Double-Entry Bookkeeping

Double-entry bookkeeping is the universally adopted system for recording financial transactions. Its central rule is that every transaction is recorded in at least two accounts — one debit and one credit — of equal value. This preserves the accounting equation:

Assets = Liabilities + Equity

Because income increases equity and expenses decrease equity, the equation can be expanded to:

Assets + Expenses = Liabilities + Equity + Income

Every transaction keeps both sides equal. The rules for increasing and decreasing each type of account are:

Mnemonic — DEAD CLIC:

• Debits increase: Expenses, Assets, Drawings (dividends)
• Credits increase: Liabilities, Income, Capital (equity)

Common transaction examples:

Before transactions are posted to the general ledger, they are first recorded in books of prime entry (also called books of original entry or day books). These are not part of the double-entry system themselves — they are chronological records that capture transaction details before those details are summarised and posted to ledger accounts.

The main books of prime entry are:

Sales Day Book (and Sales Returns Day Book)

Purchase Day Book (and Purchase Returns Day Book)

Cash Book

The Journal

The general ledger (also called the nominal ledger) is the core of the double-entry system. It contains all accounts of the business, organised by type (assets, liabilities, equity, income, expenses). Each account records debits and credits and shows a balance.

Two subsidiary ledgers are maintained alongside the general ledger to provide detail on individual counterparties:

1. Sales ledger (receivables ledger): Contains an individual account for each credit customer. Each account shows: invoices raised, payments received, credit notes, discounts allowed, and the outstanding balance. The total of all individual customer balances should agree to the trade receivables control account in the general ledger.

2. Purchase ledger (payables ledger): Contains an individual account for each credit supplier. Each account shows: invoices received, payments made, credit notes, discounts received, and the outstanding balance. The total should agree to the trade payables control account.

Control accounts act as a summary and an internal check. The control account in the general ledger is posted from the totals of the day books, while the subsidiary ledger accounts are posted from the individual entries. At any point, the control account balance should equal the sum of all individual balances in the subsidiary ledger. A discrepancy indicates an error that must be investigated.

Typical trade receivables control account:

A trial balance is a list of all ledger account balances at a specific date, arranged with debit balances in one column and credit balances in another. If double-entry has been correctly applied throughout the period, total debits must equal total credits.

Typical debit balances: non-current assets (at cost), inventory, trade receivables, other receivables & prepayments, cash & bank (if positive), expenses (purchases, wages, rent, utilities, depreciation charges), drawings / dividends.

Typical credit balances: accumulated depreciation, trade payables, other payables & accruals, loans, share capital, share premium, retained earnings, revenue (sales, other income), allowance for receivables.

The trial balance serves three purposes:

1. Arithmetical check: If total debits ≠ total credits, an error has occurred
2. Starting point for preparing financial statements: The trial balance provides the raw data that, after adjustments, is used to prepare the SoPL and SoFP
3. Summary of balances: It provides a snapshot of all account balances at a given date

Critical limitation: A trial balance that balances does not guarantee the books are error-free. Five of the six types of error will not cause the trial balance to go out of balance.

Six types of error are recognised. Understanding which errors affect the trial balance (and therefore create a suspense account) and which do not is critical for exam success.

Key exam point: Only errors where the total debits and total credits become unequal will cause the trial balance to not balance. This happens only when one side of a double entry is missing, posted at the wrong amount, or an account is mis-totalled. All other errors affect both sides equally (or offset) and leave the trial balance in balance.

When the trial balance does not balance, the difference is temporarily placed in a suspense account so that draft financial statements can be prepared while errors are investigated.

• If total debits exceed total credits: the suspense account has a credit balance (to make the TB balance)
• If total credits exceed total debits: the suspense account has a debit balance

Once errors are identified, correcting journal entries are prepared. The systematic approach to correcting any error is:

1. Write out the incorrect entry (what was actually recorded)
2. Write out the correct entry (what should have been recorded)
3. Determine the correcting entry by combining the reversal of the wrong entry with the recording of the correct entry

After all corrections, the suspense account should have a nil balance — it is fully cleared. If a balance remains, there are still unidentified errors.

Important: Only errors that caused the trial balance to go out of balance involve the suspense account in their correction. Errors of omission, commission, principle, original entry, reversal, and compensating errors are corrected with journal entries that do not involve the suspense account.

Effect on profit: When correcting errors, consider whether the correction changes the profit figure. Errors affecting expense or income accounts will change profit; errors only affecting SoFP accounts (e.g., posting to the wrong receivable) will not.