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Module: 35

Bookkeeping Fundamentals

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In this module we'll cover bookkeeping, the importance of bookkeeping and the single and double-entry

bookkeeping method.

35.1 Introduction and Importance of Bookkeeping

35.2 Single-Entry Bookkeeping

35.3 Double-Entry Bookkeeping

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35.1 Introduction and Importance of bookkeeping

In the simplest terms, bookkeeping is nothing more than record keeping. This is the simple process

of writing down financial figures in a ledger. One point should be made Journals, Records, Ledger,

Books; they are all interchangeable words for the same thing. All of these are financial records of a

business’ operations and either term will be used in business discussions. However, the most

common term is books, representing all formats. In addition, the term most often associated with

record keeping is called posting. This means a person is posting a transaction to the books.

Keeping books is a straightforward process. There are a few principles and items that you will have

to follow in the bookkeeping process. However, for the most part bookkeeping is not complex. The

most important concept in record keeping is to keep it accurate. This does not mean that mistakes

cannot or will not happen, just that when a mistake happens identifying it immediately and correcting

it is important. In keeping with this endeavor, bookkeeping practices are developed to keep errors

to a minimum.

There are two forms of bookkeeping, Single Entry and Double-Entry Bookkeeping. Both methods

can be used by small businesses although double entry is designed for businesses that are more

complex. Single entry will work fine for any small business. Single entry is similar to a simple math

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table or the income statement mentioned in module 2. It simply takes the total of income and then

subtracts expenses from the income to arrive at the final profit or loss.

Double entry is the method mentioned by Luca Pacioli in his 1494 book. It uses debit and credits as

a balancing act to ensure more accuracy in the accounts. While small business can use double

entry, every large business will use it. It is designed to make complex accounting practices or

procedures more standard and easier for business people.

For small businesses, you can use either system, although the double entry does require more

experience to master the process, than single entry. Additionally, most of the processes of data entry

into the books, the manual part of bookkeeping, are completed today with accounting software. These

software systems are designed to work either way and can make the record keeping process very easy

for business owners. In fact, the software is so good that it automates everything with ease.

Of note to bookkeeping is that every transaction will require some identifying data when placed in the

books. When books are initially setup, many companies will use two forms of identity for each

transaction. One is the date of the transaction. The other identifier is a coding system.

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The reason for a date is rather self-explanatory. It helps keep the books on point as to when the

transaction occurred and what the specific monetary amount was for that transaction. This dating

system is a way of tracking costs and income through the accounting process. However, there is another

way to track transactions, which is the coding system.

The coding system is a numbered accounting process where each form of transaction is placed into an

identifiable code grouping. For example, all incomes from a credit sale will be placed in a similar code of

either 3 or 4 digits. In the same example, income from cash sales would all be placed in the books using a

different 3 or 4 digit code. The same process would work for expenses with each form of expense having

its own 3 or 4 digit code. These codes would extend to items such as owner’s equity and distributions to

owners. Every type of transaction has its own code.

The codes are usually 3 or 4 digit codes such as 120 or 1220. Each digit in the code may represent a

grouping of the codes. For example, codes which start with a 1, whether it is a 3 or 4 digit code will be

income. Codes, which start with a 2 again either 3 or 4 digit codes, may be wage expenses. Thus in this

system code 125 would be a form of income, perhaps a cash sale from a store. While a 250 code on a

posting may be a salesperson wage for that month.

These codes just help bookkeepers and accounts track income and expenses. Thus, it helps to develop an

internal auditing system to assist people in identifying mistakes or errors. If you use a software system

to keep your books, when setting up the program it will help you determine your coding system.

35.1.1 Importance of Bookkeeping

The main reason that bookkeeping is important is it makes the recording process standard.

Standardization helps keep everything uniform, neat, and concise. Recall that one of the main

principles of accounting is to keep everything standard. Thus when looking at issues or questions,

people can make a discussion of “apples to apples” rather than “apples and oranges”

When performing bookkeeping look to maintain this adherence to standards and uniformity. This

goal is aided today by the use of software. The software will often lead a bookkeeper to learn how

the recording or posting needs to be made when there is a question. For example, if the business

uses double entry and there is a question on which account to make the credit some programs will

make suggestions or possibly do it automatically.

Finally, like every other aspect of accounting, the importance of bookkeeping is to keep everything

as honest as possible. Bookkeeping is the start of the entire process. The better the recording at

this point the more accurate the numbers are when they are used in Financial Accounting,

Management Accounting, Auditing, Taxes, and Forensics.

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35.2 Single Entry Bookkeeping

Single entry bookkeeping is often called the “bare essential” record keeping system. The system is

designed to be used by anyone who seeks a user-friendly system. When this module moves on to

double entry system, you will clearly see why single entry is more simple to use. Even though the

system is built on only the essentials, it is perfect for a small business. The process is simple and

follows the basic math actions of addition and subtraction.

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As the name implies, there is only one entry on the books for any record of transaction. Some

examples:

If a company receives $400 from one customer, there will only be one recording of the income for $400.

On one day, a business receives $300 from client A; $250 from client B; and $600 from client C. The

bookkeeper will record all three numbers in the journal (book) and then the total income for the day

will be recorded as $1150 in another book. This is still single entry bookkeeping. The recording of

entries refers to how the entries are made in a single book. Some businesses may have several books

such as day journals, income ledgers, and income statements. Therefore, even if you make a notation for

this income in more than one book, it will still be single entry bookkeeping.

Suppose that a business had $875 in income and then had to pay a utility bill for $400 on the same day.

Then in the books, the bookkeeper will record the $875 and the $400 payment. They are separate

entries but are recorded in the same book, on the same record sheet. Even if there are multiple entries

on a page it is single entry bookkeeping as it means that there is only one entry in a book for a

transaction.

All that is required for single entry is that a single notation (posting) is made for each bill and receipt

in one book.

Looking over these examples you can see some of the differences between the two forms of

bookkeeping. Single entry uses the income statement as its guiding document. Developing a

“running” list of profits and losses for the business as the month or a time period progresses. As you

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will see in double entry, the guiding document is the balance sheet. In some ways, the two

systems are looking at different concepts when recording. Single entry is looking strictly at the

bottomline of a company, while double entry looks at how the balance sheet is influenced by daily

business activities.

Another issue that you may see is that single entry bookkeeping may allow math mistakes to track

through to the bottomline. Looking at the above examples one can see that there are times in

bookkeeping that a simple math error, as simple as a transposed number could influence the books.

This is always possible in single entry bookkeeping, thus as a bookkeeper, you need to pay

particular attention to posting details. The double entry system decreases this impact because it has

a self-balancing system designed in the process. In the case of a transposed number, the self-

balancing of the double entry process would catch the numbers not equaling each other. When

using a single entry bookkeeping process you should use extra care to ensure that all the numbers

are correctly posted to the books.

Another issues to be alert to as a deficiency in single entry bookkeeping is that the system is more

open to theft. Embezzlement is a major concern for business owners; even large companies are

open to this kind of theft. However, when using a single entry bookkeeping system the opportunity to

be a victim of theft from an employee is more open. An employee or others can simply report the

wrong number and hence the system will not “catch” the issue. In double bookkeeping, it is harder to

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have outright theft as the system is designed to balance and when numbers do not balance, the theft

is easier to catch.

These issues are not offered as reasons to shy away from single entry. They are noted to make a

person aware of the issues. As a record keeping system, single entry bookkeeping is fine for any

small business. It does require vigilance, but the same is true for double entry. As a

recommendation, if your business is small and does not have too much financial complexity, then a

single entry format is fine.

The following is a simple sample of single entry bookkeeping. The period of time of the income

statement is for a month. The company has a total income of $2340. Its expenses for the month are

$500 employee wages; $200 for utilities; $340 for rent; $100 for insurance; Membership fees to an

association were $125. Please note there are no codes in this example. If codes were present, they

would be either in their own column or next to the title of each item.

Income $2340

Wages $500

Utilities $200

Rent $340

Insurance $100

Membership Fees $125

Profit or Loss $1075

This same bookkeeping process could be represented in the following table

Income $2340

Wages

$500

Utilities

$200

Rent

$340

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Insurance

$100

Membership Fees

$125

Totals $2340 $1265

Profit or Loss $1075

There could be even more changes to the table to indicate from the placement of the bottomline as a

positive number (profit) or negative number (loss) Regardless of the design of the table or how many

columns have numbers, this is single entry bookkeeping. It is using the income sheet as its guide and the

columns do not balance out like in double entry.

35.3 Double entry bookkeeping

Double entry bookkeeping is the more complicated of the two record keeping systems. The central

theme behind double entry is balance. When one segment of an account is impacted, there is an

equal and opposite impact on another side of the ledger. For examples, income on one side of the

ledger will require a similar input on either a liability or equity positon on the other side of the ledger.

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Recall that double entry uses the general accounting equation: Asset = Liabilities + Owner’s Equity.

Therefore, if something changes on the asset side of the ledger there will be an equal change to the

liabilities or owner’s equity or both. The opposite is true too. If the owner’s equity is decreased by a

certain amount, say through a distribution of funds to the owners; then the assets will be impacted.

The whole process is designed to maintain a constant balance between the two sides. Thus, they

will always equal each other and balance out in the end. Double entry looks to eliminate errors by

developing a constant balance through this equation of assets to liabilities and owner equity.

To develop this equation properly accountants all the way back to the time of Pacioli, have used it as

their guiding principle. A major part of this operation then is the use of debit and credits. Recall from

module one the definitions of credits and debits. In double entry accounting the ledger has two

columns one on the left side, the other on the right. A debit is just and entry on the left side column,

while and entry on the right side is a credit. This does not necessarily mean that a debit is a

negative number or a “negative” thing. Nor does it mean that a credit is a “positive” thing. It only

means that a debit is on the left side while a credit is on the right. This point needs to be

emphasized because it is where most confusion starts in the accounting process using double entry.

Perhaps one of the best concepts to use as an example in double entry is to think about moving

items from one point to another. When making entries (postings) into the books you are moving one

thing from one position to another and the final total will always add up. Thus if an entry is made as a

debit on assets, then there will be a credit in either liabilities or owner equity. Even though you move

an item from one to another, the balance remains the same. This is why it may be helpful to think of

the action as moving money from one point to another, even though nothing has happened in reality.

Double entry has schools or methods. There is the traditional method, which is popular in Great

Britain. While the method popular in the US is the accounting equation. Both use the accounting

equation as the guiding force. However, the British version uses items such as personal, real, and

nominal accounts. This module will use the US version, because it follows the general accounting

equation. Double entry is complicated enough without trying to learn a similar system, yet each use

different terminology.

There are some general rules or action to keep in mind when using double entry and the US

system. The following five rules are the way to keep what is debited and credited in the books as

bookkeepers make changes:

1. Accounts of Assets: a debit will increase the balance, while a credit will decrease. Yes, you heard

that correctly, debit the asset to increase the balance, while crediting it to decreased the value. This

is how the system influences assets on the ledger using double entry.

2. Accounts of Liabilities: A credit will increase a liability while a debit will decrease it.

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3. Accounts of Owner Equity or Capital: These work just like liabilities. A debit will decrease the

owner equity, while a credit will increase it.

When looking at these rules one can see the general accounting equation in action. A bit further

down we will look at some samples to show the preceding rule in action.

There are two more rules for double entry and they deal with revenue accounts and expense

accounts. These are part of the five general rules and are meant to help bookkeepers keep good

track of the flow on money in the company. In addition, these seem a bit more logical with the ideas

of debits and credits.

4. Revenue Account: An increase will be a credit while a decrease will be a debit

5. Expense account: A debit will increase expenses, while a credit will decrease expenses.

Putting these rules into a simple template or sheet of operations, it would look like this on simple table.

From looking at the above table, which just reinforces the above rules, you can see that each entry

is meant to balance out in the end. If assets increase then liabilities and/ or owner equity will

decrease. If Owner equity increases then there will be an equal decrease on the assets of the

company.

The system is much more complex than the single entry. However, by adding the complexity of

balancing out all the time, the system decreases errors. This is why large companies and even small

businesses use the system. Double entry does require study, familiarity, and a solid understanding

of the credit/ debit system. As a recommendation when learning and even using this system keep a

simple copy of the table above with you as it will remind you how the system works.

The following are some examples of how the system works, using the table as a guide.

If a business has an increase in its cash, which is an asset, the way to handle it on the books would be the

following. The first step will be a debit increase on the left side of the ledger. There will be a decrease in

the credit on the right side of the ledge, which would affect either liabilities or equity or both. The value

of the debit will equal the size of the credit, thus the books will balance.

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If Liabilities increase, which is on the right side of the ledger it will be a credit. At the same time, the

assets will have a debit on the left side of the ledger.

The system is can be very complex and confusing, especially when starting out in bookkeeping. As a

recommendation, if you are going to use double entry bookkeeping, practice at it first. Additionally,

never give up learning about the system. It does take some getting used to when first starting out, so

never expect that you will get it right away. Single entry is much easier to learn and use at first.

However, once you have double entry down and understand its principles, the entry of items and the

balancing of books is much easier. It will be much harder to miss something and mistakes or errors

will quickly be identified and resolved.

The question can be presented which is the best system. There is no right answer on this question.

Some people have rather large businesses that have revenues over 1 million dollars and they will

use a single entry system. Another person may have a very small business, which has annual

revenue of $15,000, and use double entry. There is no right or wrong way it really comes down to

personal preference. Find the process that you feel most comfortable with and the system that

makes the most sense for your business.

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35.3..1 Double entry bookkeeping example

This is a simple sample of double entry bookkeeping. To reiterate double entry is more complex than

this example will imply. However, you will be able to see the principles at work. The example used is

a balance sheet to show how the system uses the general accounting equation.

In the above sample, the company had sales of $500. The company had $200 in the bank or cash

balance. In the time period of the sample, the company paid out $400 in payments- these are

liabilities. The owner’s equity is stated at $300. Note that both sides of the ledger equal $700.

Notice that even though the company had sales of $500, these are recorded here as a debit. These

sales are assets (increase in cash) of the company so they need to be recorded as a debit according

to the equation. The company already had $200 in the bank, which is an asset, and it is a debit of

$200. On the right side of the ledger, the company paid out $400 to liabilities. Again, even though

this is bad thing it was recorded as a credit. This is in accordance with the equation. Finally, the

owner’s equity is at $300 as a credit. Everything balances out at $700 on both sides.

One note to make on the general accounting equation. Earlier it was pointed out that the way to think

of this system was as moving something from one side of the form to another side. Well it might

have crossed you mind, what happens when a company makes a sale. Yes, the cash balance goes

up, which means the other side of the equation needs to increase by an equal amount. Well what

happens when the payments are less than what the cash increased by on the sheet. That implies

that the company has made a profit for the time period of the recording. This means that something

on the opposite goes up which is the Owner’s Equity. Think of owner’s equity as the catcher of

unused cash or assets. Owner’s equity catches the leftovers and will increases, thus balancing out

the books, as well as showing that the owners made money.