Recording Financial Transactions

Question 1

Double - entry bookkeeping

Answer 1

When recording transactions by hand we use the double-entry bookkeeping method.

This system of recording financial transactions is one where each transaction is recorded twice, once as a debit and once as a credit.

This account has 3 features:

• A title indicating the item to which it relates
• A left-hand side, known as the debit side; and
• A right-hand side, known as the credit side.

“Every debit must have a credit”

One side of the account recorded will increase in the particular item and the other side will decrease. For assets the left side (debit side) will increase and the right hand side (credit will decrease).
For equity and liabilities (the left hand side will decrease) and the right hand side will (increase).

Question 2

Account

Answer 2

A record of one ore more transactions relating to a particular item.

Question 3

Why are equity and liabilities recorded in the opposite way to assets?

Answer 3

Recall that: Assets = Equity + liabilities

Assets appear on a different side to equity and liabilities.
Example: An owner puts £5,000 equity into a newly started business.

This will be recorded as:

                                        Cash I----------------------------------------I------------------------------------------I   £5000 equity

And:

                                      Equity i----------------------------------------I-------------------------------------------I
                                                          £5000 cash

Someone looking at the account can see how they are recorded in a double entry way. Someone looking at the equity account can see that £5000 arose from the receipt of cash. This is very useful information and can provide a ‘trail’ of information, so when looking back over the accounts it is easy to spot mistakes.

Question 4

Recording trading transactions

Answer 4

The rules of double-entry bookkeeping also extend to ‘trading’ transactions, that is, making revenue (sales and so on) and incurring expenses.

The accounting equation can be extended to:

Assets = Equity + (Revenues - Expenses) + Liabilities

The equation can be rearranged so that

Assets + Expenses = Equity + Revenues + Liabilities

We see that an increase in expenses are shown on the same side as assets and therefore will be recorded in the same way i.e. an increase is shown on the left hand side (debit side).

Increases in revenue are shown on the same side as equity and liabilities and therefore dealt in the same way as them.

To summarise

• Debits (left-hand entries) represent increases in assets and expenses and decreases in claims and revenues.
• Credits (right-hand entires) represent increases in claims and revenues and decreases in assets and expenses.

Question 5

Examples: Rent

Answer 5

Assets transform into expenses as they are ‘used up’.
Rent, which is usually paid in advance, is an asset when it is first paid. Rent represents the value to the business of being entitled to occupy the premises for the forthcoming period e.g. 3 months. As the 3 months progresses, this asset becomes an expense as it is ‘used up’.

Question 6

Trial Balance

Answer 6

A totalled list of the balances on each of the accounts in a double-entry bookkeeping system.

Question 7

Ledger

Answer 7

This is the book in which accounts are normally kept.