LESSON 12: Embrace the ingenious double entry bookkeepi Articles

LESSON 12: Embrace the ingenious double entry bookkeeping system as the blessing it is, and harness its full potential to tirelessly deliver 100% reliable, business-critical information

 The double-entry bookkeeping system is one of the most amazing commercial tools available. Without it businesses of all shapes and sizes would collapse into monetary mayhem. They would lose money right, left and centre without even being aware of it, until the day the coffers were cleaned out and the cheques started bouncing. Whether you […]

12.1 The basic requirements your accounting records need to fulfil

 Your business records need to satisfy these four criteria. First. It should be pretty obvious to you that the records of any business, whether a company or not, need to be kept separate from your personal finances. If business and personal records were intertwined you would get in a terrible tangle. Second. Your records have […]

12.2 Errors in financial data will proliferate like weeds in a neglected flowerbed if you let them. Here’s how to stamp them out

 One of the great strengths of the double entry system is that it has an inbuilt mechanism to increase the accuracy of the data it records. For example, suppose someone owed your business £520, and you wanted to record that in your accounting system. It would be perfectly possible to inadvertently record the amount as […]

12.3 Why not just keep things nice and simple?

 Do you really need to engage with all the paraphernalia of a double-entry accounting system? Why can’t you keep your records in a simpler way, such as on a spreadsheet, or even as simple informal paper records? Well, let’s answer this. It is an important point because it also demonstrates why you would be well-advised […]

12.4 How the crucial concept of business ownership (owners’ equity) embodies the fact that your business is indeed your slave

 To achieve all these things, the double-entry system recognises the fact that the business itself is owned. To do this it uses the concept of owners’ equity. At its most basic, owners’ equity is a mathematical device to enable the numerical checking process that is ingrained within double-entry to operate. However, owners’ equity is more […]

12.5 In an accounting system, numbers can be either positive or negative

 In the accounting records the things the business owns (assets) are recorded as ordinary positive amounts. And the things the business owes to others (liabilities – such as loans) are recorded as negative amounts. This makes perfect intuitive sense. It is what you would expect. Let’s see this on a simple Balance Sheet where a […]

12.6 The paradox of profit; understand this and shoot to the top of the finance class

 Here again is our chain of logic. The things a business owes are recorded as negative amounts, which is just what you would expect. The business owes to its owners the total of the capital and reserves (owners’ equity), which also makes sense. Therefore the capital and reserves must be negative amounts. Therefore profit must […]

12.7 Implications for the Profit and Loss Account

 The following final twist seems intuitively ridiculous but again it is right and is consistent. Consider the implications on the Profit and Loss Account of what we have been saying. Profit is recorded as a negative amount. Since profit is the excess of sales income over costs, it follows that sales too must be recorded […]

12.8 How transactions are recorded in your accounting system

 We have seen how in theory the total of all transactions must add up to zero, but how does this come about in practice? To answer this we have to consider exactly how individual transactions are recorded in your accounting system. Whenever a transaction is recorded its equal and opposite effects on ownership are recorded. […]

12.9 Error prevention and the use of columns

 Accounting systems are designed so that the operator is forced to type the numerical value in twice – once to record the positive aspect and again to record the negative aspect. The accounting system then compares the positive and negative amounts for the transaction and will only save the transaction if the positive equals the […]

12.10 Debits and Credits are no more than plus and minus; its as simple as that

 Before we go any further I ought to tell you that positive numbers are termed debits, and negative numbers are termed credits. ‘Debit’ and ‘Credit’ are the original terms which were applied centuries ago when the double entry system was first devised (in Italy), and they have stuck. Nowadays these terms are simply labels. It […]

12.11 How individual accounts work, and how each has a total, or ‘balance’

 As you know, your accounting system is made up of numerous accounts. Each account is simply a device for collecting similar items together. You can think of each account as an analysis slot, or a pot. The point of having numerous accounts is that they enable you to classify your financial transactions. For example, all […]

12.12 Why is your bank statement the wrong way round?

 Skip this explanation if you want, and return to it when you want the answer. But here is the explanation. When money goes into your bank account, it is recorded in your records on the left, as a positive amount (debit). But if you look at your bank statement the money you pay in appears […]

12.13 Resume of the double entry system

 If you are a business owner you now know all you need to about the theory of double entry bookkeeping. Before we move on to consider how a set of accounts is produced and what they mean, here is a resume of the double entry system. Accounting systems are based on an age-old system called […]