The Accounting System & Double Entry Bookkeeping The principles of double entry bookkeeping and the effect

Purpose of accounting To be able to record and keep a record of all business transactions Helps identify whether the business is running successfully Helps identify costs incurred Helps identify the financial position of the business

The 5 stages of the accounting system 1.Financial transaction – a sale, purchases or a payment placed. 2.Financial document – invoice, credit note, receipt or payment is generated for the transaction. 3.Books of prime entry- the document is recorded into one of the books. 4.Leger Accounts – the main accounting records using the double entry system. 5.Trial Balance – a listing of the ledger accounts and a source for the financial reporting (profit & loss etc)

Principles of double entry bookkeeping The fundamental principle of DE bookkeeping is: – Each transaction has two effects There are 3 main principles – Separate entity concept – the owner of a business is a separate entity to the business (sole traders/ partnerships) – The Accounting Equation – Assets less Liabilities equals Capital, Assets equals Capital less Liabilities – The Dual effect –each and every transaction undertaken by a business has two effects on the business

Accounting Equation Elements Asset – items the business owns to help them trade – Cash, machinery, vehicles, stock & trade receivables (customers) Liabilities – amounts that are owed to another party – Loans, overdrafts, mortgage & trade payables (suppliers) Capital – is the amount owed by the business to its owner or separate entity

Income & Expenses The selling of goods and services create an INCOME, but it can include interest received from investments, sundry incomes – rent received, sale of assets and commission received. The purchasing of goods for re-sale are AN EXPENSE to the business. Other expenses are wages, utilities, stationery, insurances and repairs.

Dual effect For every transaction it has two effects on the business. – The receiver effect, commonly known as a debit – The giver effect, commonly known as a credit You must analyse the transaction and ascertain as to: – what came in/receive? – What went out/ give out?

The Dual effect –examples 1. Capital – setting up a business using £20, An expense – purchasing good for re-sale for £1, An asset –new computer worth £ An income – sales worth £700 as a cash transaction 5. A liability – paying the VAT due from the sales of £100 1.Cash goes into the bank account for £20,000 2.Purchases of £1,500 have been made and are held in the warehouse 3.The business has a computer to the value £ The business owes an outside entity £20,000 2.Cash of £1,500 has been paid out 3.The business has £ less in the bank account

Dual effects – continuation 4.The bank account has increased by £700 5.The VAT liability has been reduced as you have cleared the debt owed 4.Sales of £700* have been made (given out) 5.The bank account has been reduced by £100* *For true double entry we would have shown the sales value as £600 and the VAT as £100

Capital and revenue expenditure /income Capital expenditure is the expenditure used to purchase fixed assets or make additions to existing fixed assets, they are purchased to enable the business to generate an income, make a profit. Revenue Expenditure is the expenditure incurred on every day running cost, it is the costs that can be used up within a few days (stationery) and does not add value to any assets.

Capital & revenue receipts A capital receipt is the monies received after the sale of an asset, usually sold second hand due to an upgrade on the same style asset. Most common example is the sale of a motor vehicle. Revenue receipt is the monies received through sales of goods or other revenues interest received, royalties or rent received.