You will probably have heard about double-entry bookkeeping but do you have a firm grasp of it? This is quite important to understand the basics as it is the foundation of understanding accountancy.
Essentially double-entry means every single financial transaction affects at least 2 different accounts, done using debits & credits (will explain later). Dates are very important for this too – so a business knows how much is actually earnt and how much is actual expenses in any period (ie month/quarter/year).
It’s also important to understand that actual cash coming in and out can be different to what is recognised by business as the revenue or expenses – considering the period for all of this may be different (eg. you work a month but get paid the following month – your bank account might show money coming in for February but the work was actually done and earnt in January)
Payments & Receipts
Examples
A single Payment for say Advertising will do two things.
1) it will increase the Advertising expense; and
2) it will decrease the money in a bank account (or from petty cash)
A single Receipt for say Sales Revenue/Income will do two things.
1) it will increase the Sales Revenue account (record of income earnt); and
2) it will increase the money in a bank account (or actual cash if not deposited)
The current system does all this automatically behind the scenes – a user enters a transaction which includes selecting an Expense or Receipt Detail from the drop down list (step 1 in examples above), and also a Payment Method such as bank accounts, cash etc (step 2 in examples above)
These figures are then reflected in the Profit & Loss Summary which is a report of the Revenue and Expenses in a set period of time such as month/year (per step 1 in the examples above).
The Trial Balance is a report of all types of accounts and the relevant balances (per both steps in the examples above).
The Bank Reconciliation is used for checking the bank account and works on the amounts coming in and out of a single bank account (per step 2 in the examples above). Don’t worry yet about the specifics of this – we will cover later.
With VAT
The inclusion of VAT or Sales Tax makes it only a little more complex but the double-entry concept is the same - at least 2 different accounts will be affected.
Examples
A single Payment for say Advertising will do two things.
1) it will increase the Advertising expense (excluding VAT); and
2) it will reduce the VAT liability account (VAT Amount) – which later the total is to be paid to the tax office; and
3) it will decrease the money in a bank account (or from petty cash)
A single Receipt for say Sales Revenue/Income will do two things.
1) it will increase the Sales Revenue account (excluding VAT); and
2) it will increase the VAT liability account (VAT Amount) – which later the total is to be paid to the tax office; and
3) it will increase the money in a bank account (or actual cash if not deposited)
Amounts may look for the above example (applicable to both examples) along the lines of:
1) £ 100.00
2) £ 20.00 (if 20% VAT – per current UK rate)
3) £ 120.00
Debits & Credits
These are similar to plus and minus but not exactly the same. They do mean increase and decrease but which depends on the type of account.
Types of Accounts
Types of accounts can be broken down into different levels as follows:
- Balance Sheet
- Assets
- Current Assets (eg. cash, debtors / money owed in from customers)
- Non-Current Assets / Fixed Assets (eg. Property & Buildings, Computers, Office Equipment)
- Liabilities
- Current Liabilities (eg. bank overdraft, creditors / money owed out to suppliers, VAT / Sales tax to be paid to tax office)
- Non-Current Liabilities (eg. Long-term loans, Hire Purchases)
- Equity (eg. owner’s equity / investment, shares issued)
- Profit and Loss
- Revenue / Income
- Expenses
The different meaning of increase/decrease with debits and credits can be applied to the 2nd level of account types as follows:
Debit
Increases Expenses
Increases Assets
Decreases Revenue
Decreases Liabilities
Decreases Equity
Credit
Increases Revenue
Increases Liabilities
Increases Equity
Decreases Expenses
Decreases Assets
These different meanings for a Debit and a Credit balance in bookkeeping means a transaction will have debit(s) = credit(s) – hence the Trial Balance report which is a list of accounts and their balance to ensure that is correct > Debits = Credits
Examples
A single Payment (like in the worksheet) for say Advertising will do two things.
1) Debit (increase) Advertising expense; and
2) Credit (decrease) the bank account (a current asset account)
A single Receipt (per the worksheet) for say Sales Revenue/Income will do two things.
1) Credit (increase) the Sales revenue; and
2) Debit (also increase) the money in a bank account (asset)
So you can see in both examples the Debits will equal the Credits, but the second example shows that it actually “increases” two accounts since both of these accounts have different meanings of increase when it comes to debits and credits.
