verification techniques (the trial balance, control accounts, reconciliations) covered in the next chapter. The dual effect is therefore not busywork; it is what makes the whole system trustworthy.

\text{Assets} = \text{Capital} + \text{Liabilities}

The accounting equation

The identity that must hold at every instant. Rearranged, Capital = Assets - Liabilities, so capital is the owner's residual claim (net assets).

\text{Capital}_{\text{closing}} = \text{Capital}_{\text{opening}} + \text{Profit} - \text{Drawings} + \text{Capital introduced}

The expanded capital relationship

Capital rises with profit and new capital and falls with drawings and losses. This links the ledger to the income statement and statement of financial position.

Worked example

Tracing transactions through the equation

A business starts with capital of £10,000 in the bank. It then (i) buys equipment for £4,000 by cheque and (ii) buys inventory for £3,000 on credit. Show the effect on the accounting equation after each transaction.

Opening position
Assets: bank £10,000. Capital £10,000. Liabilities £0. The equation holds: 10,000 = 10,000 + 0.
After buying equipment
Bank falls to £6,000; equipment rises to £4,000. Total assets are still £10,000; one asset was swapped for another. Equation: 10,000 = 10,000 + 0.
After buying inventory on credit
Inventory rises by £3,000 (assets now £13,000); a payable of £3,000 arises (liabilities £3,000). Equation: 13,000 = 10,000 + 3,000.

Result: After both transactions, assets of £13,000 (bank £6,000 + equipment £4,000 + inventory £3,000) equal capital £10,000 plus liabilities £3,000 - the equation stays in balance throughout.

Typical mistakes

Recording only one side of a transaction, so the equation no longer balances.
Treating capital as cash - capital is the owner's claim on the net assets, not a pot of money.

Active revision

For each transaction, state the two items in the accounting equation that change and the direction of each change: (a) owner pays £5,000 into the bank; (b) buys a van for £7,000 by cheque; (c) buys goods for £2,000 on credit.

Active recall

Recall the key points — then reveal.

Sources: AQA A-level Accounting 7127 specification (AQA)

Debit and credit, source documents and books of prime entry#

StandardAQA 7127 3.3

The rules of debit and credit

Fig. 2Debit increases assets and expenses (and reduces liabilities, capital and income); credit increases liabilities, capital and income (and reduces assets). Debits always equal credits.

Double entry records the dual effect using two columns in every account: the debit (left) and the credit (right). The rules of debit and credit follow directly from the accounting equation. An account is debited to record an increase in an asset or an expense, or a decrease in a liability or in capital or income; an account is credited to record an increase in a liability, capital or income, or a decrease in an asset. A useful way to remember the pattern is that assets and expenses are 'debit-natured' (they increase on the debit side), while liabilities, capital and income are 'credit-natured' (they increase on the credit side). For every transaction, one account is debited and another credited with the same amount, so debits always equal credits.

Transactions do not go straight into the ledger. They begin with a source document - a physical or electronic record that evidences the transaction and provides the details: an invoice for a credit sale or purchase, a credit note for a return, a cheque counterfoil or bank statement for a payment, a receipt, a till roll. Source documents are the audit trail: they prove a transaction happened and allow it to be checked. Good practice - and honest accounting - depends on every entry being supported by a source document, which is why examiners expect you to know which document underlies which entry.

The details from the source documents are first listed in the books of prime entry (also called books of original entry or day books), which are not part of the double entry themselves but the place where transactions are gathered before posting. The main ones are the sales day book (credit sales), the purchases day book (credit purchases), the sales returns and purchases returns day books, the cash book (all bank and cash receipts and payments - itself part of the ledger), the petty cash book (small cash payments, often on the imprest system) and the journal (for one-off or unusual entries such as opening balances, the correction of errors, depreciation and asset disposals). Grouping similar transactions in day books makes the system efficient and provides useful totals to post.

From the books of prime entry the transactions are posted to the ledger accounts using double entry. The ledger is traditionally divided into the sales ledger (the personal accounts of credit customers - receivables), the purchases ledger (the personal accounts of credit suppliers - payables) and the general or nominal ledger (all the other accounts - assets, expenses, income, capital, and the control accounts). This structure keeps the many individual customer and supplier accounts separate from the summary accounts, and it underpins the control-account checks in the next chapter. Understanding the journey - source document, book of prime entry, ledger - is essential, because a question may test any stage of it.

Worked example

From source document to ledger

A business buys goods for £900 on credit from Ace Supplies. Identify the source document and book of prime entry, and state the double entry.

Source document
The purchase invoice from Ace Supplies evidences the credit purchase and gives the amount, £900.
Book of prime entry
The invoice is listed in the purchases day book, which gathers all credit purchases before posting.
The double entry
Debit Purchases £900 (an expense/asset increases, recorded on the debit side) and credit Ace Supplies £900 (a payable - a liability - increases, recorded on the credit side). Debits equal credits.

Result: Source document: purchase invoice; book of prime entry: purchases day book; ledger entry: Dr Purchases £900, Cr Ace Supplies (payables) £900.

Typical mistakes

Reversing debit and credit - for example crediting an asset when it increases.
Confusing the books of prime entry (which merely list transactions) with the ledger (where the double entry is made); the cash book is part of the ledger, the sales day book is not.

Active revision

A business sells goods for £600 on credit to J Patel. State the source document, the book of prime entry, and the two ledger accounts debited and credited.

Active recall

Recall the key points — then reveal.

Sources: AQA A-level Accounting 7127 specification (AQA)

Posting to the ledger, balancing and the trial balance#

StandardAQA 7127 3.3

The bank account (T-account)

Fig. 3The bank account balanced: receipts of £24,000 on the debit side, payments of £12,000 on the credit side, leaving a debit balance carried down of £12,000.

Once transactions are posted, each ledger account is periodically balanced to find its net position. Balancing an account means totalling the two sides, entering the difference as a balance carried down (c/d) on the smaller side so that the two totals agree, and bringing that balance down (b/d) on the opposite side as the opening balance for the next period. An account with a larger debit side has a debit balance (typical of assets and expenses); an account with a larger credit side has a credit balance (typical of liabilities, capital and income). The balance on each account is the figure that will appear in the trial balance and, ultimately, the financial statements.

The trial balance is a list of all the ledger balances at a point in time, with the debit balances in one column and the credit balances in another. Its primary purpose is to check the arithmetical accuracy of the double entry: because every transaction was recorded with equal debits and credits, the total of the debit balances should equal the total of the credit balances. If the two totals agree, it gives some assurance (though not proof - see the next chapter) that the books balance. The trial balance also serves as the convenient starting point from which the financial statements are prepared.

It repays effort to know which balances are debits and which are credits, because a misclassified balance is a common and costly error. Debit balances include all assets (premises, equipment, inventory, trade receivables, bank when positive, cash), all expenses (purchases, wages, rent, and so on) and drawings. Credit balances include all liabilities (trade payables, loans, bank overdraft), capital, and all income (sales, and other revenue). Sales returns are a debit (they reduce income), purchases returns are a credit (they reduce an expense). Getting these the right way round is what makes a trial balance actually balance.

A worked posting shows the model end to end. Suppose a new business undertakes these transactions: the owner pays in £20,000 capital to the bank; buys machinery £8,000 by cheque; buys goods £5,000 on credit from Jones; sells goods £6,000 on credit to Smith; pays rent £1,000 by cheque; receives £4,000 from Smith; and pays Jones £3,000. Posting each with double entry, then balancing the accounts, gives a bank balance of £12,000 (Dr), machinery £8,000 (Dr), purchases £5,000 (Dr), Smith £2,000 (Dr), rent £1,000 (Dr), capital £20,000 (Cr), Jones £2,000 (Cr) and sales £6,000 (Cr). The trial balance then totals £28,000 on each side - the debits equal the credits, confirming the double entry is arithmetically correct.

The trial balance

Fig. 4The trial balance: debit balances total £28,000 and credit balances total £28,000, confirming the double entry is arithmetically in balance.

Worked example

Balancing an account and its trial-balance figure

Smith owes for a £6,000 credit sale and then pays £4,000 by cheque. Prepare Smith's account, balance it, and state whether the balance is a debit or credit and where it appears in the trial balance.

Post the two entries
The £6,000 sale is a debit in Smith's account (a receivable, an asset, increases). The £4,000 receipt is a credit in Smith's account (the receivable falls as cash is received).
Balance the account
Debit side £6,000; credit side £4,000. Balance c/d = £2,000 on the credit side to make the totals £6,000 each; brought down as a £2,000 debit balance.
Classify for the trial balance
Smith has a £2,000 debit balance (he still owes the business £2,000), so it appears in the debit column of the trial balance as a trade receivable.

Result: Smith's account has a £2,000 debit balance - a trade receivable - which appears in the debit column of the trial balance.

Typical mistakes

Putting a balance on the wrong side of the trial balance (for example a bank overdraft as a debit, or drawings as a credit).
Treating the balancing of an account carelessly - the balance c/d goes on the smaller side and is brought down on the opposite side.

Active revision

From the transactions in the key points, prepare the machinery, purchases, Smith, capital and sales accounts, balance them, and confirm the trial balance totals agree.

Active recall

Recall the key points — then reveal.

Sources: AQA A-level Accounting 7127 specification (AQA)

Discounts, irrecoverable debts and asset disposals#

AdvancedAQA 7127 3.3

Disposal of a non-current asset

Fig. 5The disposal account compares carrying amount with proceeds. Cost £20,000 (Dr) versus depreciation £14,000 plus proceeds £8,000 (Cr) gives a £2,000 profit on disposal.

Discounts come in two kinds that are treated very differently. A trade discount is a reduction in the list price given to certain customers (for buying in bulk or being in the trade); it is deducted before the invoice is drawn up, so the transaction is recorded net of it and the trade discount itself never appears in the ledger. A cash discount (also called a settlement discount) is a reduction offered for prompt payment; because it depends on when the customer pays, it is recorded when taken. A discount allowed (to a customer) is an expense of the business and is debited to a discounts-allowed account; a discount received (from a supplier) is income and is credited to a discounts-received account. Distinguishing the two - trade discount not recorded, cash discount recorded - is a frequent exam point.

Irrecoverable debts (bad debts) arise when a credit customer will not pay - because they have become insolvent, disappeared or disputed the debt beyond recovery. Prudence requires that the asset be removed once recovery is genuinely not expected: the debt is written off by debiting an irrecoverable-debts expense account (a cost in the income statement) and crediting the customer's account (removing the receivable). Occasionally a debt written off in an earlier period is later recovered; this is recorded by debiting the bank with the receipt and crediting an irrecoverable-debts-recovered account (income), rather than reinstating and re-clearing the customer's account. These entries keep receivables at a realistic value and recognise the cost of extending credit.

The disposal of a non-current asset must be accounted for so that the asset and its accumulated depreciation are removed from the books and any profit or loss on disposal is recognised. A disposal account is opened. The asset's original cost is transferred out of the asset account into the disposal account (debit disposal, credit the asset at cost); the accumulated depreciation on that asset is transferred out of the accumulated-depreciation account into the disposal account (debit accumulated depreciation, credit disposal); and the sale proceeds are recorded (debit bank or receivable, credit disposal). The balance remaining on the disposal account is the profit or loss on disposal: a credit balance is a profit (proceeds exceeded the carrying amount), a debit balance is a loss.

The logic of the disposal account is that it compares the proceeds with the asset's carrying amount (net book value). If a machine cost £20,000, has accumulated depreciation of £14,000 (so a carrying amount of £6,000) and is sold for £8,000, the disposal account is debited with £20,000 cost and credited with £14,000 depreciation and £8,000 proceeds; the credit side (£22,000) exceeds the debit side (£20,000) by £2,000, which is a profit on disposal transferred to the income statement. A profit or loss on disposal simply corrects the depreciation charged over the asset's life: it arises because the estimated depreciation did not exactly match the fall in the asset's value, so it is really an adjustment to past expense, not a trading gain.

\text{Profit or loss on disposal} = \text{Proceeds} - \text{Carrying amount}

Profit or loss on disposal

Carrying amount (net book value) = cost - accumulated depreciation. A profit if proceeds exceed carrying amount; a loss if they fall short. It corrects the depreciation estimate.

Worked example

Profit or loss on the disposal of an asset

A machine costing £20,000 has accumulated depreciation of £14,000 and is sold for £8,000 by cheque. Prepare the disposal account and calculate the profit or loss on disposal.

Transfer cost and depreciation
Debit the disposal account with the cost £20,000 (crediting machinery). Credit the disposal account with the accumulated depreciation £14,000 (debiting the accumulated-depreciation account). The carrying amount is £20,000 - £14,000 = £6,000.
Record the proceeds
Debit bank £8,000 and credit the disposal account £8,000 with the sale proceeds.
Find the balance
Disposal account: debit £20,000; credit £14,000 + £8,000 = £22,000. The credit side exceeds the debit side by £2,000, a profit on disposal, transferred (debit disposal, credit income statement).

Result: Proceeds £8,000 less carrying amount £6,000 gives a £2,000 profit on disposal, shown as a credit balance on the disposal account and taken to the income statement.

Typical mistakes

Recording a trade discount in the ledger - it is deducted before entry and never appears.
Comparing proceeds with cost instead of with carrying amount when calculating profit or loss on disposal, or forgetting to remove the accumulated depreciation.

Active revision

A van costing £18,000 with accumulated depreciation of £11,000 is sold for £5,000. Prepare the disposal account and state the profit or loss on disposal.

Active recall

Recall the key points — then reveal.

Sources: AQA A-level Accounting 7127 specification (AQA) · Ofqual - GCE AS and A level qualifications (Ofqual)

References & sources

Sources

AQA

AQA A-level Accounting 7127 specification

Ofqual

Ofqual - GCE AS and A level qualifications

The double entry model

4 sections~18 min reading time4 competenciesLevel Foundation 1 · Standard 2 · Advanced 1

The double entry model

Key points

Tracing transactions through the equation

Key points

From source document to ledger

Key points

Balancing an account and its trial-balance figure

Key points

Profit or loss on the disposal of an asset

Sources

The double entry model

Key points

Tracing transactions through the equation

Key points

From source document to ledger

Key points

Balancing an account and its trial-balance figure

Key points

Profit or loss on the disposal of an asset

Sources