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Double Entry System
According to this concept every business transaction has a dual aspect. This concept is explained in detail below:
The properties owned by a business enterprise are referred to as assets and the rights or claims to the various parties against the assets are referred to as equities. The relationship between the two may be expressed in the form of an equation as follows:
Equities = Assets
Equities may be subdivided into two principal types: the rights of creditors and the rights of owneRs. The rights of creditors represent debts of the business and are called liabilities. The rights of the owners are called capital.
Expansion of the equation to give recognition to the two types of equities results in the following which is known as the accounting equation:
Liabilities + Capital = Assets
It is customary to place ‘liabilities’ before ‘capital’ because creditors have priority in the repayment of their claims as compared to that of owners. Sometimes greater emphasis is given to the residual claim of the owners by transferring liabilities to the other side of the equation as:
Capital = Assets – Liabilities
All business transactions, however simple or complex they are, result in a change in the three basic elements of the equation. This is well explained with the help of the following series of examples:
(i) Mr. X commenced business with a capital of Rs. 3,000: the result of this transaction is that the business, being a separate entity, gets cash-asset of Rs. 30,000 and has to pay to Mr. X Rs. 30,000, his capital. This transaction can be expressed in the form of the equation as follows:
Capital = Assets
Mr. X = 30,000
Cash = 30,000
(ii) purchased furniture for Rs. 5,000: the effect of this transaction is that cash is reduced by Rs. 5,000 and a new asset viz. Furniture worth Rs. 5,000 comes in, thereby, rendering no change in the total assets of the business. The equation after this transaction will be:
Capital = Assets
Mr. X = 30,000
Cash + Furniture = 25,000 + 5,000
(iii) borrowed Rs. 20,000 from mr. Gopal: as a result of this transaction both the sides of the equation increase by Rs. 20,000; cash balance is increased and a liability to Mr. Gopal is created. The equation will appear as follows:
Liabilities + Capital = Assets
Creditors + Mr. X Cash + Furniture = 20,000 30,000 45,000 5,000
(iv) purchased goods for cash Rs. 30,000: this transaction does not affect the liabilities side total nor the asset side total. Only the composition of the total assets changes i.e. Cash is reduced by Rs. 30,000 and a new asset viz. Stock worth Rs. 30,000 comes in. The equation after this transaction will be as follows:
Liabilities + Capital = Asset
Liabilities (Creditors) = 20,000
Capital (Mr. X) = 30,000
Asset (Cash + Stock + Furniture) = 15,000 + 30,000 + 5,000
(v) goods worth Rs. 10,000 are sold on credit to ganesh for Rs. 12,000. The result is that stock is reduced by Rs. 10,000 a new asset namely debtor (mr.ganesh) for Rs. 12,000 comes into picture and the capital of Mr. X increases by Rs. 2,000 as the profit on the sale of goods belongs to the owner. Now the accounting equation will look as under:
Liabilities + Capital = Asset
Liabilities (Creditors) = 20,000
Capital (Mr. X) = 32,000
Asset (Cash + Debtors + Stock + Furniture) = 15,000 + 12,000 + 20,000 + 5,000
(vi) paid electricity charges Rs. 300: this transaction reduces both the cash balance and Mr. X’s capital by Rs. 300. This is so because the expenditure reduces the business profit which in turn reduces the equity.
The equation after this will be:
Liabilities + Capital =Assets
Creditors + Mr. X = Cash + Debtors + Stock + Furniture
20,000 + 31,700 = 14,700 + 12,000 + 20,000 + 5,000
Thus it may be seen that whatever is the nature of transaction, the accounting equation always tallies and should tally. The system of recording transactions based on this concept is called double entry system.
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