Topic 3:

Double entry
bookkeeping
system
Learning Outcomes

On the completion of the chapter, you should be able to:

1. Understand the double-entry bookkeeping system.

2. Explain what is meant by the terms' ‘debit’ and ‘credit’ and their rules.
3. Create some simple ledger accounts.
4. Recognise the flow of the accounting process, starting with journalising,
postings, and trial balance.
5. Distinguish the types of financial statements.
Bookkeeping System: Double-entry
Business transactions have the dual effects records. It means
one transaction affects at least 2 accounts. This process is
called double entry recording.

Examples:
• Cash receipt from the owner RM75, 000: this transaction will
increase the Cash account and the Owner’s equity account by
RM75,000.

• Using cash to buy a vehicle RM60,000: this transaction will reduce

the Cash account and at the same time increase the Vehicle
account by RM60,000.
Debit and Credit System

The effects of increase and decrease are recorded using a

system utilizing debits and credits.

For each business transaction, the total debit must be equal to

the total credit.
It means that for every debit there must be a corresponding credit.
 The principle of debits and credits
The principle can be represented by the accounting equation as

DEBITS CREDITS
Assets + Expenses = Liabilities + Owner’s equity + Revenue

As in the accounting equation,

Assets and expenses are placed at the left-hand side (debit side).

Liabilities, owner’s equity and revenue are at the right-hand side (credit
side).
Account
The layout of a page of an accounts book is divided into two halves.
The left-hand side of each account is the ‘debit’ side, and the right-hand side is
the credit side.
Accounts can be in columnar form or T- form (Informal account term).

The type of account determines the side on which increases and

decreases of value are recorded.
Chart of Account
A chart of accounts (COA) lists all the financial accounts of an organisation for
bookkeeping, identification, and classification purposes.

Each of the accounts created is given a suitable name and code number.

The COA generally features five account types: asset, liability, equity, income, and
expense. The first three account types affect the balance sheet, the last two impact
the income statement.
Example of COA
 Rules of debits and credits

ASSETS

• To increase an asset → DEBIT entry

• To decrease an asset → CREDIT entry

Assets accounts will have a debit balance (normal balance)

Rules of debits and credits

LIABILITIES AND OWNER’S EQUITY

The double entry rules for liabilities, and capital are the opposite of
the rules for assets.

• To increase a liability/capital →CREDIT entry

• To decrease a liability/capital → DEBIT entry

Both Liability and Owner’s Equity accounts will have a credit balance as a
normal balance
Rules of debits and credits
REVENUES AND EXPENSES
Revenue and expenses account rules are determined by their effect on
owner’s equity balance.
Revenue increases the owner's equity; thus, its debit credit rule follows the
owner's equity account. Revenue accounts will have a credit balance.
In contrast, expense accounts negatively affect the owner's equity balance,
hence their debit credit rule is a contra of the owner’s equity account.
Expenses will have a debit balance.

• To increase a liability/capital/revenue →CREDIT entry

• To decrease a liability/capital/revenue → DEBIT entry

• To increase an asset/expense → DEBIT entry

• To decrease an asset/expense → CREDIT entry
Rules of debits and credits summary
Normal balances for each type of
accounts
 • The Cash Account was created by placing any
Examples increase in the debit side and a decrease in the
credit side.
Examples
 Examples: List of Cash Transactions

Examples:
1. Zara invested RM29 000 cash in the business.
2. Zara borrowed RM20 000 from RHB bank.

Which account should be debited, and which account should be

credited for each transaction?
AnAn is in business as a retailer distributor. The following is a list of her
transactions for March 2023:

• Goods purchased from Emma on credit.

• AnAn invests further capital in cash into the business.
• Goods sold for cash
• Machinery purchased, paid in cash.

Required:
State which account in AnAn’s books of account should be debited and
which account should be credited for each transaction.
Flow of accounting information

A. Business transactions
Accounting process starts with identifying business transactions that have
occurred. Transactions are verified based on business records such as purchase
and sales invoices, cash register tapes, cheque and receipts.

B. Journalizing
Journal records each business transactions and turns them to specified accounts in
chronological order. The accounts created will be then be posted to the respective
accounts in the ledgers.

General journal contains all business transactions

Special journal records transactions involving substantial quantities of data, such
as sales journal, purchases journal, cash receipts journal, cash payments journal,
and payroll journal. These journals prevent excessive entries in the general journal.
Flow of accounting information

C. Posting items to the ledgers

Ledger will show the total balance of every Asset, Liability, Equity,
Revenue and Expense account that has been recorded in the
journal.

D. Trial Balance
Trial Balance lists down every balance of the accounts.

E. Preparation of Financial Statements

Financial statements can be prepared once the Trial Balance is
completed.

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Flow of accounting information
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Journal
Transactions are first recorded in the journal. It is a chronological order
of records. There are different kinds of journals. Examples: Cash
Receipts Journal and Cash Payment Journal

Ledger accounts
The next stage after journalizing is posting information from the journal
to the ledger. The general ledger will show all the changes to the
particular account (Assets, Liabilities, Owner’s Equity, Revenue and
Expense).
 Trial balance
• After the General Ledger accounts are completed, the next step is to
record all the accounts balance in the Trial Balance. The trial
balance is a statement that lists the balance of each account. It is a
convenient way of checking that all transactions and all the balances
have been entered correctly in the ledger accounts.
• Refer to note for examples of journal, ledger and trial balance.
 Preparation of
financial statements

• Income statement/ Statement of financial

performance
• Owner’s equity statement /Statement of
retained earnings
• Balance Sheet/ Statement of Financial
Position
• Cash Flows Statement
Income statement/ Statement of financial performance

• The income statement presents the net income/loss

incurred within a certain period of time.
• Also known as profit and loss account.
• To find the answer for “how profitable is the business?”
• Accounting periods can run from any date of the year for
example July 1st to June 31st, April 1st to March 31st.
• It shows the performance for a firm in certain period
normally for a year (monthly, quarterly or semiannually).
• Example of Income statement
 Income Statement

Revenue
SALES • Cost of Goods Sold
- EXPENSES • Operating Expenses
• Financing Costs
= PROFIT • Taxes

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 Main elements in the income statement

1. Sales – Income from sales of products or services

2. Cost of good sold – Cost of producing the product

3. Operation expenses – expenses related to marketing and
distributing the products or services, and also
administration cost

4. Financing cost – Interest paid to debtors and dividend paid

to preferred stockholders (excluding dividend paid to
common stockholders)

5. Tax expenses – Amount of tax depends on company’s

taxable income.
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Example of income statement
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 Income Statement (for company)

SALES
- Cost of Goods Sold
GROSS PROFIT
Operating
Activities
- Operating Expenses
OPERATING INCOME (EBIT)
- Interest Expense
EARNINGS BEFORE TAXES (EBT)
- Income Taxes Financing
EARNINGS AFTER TAXES (EAT) Activities
- Preferred Stock Dividends
NET INCOME AVAILABLE TO COMMON STOCKHOLDERS
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Owner’s equity statement/The
statement of retained earnings

This statement summarizes the changes in

owner’s interest in the firm that have occurred
during the accounting period. These changes
comprise capital, drawings and the profit for the
period. The statement usually covers a twelve-
month period.
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Balance Sheet/ Statement of Financial Position

Balance sheet is a statement that shows the financial position for a

company at certain time. This statement is usually drawn up annually.

It provides a snapshot of assets, liabilities and equities of a company.

Total Asset = Total Liability + Total Equity

 Balance Sheet (for company)
Assets Liabilities (Debt) & Equity
Current Assets Current Liabilities
Cash Accounts Payable
Accrued Expenses
Marketable Securities Short-term loans
Accounts Receivable Long-Term Liabilities
Inventories Long-term notes
Prepaid Expenses Mortgages
Equity
Fixed Assets Preferred Stock
Machinery & Equipment Common Stock (Par value)
Buildings and Land Additional Paid in Capital
Other Current /Noncurrent Assets Retained Earnings
(minor assets that do not fit into any of
the main asset)
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Balance Sheet
▪ Types of assets :
✓ Current asset
✓ Fixed asset
✓ Other asset
▪ Types of financing :
✓ Liability (Debt)
✓ Long-term liability
✓ Owners’ equity

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Balance Sheet: Current Assets
✓It includes the assets with high liquidity (can be converted within 1 year)
✓Among the current assets are:
• Cash
• Marketable securities
• Account receivable
• Inventory
• Prepaid expenses

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Balance Sheet: Current Assets
▪ Cash – currency or coins owned by company either in bank account or hand.
▪ Marketable security – investment on short term financial assets with high liquidity.
Example: T-bill, bankers acceptance, etc.
▪ Account receivable – the cash payment agreement by customers whose bough by
credit.
▪ Inventory – raw materials, work in process and final products that will be sold.
▪ Prepaid expenses – it is reported in profit and loss account and deducted as
expenses income statements after has been used. Example: rent expenses and
insurance.

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Balance Sheet: Fixed Assets
• Cannot be converted into cash in short period.
• Including plant and machinery, building and land.
• Some businesses have more fixed assets than the other. Example: factory

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Balance Sheet: Other Assets
o Besides current and fixed assets. E.g., intangible assets such as pattern,
copyright, trademark or any other minor assets. Intangible assets are only listed
on a company's balance sheet if they are acquired assets with an identifiable
value and useful lifespan.
o Information exposed is different because it reported based on cost in the time
transaction occur. The value appeared known as ‘accounting book value’ of the
company.
o Accounting book value – Value of assets as shown in balance sheet of a firm. It
represents historical cost compared to present value of the asset.

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Balance Sheet: Debt
▪ Liability is money borrowed and must be pay back at fixed date. It includes credit
give by suppliers and bank loans.
▪ Current debt/short-term liabilities - liability that must be paid within 12 months.
▪ Sources of short-term liability:
✓ Account payable
✓ Other payable
✓ Accrued expenses
✓ Short-term notes

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Balance Sheet: Long-term Debt
▪ Covers loan from bank or other sources that provide capital for liability term more than
1 year.

▪ Example; loan from bank where the period of payment is 5 years or loan of buying
machinery, building, equipment or land for period 25 to 30 years.

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Balance Sheet: Equity
▪ Equity = investment by shareholders in the company and the profit which is not
distributed to them will be pooled in company.
▪ Preferred stockholders
✓ Received dividend in fixed amount.
✓ Priority after creditor pay the liability.
▪ Common stockholders
✓ Receive whatever left over-good or bad.
✓ The firm common stock value as reported in balance sheet includes sales value
of the stocks and the firm’s retain earning.
✓ Retain earning - earning assembled and retained and will be reinvest in the firm.

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Cash Flows Statement

• A cash flow statement summarizes inflows

and outflows of cash for the business. Cash if
very important for the business because it is
the lifeblood of the business.

• The cash flow can be drawn up more often

instead of annually. It covers the flows of cash
over a certain period of time.
 Statement of Cash Flows
▪ Shows the changes of cash for the company in certain period of time.
▪ Divided sources and uses of cash into THREE components:
1. Cash flow from operating activities
2. Cash flow from investment activities
3. Cash flow from financing activities.
▪ Increasing (decreasing) of net cash is total cash flow from operating,
investing and financing activities. This changes will be added with
beginning balance to get ending cash balance.

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Cash flow categories
• Operating activities are related to the business’s ability to generate cash from
operations. It includes all inflow and outflow transactions related to the income
statement, current assets, and current liabilities that directly affect the operation of the
business. sale of products and services, the collection of accounts receivable, all
operating expenses

• Investing activities refer to business activities involving the purchase and sale of long-
term assets, as well as other activities associated with investments. Examples:
purchase or sale of fixed assets

• Financing activities category reports changes in the balances of the long-term liability
and stockholders' equity accounts. Examples: issuance of bonds payable, common
shares and preferred shares, and long-term loans from banks

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The End
• Refer to attachment in PDF
file