process accounting data using the double entry system

2.1 The Double‑Entry System of Book‑keeping

Learning Objective

By the end of this lesson you will be able to process accounting data using the double‑entry system – from the source document right through to the unadjusted trial balance.

1. What is the Double‑Entry System?

• Every financial transaction affects at least two accounts.
• One account is **debited** and another is **credited**; the total of all debits must equal the total of all credits.
• The system keeps the accounting equation in balance: $$\text{Assets} = \text{Liabilities} + \text{Owner’s Equity}$$
• Primary books of prime entry: Journal (chronological) and Ledger (individual accounts).

2. Source Documents – Where Transactions Begin

Transactions are recorded because a reliable **source document** exists. Typical documents include:

• Invoice (sales or purchases)
• Receipt
• Credit note / Debit note
• Bank statement
• Petty‑cash voucher
• Payroll sheet

Identify the document, read it carefully and decide which accounts are involved.

3. Types of Accounts

4. Debit / Credit Rules – Quick Reference

5. Books of Prime Entry (Other Than the General Journal)

• Cash Book – records all cash receipts and payments.
• Sales Journal (Sales Day Book) – records credit sales of goods.
• Purchases Journal (Purchases Day Book) – records credit purchases of goods.
• Petty‑Cash Book – records small, frequent cash outlays.
• General Journal – used for non‑routine transactions (e.g., depreciation, opening balances, adjustments).

6. Division of the Ledger

The ledger is split into three sections to make posting easier. When you “post to the ledger” you must send each entry to the correct division.

• Sales Ledger – individual debtor (customer) accounts.
• Purchases Ledger – individual creditor (supplier) accounts.
• Nominal Ledger – all other accounts (assets, liabilities, equity, revenue, expense).

Example – credit sale to “Alpha Ltd” for £1,200:

• Sales Ledger – Alpha Ltd (Debtor) – Debit £1,200
• Nominal Ledger – Sales Revenue – Credit £1,200

7. Steps in the Double‑Entry Process

1. Obtain the source document. Verify the date, amounts and parties involved.
2. Identify the accounts affected. Use the account‑type table to decide whether each is an Asset, Liability, etc.
3. Classify the transaction. Is it a sale, purchase, receipt, payment, discount, etc.?
4. Apply the debit/credit rules. Record the amount as a debit for the account that increases (or decreases, if the rule says so) and as a credit for the other account.
5. Enter the transaction in the appropriate book of prime entry. (e.g., Sales Journal for credit sales.)
6. Post to the General Journal. Include date, accounts, amounts and a brief explanation.
7. Post from the General Journal to the relevant T‑accounts in the ledger. Send each entry to the correct division (Sales, Purchases or Nominal).
8. Balance each ledger account. The closing balance (debit or credit) shows the effect on profit or loss – e.g., a credit to a revenue account increases profit.
9. Transfer the balances to the unadjusted trial balance. List every account with its closing balance; total debits must equal total credits.

8. Journal Entry Format

9. Trade Discount vs. Cash Discount

Debit  Cash               £980
Debit  Discount Received   £20
   Credit  Accounts Receivable   £1,000
                

10. Posting to T‑Accounts (Standard Layout)

Using the three journal entries above, the T‑accounts are shown in the conventional left‑debit / right‑credit format.

                     Cash
          ---------------------------------
          | Debit | Credit | Balance (Dr) |
          | 5,000 |        | 5,000        |
          |       | 2,200  | 2,800        |
          |       |   800  | 2,000        |
          ---------------------------------

               Owner’s Capital
          ---------------------------------
          | Debit | Credit | Balance (Cr) |
          |       | 5,000  | 5,000        |
          ---------------------------------

                     Equipment
          ---------------------------------
          | Debit | Credit | Balance (Dr) |
          | 2,200 |        | 2,200        |
          ---------------------------------

                    Rent Expense
          ---------------------------------
          | Debit | Credit | Balance (Dr) |
          |   800 |        |   800        |
          ---------------------------------

Each account now shows its closing balance, which will be transferred to the trial balance.

11. Preparing an Unadjusted Trial Balance

The unadjusted trial balance is compiled **before** any year‑end adjustments (depreciation, accruals, etc.). It simply lists the closing balance of every ledger account.

Because total debits equal total credits, the trial balance **balances**, indicating that posting has been carried out correctly. Limitation: a balanced trial balance does **not** guarantee that there are no errors (e.g., omitted transactions or equal‑amount errors).

12. Common Errors to Watch For

• Omitting an account – every transaction must involve at least two accounts.
• Reversing debit and credit amounts.
• Failing to keep the accounting equation in balance.
• Mis‑classifying an account (e.g., treating revenue as an expense).
• Recording discounts incorrectly – remember trade discounts are netted off before recording; cash discounts are recorded when taken.
• Using the wrong book of prime entry (e.g., posting a credit purchase in the cash book).
• Transferring balances to the trial balance without first balancing each ledger account.

13. Practice Exercise

Record the following transaction, post to the ledger, and prepare an unadjusted trial balance.

1. On 12‑02‑2025 the business purchased inventory on credit for £1,500.

Solution Steps

1. Source document: Purchase invoice dated 12‑02‑2025.
2. Identify accounts: Inventory (Asset) and Accounts Payable (Liability).
3. Apply debit/credit rules: Debit Inventory £1,500, Credit Accounts Payable £1,500.
4. Journal entry:

   Date        Account Debited   Debit (£)   Account Credited   Credit (£)   Explanation
   12‑02‑2025  Inventory         1,500       Accounts Payable    1,500       Purchased inventory on credit.
           

5. Post to T‑accounts:

                        Inventory
             ---------------------------------
             | Debit | Credit | Balance (Dr) |
             | 1,500 |        | 1,500        |
             ---------------------------------
   
                   Accounts Payable
             ---------------------------------
             | Debit | Credit | Balance (Cr) |
             |       | 1,500  | 1,500        |
             ---------------------------------
           

6. Update the trial balance:

   Account	Debit (£)	Credit (£)
   Cash	2,000
   Equipment	2,200
   Rent Expense	800
   Inventory	1,500
   Accounts Payable		1,500
   Owner’s Capital		5,000
   Total	7,500	7,500

14. Summary

The double‑entry system ensures that every financial transaction is recorded in a way that maintains the fundamental accounting equation. By:

• starting from a reliable source document,
• identifying the correct accounts and their types,
• applying the debit/credit rules consistently,
• using the appropriate book of prime entry,
• posting accurately to the three ledger divisions (sales, purchases, nominal),
• balancing each ledger account and interpreting its effect on profit or loss, and
• transferring the balances to a correctly prepared unadjusted trial balance,

students produce a set of accounts that are accurate, reliable, and ready for the next stage of the accounting cycle (adjustments and financial statements). Mastery of these steps is essential for success in the Cambridge IGCSE Accounting (0452) examination.