UNIT TWO: PREPARATION OF BOOKS OF ACCOUNTS: DOUBLE ENTRY SYSTEM

WHAT IS AN ACCOUNT?

An account is a record of transactions that took place in an organization with in given

period made in a summarized form and in a chronological. All the related transactions are
brought together into one account. An account is also taken to be a separate record that is
kept of the increase and decrease in each element of the accounting equation (i.e. Assets,
liabilities and owners equity). Accounts in manual accounting system are presented in a T-
form. The left-hand side of the account is the debit side while the right-hand side is the
credit side.

Name of the Account

Debit Side Credit Side

Debit and credit means either increasing or decreasing an account depending on the nature
or type of an account. It is similar to plus or minus signs used in mathematics. The rule of
debit and credit is based on the location of assets, liabilities and owners equity. N.B The
accounting equation: Assets = Liabilities+ Owners Equity.

Assets appear on the left-hand side (debit side) of the accounting equation while the
liabilities and owners equity appear on the right-hand side (credit side) of the accounting
equation. At the end of the recording exercise total debits must be equal to total credits.

 To debit an account refers to making an entry on the debit side (left-hand side) of an
account.
 To credit an account refers to making an entry on the credit side (right-hand side) of an
account.

In computerized accounting system, an account is written with a running balance as shown

below.

Date Particulars Debit Credit Balance

THE DOUBLE ENTRY SYSTEM IN ACCOUNTING

The double entry system of preparing book of accounts involves recording transactions
twice. The principle/rule of double entry states that: a) for every debit entry there is a
corresponding credit entry and, b) for every credit entry there is a corresponding debit
entry.

NOTE. The above double entry rule is very important in accounting and failure to conform
to the rule of double entry will mean that accounts will not balance, more specially, the trial
balance.

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THE EFFECTS OF DOUBLE ENTRY ON OWNERS’ EQUITY

Owner’s equity can be increased by sales revenue, gains in income or increase in capital
itself. Owner’s equity can be reduced by losses, expenses and costs, owner’s drawings of
cash or other assets, and reduction in capital itself.

1. Revenue: is income earned from carrying out the main activities of the business such as
selling goods or offering services. Therefore revenue increases the owner’s equity.
 Increases in revenue are noticed on the right-hand side (credit side) of the account.
 Decreases in revenue are noticed on the left-hand side (debit side) of the account.

2. Expenses: are costs of operating the business. Therefore expenses reduce the owners’
equity.
 Increases in the expenses are noticed on the left-hand side (debit side) of the account.
We debit the expenses account when an expense is incurred.
 Decreases in expenses are noticed on the right-hand side (credit side) of the account.
We credit the expenses account when an expense is reduces.

3. Drawings: These refer to funds or assets taken out of the business by the owner.
Drawings are not expenses of the business but the drawings account is debited just like
expenses account.
 Increases in the drawings are noticed on the left-hand side (debit side) of the account.
We debit the drawings account with the increase in the drawings.
 Decreases in drawings are noticed on the right-hand side (credit side) of the account.
We credit the drawings account with decrease in the drawings.

DOUBLE ENTRY RECORDING OF PURCHASES, SALES AND RETURNS

1. Purchases: Purchases refer to the goods bought by the business for resale in the
normal course of business. The purchase of fixed assets such as land is not treated as a
purchase for accounting purposes unless that business deals in buying and selling of land
(real estates business) in it normal course of business.
 When goods are purchased the purchases account is debited since there is an increase in
an asset.
 When goods are returned or sold the purchases account is credited since there is a
reduction in an asset.

2. Sales: A sale occurs when goods which were bought for resale in the normal course of
business are sold. The disposal of fixed assets which are not part of the goods bought
for resale in the normal course of business is not treated as a sale but it is treated as
assets disposal for accounting purposes.
 When goods are sold in the normal course of business we debit the sales account.
 When goods are returned which were previously sold the sales account is credited.

3. Returns: In some cases goods which had been bought or sold to a business are returned.
The reasons for returning the goods may include; defects, expiry, more quantity than
ordered for, etc. This is what is known as returns in accounting language. The goods can be

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returned to the business (returns inwards or sales returns) or the business can return the
goods to the suppliers (returns outwards or purchase returns).

a) Returns inwards-When goods are returned to the business this increases the asset of
stock in the business, but also reduces the amount the business owing from a customer/
debtor (i.e. decreases the current asset of debtors).
 When good are returned to the business we debit the returns inward account of the
business.
 When the goods are returned to the business the corresponding credit entry is made in
the debtors account or the individual account of the respective debtor.

b) Returns outwards-When good are returned to the buyers this reduces the asset of
stock in the business, but also reduces the amount the business owes to a
supplier/creditor (i.e. reduces the liability).
 We debit the creditors account when the goods are returned by the business to the
suppliers.
 We credit the business’ returns outwards account to show that we returned goods to the
supplier.

PERSONAL ACCOUNTS

These are for debtors and creditors and contain the name of a business, person or firm. In
the ledger there may be three types of personal accounts namely:

1. Capital account records transactions between the business and the owner. Any amount
invested or withdrawn by the owner is recorded in this account.

2. Creditors account records the amount owing to creditors i.e. persons to whom money is
owed by the business. Goods purchased on credit basis from suppliers create a liability of
the business. These amounts owing to creditors are recorded in the personal accounts,
which are opened separately for each creditor. These individual accounts contain the
names of the creditors.

3. Debtors account records the amount owed to the business against goods sold to
customers on credit basis. Debtors are persons owing money to the business. A separate
account is opened for each debtor. These individual accounts contain the names of the
debtors.

IMPERSONAL ACCOUNTS

They are accounts which do not contain the name of any person or business and they are of
two types:-

1. Real accounts: These are accounts in which property is recorded. Real accounts relate
to tangible items owned by the business (i.e. represent something that can be seen
touched or moved like the asset accounts for motor vehicle, land, stock, cash, furniture,
etc.

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2. Nominal accounts: These are accounts in which expenses, income, and capital are
recorded. Nominal accounts relate to intangibles items (i.e. the accounts record
transactions that have nothing to show) e.g. sales revenue/ income/gains/
expenditures such as purchases, electricity, salaries and wages etc.

Diagrammatic illustration of the distinction between

Personal and Impersonal accounts

Accounts

Personal Impersonal
Accounts Accounts

Real accounts for Nominal accounts

Debtors’ Creditors’ property of all for expenses, income
accounts accounts kinds and capital

Make the debit and credit entries for each of these transactions I
a) Paulo started business with cash of 4,000,000/=.
b) He bought a motor vehicle from Spear Motors for the business at 1,000,000/= cash.
c) Bought stock in trade at 5,000,000/= on credit from M/s. Kiwani suppliers.
d) Paid shillings 2,500,000/= cash to M/s. Kiwani suppliers.

Record the debit and credit entries for each of these transactions 2
Mr. Kalimagezi is a trader operating in Kikubo in Kampala.
a) During the month of March 2008 Kalimagezi started trading with cash 10,000,000/=.
b) March 3rd, he purchased goods at 5,000,000/= cash.
c) March 11th, he sold goods worth 4,500,000/= for cash.
d) March 22nd, he paid ground rent worth 1,200,000/= by cheque.
e) March 23rd , he acquired a motor vehicle worth 7,500,000/= on credit from M/s. Toyota
Uganda Ltd
f) March 25, he bought goods worth 2,500,000/= on credit.
g) March 27, he paid cash for goods purchased on March, 25 amounting to 1,500,000/=.
h) March 30th, he used 400,000/= business cash for his private party.

Practice Assignment.
a) M/s. Daisy Ltd bought furniture worth 2,000,000/= cash.
b) The debtors of the company amounting to 65,000,000/= settled part of their
indebtedness by cheque worth 40,000,000/=.
c) The company acquired a 5 year loan of 5,000,000/= from Bank of Africa.
d) Purchased goods on credit from M/s. Bukenya Electrical Ltd worth 20,000,000/=
e) A cash payment of 10,000,000/= was made to M/s. Bukenya Electrical Ltd.
f) The company raised more capital worth 50,000,000/= cash by issue of shares.

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 SUMMARY OF RULES FOR DEBIT AND CREDIT

These rules of debit and credit relate to six classes of accounts listed below:

Classes of Accounts Changes Rules

Increase Debit

Assets
Decrease Credit

Increase Credit
Liabilities

Decrease Debit

Increase Credit
Revenue

Decrease Debit

Increase Debit
Expense

Decrease Credit

Increase Credit
Capital

Decrease Debit

Increase Debit
Drawings

Decrease Credit

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