| The Equity Accounting System: User's Guide Rev 2.0 for Equity V3.305 | ||
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The double entry method is an accounting process for recording, classifying and summarising information to make it meaningful.
The method adopts this use of ledgers (accounts). To illustrate the double entry method it is, however, necessary to introduce the terms `Debit' and `Credit'.
Anything that can be expressed in monetary terms should be recorded in the "books", whether computerised or not. When we record the use of something of value, or where this valuable item is going (e.g. money in the cheque account)' we are recording a Debit. When we record a source of something of value, or where this valuable thing came from (e.g. money from a creditor), we are recording a Credit.
Let's take some time to work out why this system of debits & credits is so important. If we record only debits, we will only know where things of value are used in our business, and not know what we owe. Consequently, we can damage out credit rating, our credibility and our image. If we record only credits, we will only know where things of value are coming from. Consequently, we will never know the amount of money in the bank, the amount of stock on the shelves or the assets we own.
Using the double entry method will avoid a great deal of trouble and confusion.
Debit = Where things of value are "going to". Credit = Where things of value are "coming from".
OR
Double Entry Method = for everything of value, record where it "came from" and where it is "going to".
Here's an example.
Let's say you have $1000.00 that you want to use to start up your business. This "seed capital" is deposited in a cheque account for easy access.
If you use a "single entry" method, you would record the amount deposited but ignore the source of the money. In the "double entry" method, we record the use of the money, a debit, as the check account; AND we record the source of the money, a credit, as the owners capital. The record of this transaction might look like this.
Method 1
Today, January 1, 1990, we opened our company checking account with a $1000.00 deposit from Mr Alex Smith.
Or in a more systematic way:
Method 2
| Account | Debit | Credit |
| (Use of money) | (Source of money) | |
| 1/1/90 | ||
| Cash in Bank | 1000.00 | |
| Owner's Capital | 1000.00 |
Both methods are valid, however the second way is more systematic, easier to read and clearly identifies the "comings" and "goings", or credits and debits, of the transaction.
Equity records your transactions using the second method. The results are accurate and impressive financial records.
An account is a single record within the ledger representing a particular use or source of money. Most businesses have many accounts so that uses and sources of money can be clearly classified. To avoid duplicate accounts, businesses keep a list of all accounts. This is called the Chart of Accounts and will look something like the list below, with each account allocated a unique number.
1000 Cash at Bank (Check Account)
1100 Trade Debtors
1200 Stock on Hand
2000 Trade Creditors
2100 Bank Overdraft
3000 Capital (Owner's Equity)
3100 Profit/Loss
3200 Retained Earnings
4000 Credit Sales
4100 Other Income
5000 Cost of Goods Sold
5200 Accounting Fees
5300 Bank Charges
5400 Rent
Most accounts will be both a source of money and a use of money. To say this another way, most accounts will have money "go to" them or "come from" them. For example the check account can have money "go to" it in the form of a deposit, or "come from" it in the form of a cheque.
Equity provides a starter Chart of Accounts that you can add to. This means your Chart of Accounts will be tailored for your own business.
In Equity every account will fall into one of five categories. These are Assets, Liabilities, Capital, Revenue and Expenses. Each account has its own identifying number which will begin with a 1, 2, 3, 4 or 5 respectively. Accounts starting with 6, 7, 8 and 9 are all classed as Expenses.
Assets are usually broken down into two categories, these being Current and Fixed.
Current Assets are those things a business owns that are intended to be converted to cash within 12 months (e.g. cash, debtors, stock, etc.). They are usually listed in the order in which they will be converted to cash, with the earliest first. Thus, Cash at bank is listed first, debtors second, stock third and finally some of the pre-paid expenses.
Fixed Assets are those things owned by the business that are used to generate income. They are not acquired for the purpose of converting them to cash. While they may be converted to cash at some time, they generally must be replaced so that the business can continue to operate. Fixed assets are usually listed in order of the estimated length of their useful (or economic) life, with the shortest expected life first. Examples of fixed assets are cash registers, computers, manufacturing machinery, carpets, desks etc.
Like assets, liabilities are usually broken down into two categories - Current and Non-Current.
Current Liabilities are debts the business has incurred that must be repaid during the next 12 months. They are listed in order of when they fall due, with the earliest first. They include creditors and short term loans (such as bank and overdraft).
Non-Current Liabilities are other debts the business has that must be repaid during the next two or more years of operation. They are also listed in order of the length of the term of the loan.
Capital or equity, is a loan from the owner, or the shareholder's equity in the case of a company. This may not be repaid until such time as the ownership changes. Capital is the total capital investment by the owner or owners. It is composed of the initial investment plus any additional investments, drawings the owner has taken out, net profit (or loss) and retained earnings, which is the running total of all profit or loss for the previous years' running of the business.
Revenue is income. You can have as many Revenue accounts as your particular business needs. Some businesses show the income from each operation section of the businesses separately. Others show income by major product groups. The simplest method would be to show income from the major part of the business as `Sales' and any minor income from investment interest, commissions, etc., as `Other', but this doesn't really indicate where your revenue is coming from. How you set up your revenue accounts is entirely up to you.
Expenses represent the cost of earning income. Each expense account should clearly identify an area of expenditure. Phone, electricity, bank charges, wages, cost of goods sold, etc., are all examples of expenses.