Principles of Double Entry and Accounting Basics

Financial Accounting is built upon the foundation of the Double Entry system. This system ensures that every financial transaction affects at least two accounts, maintaining the fundamental accounting equation.

1. Source Documents

Source documents are the physical evidence of financial transactions. They provide the information needed to record entries in the books of original entry.

• Receipts: Issued when cash is received.
• Invoices: Issued for credit sales or purchases.
• Credit Notes: Issued by a seller to a buyer when goods are returned (Returns Inward).
• Debit Notes: Sent by a buyer to a seller to request a credit note for goods returned (Returns Outward).
• Petty Cash Vouchers: Documents supporting small cash payments.

2. Books of Original Entry (Prime Entry)

These are the books where transactions are first recorded before being posted to the ledger. They include:

• Sales Day Book (Sales Journal)
• Purchases Day Book (Purchases Journal)
• Returns Inward and Outward Journals
• Cash Book (serves as both a book of original entry and a ledger account)
• Journal Proper (General Journal) for non-routine transactions like the purchase of fixed assets on credit.

3. The Accounting Equation

The entire accounting system is based on: Assets = Capital + Liabilities.

Changes in one element must be balanced by changes in another. For example, if a business buys a vehicle with cash, one asset (Vehicle) increases and another asset (Cash) decreases, keeping the equation in balance.

4. The Ledger and Double Entry

The ledger is the principal book of accounts. It is divided into:

• Personal Ledger: Accounts for debtors and creditors.
• Impersonal Ledger: Divided into Real Accounts (Assets) and Nominal Accounts (Expenses and Income).

The Rule: Debit the receiver, Credit the giver.

5. Trial Balance and Errors

A Trial Balance is a list of debit and credit balances extracted from the ledger to check arithmetical accuracy. If it doesn't balance, it indicates errors. However, some errors do not affect the trial balance:

• Error of Omission: Transaction completely omitted.
• Error of Commission: Correct amount, wrong personal account.
• Error of Principle: Transaction recorded in the wrong class of account (e.g., treating an asset as an expense).
• Compensating Error: Errors on the debit side are cancelled by errors on the credit side.

When the trial balance fails to agree, the difference is temporarily placed in a Suspense Account until the errors are located and corrected.