Learning Outcomes

After studying this Chapter, you shall be able to:

 Know the meaning and concept of Double Entry System
 Understand the advantages and disadvantages of Double Entry System
 Know the Classification of Accounts under traditional approach
 Learn the types of accounts in modern approach.

4.1 INTRODUCTION

Every business transaction has two aspects affecting at least two accounts in opposite
directions. In fact, on the one hand value id received and on the other hand sacrifice in
resource is made or some liability increases. One aspect is debited and other account is
credited. Let us illustrate it with an example. If a business purchases a machinery for
cash, then machinery is coming into the firm whereas there is decrease in cash.
Similarly, when goods are purchased on credit, goods increase in the business and
liability is also increased. In fact, there can be no transaction which affects only one
account or which has only one aspect.
In other words, one person (or account) receives the benefit and other one sacrifices it.
The account of the person who is receiving the benefit is debited and the account of
other person is credited who is sacrificing. This system of considering two aspects of
each and every transaction is the basis of Double Entry System.
The double entry system is a system of book-keeping so named because every entry to
an account requires a corresponding and opposite entry to a different account. The
double entry has two equal and corresponding sides known as debit and credit.

4.2 Definitions of Double Entry System

The following are some of the definitions:

According to J.R. Batliboi, “Every business transaction has a two-fold effect and that it
affects two accounts in opposite directions and if a complete record was to be made of
each such transaction, it would be necessary to debit one account and credit another
account. It is this recording of the two fold effect of every transaction that has given to
the term Double Entry System.”

William Pickles defined Double Entry System as, "The Double Entry System seeks to
record every transaction in money or Money's worth in its double aspect- the receipt of
a benefit by one account and the surrender of a like benefit by another account, the
former Entry being to the debit of the account receiving and the letter to the credit of
the account surrendering."

Basic Accounting for Non-Commerce students (GMC) CA. (Dr.) K. M. Bansal

Chapter 4 2 Double Entry System
“Every transaction involving money or money’s worth has two fold aspects, the
receiving of a value on the one hand and the giving of the same value on the other.
This two fold nature in all transactions must be recorded in the books and this gives
rise to the term Double Entry Book keeping”. - Munro and Palmer

On the basis of above definitions, it can be said that the system under which every
transaction is accounted in two accounts for the equal amount of money debiting one
and crediting the other ignoring no account is called as Double Entry System.

4.3 History of Accounting

Accounting has a rich heritage. The early development of accounting began thousands
of years ago and can be traced to ancient civilizations mainly Babylonia and Egypt
around 4000 B.C. They recorded transaction of payment of wages and taxes on clay
tablets. Babylonia, also known as the city of Commerce, used accounting for business
to detect frauds, inefficiencies and also to trace losses taking place due to theft or
otherwise.

The Romans (700 B.C. to 400 A.D.) started preparing memorandum or day book where
receipts and payments were recorded and posted to ledgers on monthly basis.

In India, the accounting could be traced back to a period when 23 centuries ago,
Kautilya, a minister in Chandragupta’s kingdom wrote a book named Arthashasthra,
which also described the method of maintaining accounts.

In 1494, an Italian mathematician Luca Pacioli wrote a book ‘Summa de Arihmetica,

Geometria, Proportion at Proportionality’ (Review of Arithmetic and Geometric
proportions). A portion of this book contained the knowledge of business and book-
keeping for the first time. He used the words Debito and Credito to record business
transactions. He discussed the details of memorandum, journal and ledger and
specialized accounting procedures. He is honored as the Father of Accounting.

4.4 Characteristics of Double Entry System

The following are the important features of the double Entry System:

(1) Two Accounts: Every business transaction affects two accounts simultaneously,
out of which one is debited and other one is credited. There are certain
transactions that affect more than two accounts. But, the total amount debited is
equal to the total amount credited, in respect of a single transaction.
(2) Recording of all transactions: Under traditional system, the accounts are
classified as personal and impersonal accounts. The double entry system records
all the transactions on the basis of nature of these accounts.
(3) Golden rules: There are three fundamental rules of double entry system. These
have been explained in chapter 6. These rules are the fundamentals of double
entry system.
(4) Completer accounting System: It is a scientific and complete accounting system.
(5) Checking of Accuracy: Under this system, the arithmetical accuracy is checked by
the preparation of Trial balance. It has been explained in chapter 8.

Basic Accounting (GMC) CA. (Dr.) K. M. Bansal and Dr. Ritu Gupta
Chapter 4 3 Double Entry System

4.5 Advantages of Double Entry System

This system has the following advantages:

(1) Every transaction is recorded completely on the basis of nature and type of
account i.e. personal, real and nominal. The business transactions may be
classified as Asserts, Liabilities, Expenses, Revenue and Capital.
(2) Since, the entries are passed on the basis of documentary evidences; the
reliable information is generated by Double entry System.
(3) The double entry system is a systematic and scientific method.
(4) The net result (Profit or Loss) can easily be calculated under this system.
(5) The financial statements prepared on the basis of double entry system can be
compared with the statements of prior periods.
(6) The chances of frauds and embezzlement are minimized when the recording is
done on the basis of double entry system.

4.6 Disadvantages of Double Entry System

Although Trial Balance can be prepared to check the arithmetical accuracy of the
transactions processed under double entry system, but this system does not provide any
solution to the following errors:

(1) Errors of Principle: These errors are related with the wrong classification of
Revenue and Capital. For example: If purchase of Machinery is recorded as
purchase of goods, then this error will not be reflected under double entry
system because this system is based upon the fact that every debit has its
corresponding credit.
(2) Errors of Omission: If the transaction is not recorded in the books at all, then
both the aspects, debit and credit, are missing. The Trial Balance will tally and
this mistake cannot be detected.
(3) Compensating Errors: These are the combination of two or more errors in such
a manner that the effect of one error is compensated by another error. Thus,
the net effect of errors automatically vanishes.

Under this system, number of books is required to be kept. The success of

double entry system depends upon the correct classification of nature of
account and the rules of debit and credit. Therefore, trained persons are
required to execute and implement this system.

4.7 Classification of Accounts

The accounts can be classified in two ways:

(1) Traditional Approach (English Approach)

(2) Modern Approach (American Approach)

Basic Accounting (GMC) CA. (Dr.) K. M. Bansal and Dr. Ritu Gupta
Chapter 4 4 Double Entry System
These two approaches have been explained in detail in Para 4.8 and 4.9 of the
same chapter.

4.8 Traditional Classification

There are three types of accounts maintained by a business organization.
Accounts

Personal Impersonal

Real Nominal
1. Personal Accounts
These accounts relate to persons, i.e., individuals, firms, companies, debtors,
creditors, etc. The main purpose of preparation of personal account is to
ascertain the balance due to or from persons. These accounts can be classified
into three categories:
(a) Natural Personal accounts: These are the accounts of natural persons i.e.,
human beings like Ram, shyam, Radha, etc. Thus, examples are Shyam’s
A/c, Ram’s A/c, etc.
(b) Artificial Personal accounts: These are the persons having their existence
in the eyes of law like corporate bodies or institutions, companies, clubs,
etc. So, these are the accounts of corporate bodies or institutions which are
recognized as persons in business dealings.
(c) Representative Personal Accounts: These are the accounts which are not
in the name of any person or organization but are represented as personal
accounts. For example if wages are due to workers, an outstanding wages
account will be opened in the books. This outstanding account represents
the amount payable to the workers. The other examples are prepaid rent,
outstanding rent, accrued commission, etc.

2. Impersonal Accounts
These are the accounts other than personal accounts. These can be further sub-
divided into two Accounts:
(a) Real Accounts
These accounts relate to tangible and intangible assets of the firm
(excluding Debtors). The examples of Tangible Assets are Land, Building,
Plant, Machinery, Furniture, Investments, etc. The examples of Intangibles
are Goodwill, Patents, Trademark, etc.

(b) Nominal Accounts

These accounts relate to expenses, losses, incomes and gains. The
examples are salary account, interest paid account, royalty account,
commission received account, etc. At the end of the year, nominal
accounts are not balanced as these are transferred to profit and loss
account. That is why these are called as temporary accounts.

Did You Know Impact of words “Outstanding and Prepaid”

Basic Accounting (GMC) CA. (Dr.) K. M. Bansal and Dr. Ritu Gupta
Chapter 4 5 Double Entry System

1. If prepaid or outstanding is prefixed or suffixed with any nominal account then it

becomes personal account. For example wages is a personal account but
outstanding wages is a personal account.
2. Bank is a personal and Cash is a real account.

Illustration 4.1 Classify the following accounts according to the traditional approach:
Capital, Cash, Salaries, Wages, Outstanding Wages, Prepaid Salaries, Discount
Received, Bank Account, Furniture and Fixture, Commission Received, Light, Power and
electricity, Drawings, Debtor, Loan from Mohan, A society, Stock or Inventories,
Machinery, Conveyance Charges, Doubtful Debts and Bad Debts.
Solution
S.N. Item of Account Nature of Account
1. Capital Personal
2. Cash Real
3. Salaries Nominal
4. Wages Nominal
5. Outstanding Wages Personal
6. Prepaid Salaries Personal
7. Discount Received Personal
8. Bank Account Personal
9. Furniture and Fixture Real
10. Commission Received Nominal
11. Light, Power and electricity Nominal
12. Drawings Personal
13. Debtor Personal
14. Loan from Mohan Personal
15. A society Personal
16. Stock or Inventories Real
17. Machinery Real
18. Conveyance Charges Nominal
19. Doubtful Debts Personal
20. Bad Debts Nominal

4.9 Golden Rules of Accounting (Traditional Approach)

All the three types of accounts have separate and unique rules of accounting. Each
account has two rules, one related to debit and other related to credit. These rules are
called as golden rules of accounting as the entries are recorded on the basis of these
rules and it forms the basis of double entry book keeping system.

Rule for Personal A/cs. Debit the Receiver and Credit the Giver
Rule for Real A/cs. Debit what comes in and Credit what goes out
Debit all expenses and losses and credit all incomes and
Rule for Nominal A/cs. gains

Basic Accounting (GMC) CA. (Dr.) K. M. Bansal and Dr. Ritu Gupta
Chapter 4 6 Double Entry System
Illustration 4.2 Decide the accounts to be debited or credited in respect of following
transactions:

(a) Shiv started business with cash.

(b) Purchased Furniture for cash
(c) Goods purchased for cash.
(d) Salary paid.
(e) Sold goods for cash.
(f) Paid commission in cash.
(g) Interest allowed by bank.
(h) Paid instalment of loan.
(i) Withdrew cash from bank for office use.

Solution
Accounts Involved Nature of Effect on Accounts Whether to be
Accounts debited or
Involved credited
(a) Cash A/c Real Cash is coming in Debit
Capital A/c Personal Shiv is the giver Credit
(b) Furniture A/c Real Furniture is coming in Debit
Cash A/c Real Cash is going out Credit
(c) Purchases A/c Real Cash is coming in Debit
Cash A/c Personal Shiv is the giver Credit
(d) Salary A/c Real Cash is coming in Debit
Cash A/c Personal Shiv is the giver Credit
(e) Cash A/c Real Cash is coming in Debit
Sales A/c Personal Shiv is the giver Credit
(f) Commission A/c Real Cash is coming in Debit
Cash A/c Personal Shiv is the giver Credit
(g) Cash A/c Real Cash is coming in Debit
Capital A/c Personal Shiv is the giver Credit
(h) Cash A/c Real Cash is coming in Debit
Capital A/c Personal Shiv is the giver Credit
(i) Cash A/c Real Cash is coming in Debit
Capital A/c Personal Shiv is the giver Credit

4.10 Classification of Accounts under Modern Approach)

Under Modern Approach, all the accounts are classified into five categories:
Category of Account Rule of Debit and Credit
1 Asset Account: Debit the increases
These are related with the economic &
resources of an enterprise. Credit the decreases
For example: Land, Building, Plant,
Furniture, Machinery, Patents,
Inventory, Cash, etc.
2 Liability Account: Debit the decreases
These are the lenders, creditors for &
goods, outstanding expenses, etc. It Credit the increases
represents the liability of the business
towards the external parties.
3 Capital Account: Debit the decreases
These are the accounts of owners and &

Basic Accounting (GMC) CA. (Dr.) K. M. Bansal and Dr. Ritu Gupta
Chapter 4 7 Double Entry System

partners who have invested amount in Credit the increases

the business.
For example: Capital and Drawings
4 Revenue Account: Debit the decreases
These are the accounts of incomes &
and gains. Credit the increases
For example: Sales, Discount
Received, Bad Debts Recovered,
Commission received, Interest
received, etc.
5 Expense Account: Debit the increases
These are the accounts of expenses or &
losses incurred. Credit the decreases
For example: Purchases, Wages,
Salaries, Depreciation, Discount
Allowed, etc.

4.11 Rules of Accounting (Modern Approach)

The following are the rules for debit and credit at a glance:
Type of Account Account to be debited Account to be credited
1 Asset A/c Increase Decrease
2 Liability A/c Decrease Increase
3 Capital A/c Decrease Increase
4 Revenue A/c Decrease Increase
5 Expense A/c Increase Decrease

Illustration 4.3 Classify the following into Assets, Liabilities, Capital, Revenue and
Expenses:
Plant, Rent, Carriage Inwards, Discount Received, Capital, Bank Loan, Sales,
Drawings, Bills Payable, Machinery, Carriage Outwards, Wages, Outstanding
Expenses, Accrued Income, Income received in advance, Debtor, Furniture,
Advance Income, Goodwill, Purchases, Salary and Cash
Solution

Assets Liabilities Capital Revenue Expenses

Plant Bank Loan Capital Sales Rent
Machinery Bills Payable Drawings Discount Carriage
Received Inwards
Accrued Income Carriage
Income received in Outwards
advance
Goodwill Advance Purchases
Income
Furniture Outstanding Wages
Expenses
Debtor Salary
Cash

Illustration 4.4

Basic Accounting (GMC) CA. (Dr.) K. M. Bansal and Dr. Ritu Gupta
Chapter 4 8 Double Entry System
On which side will the increase in the following accounts being recoded, under
modern approach. Also identify their nature.
1. Goodwill
2. Outstanding Rent
3. Cash
4. Shyam (Debtor)
5. Purchases
6. Owner’s A/c
7. Sales
8. Bank Overdraft
9. Salary
Solution
S. Account Nature To record
No. Increase in
account
1 Goodwill Asset Debit
2 Outstanding Liability Credit
Rent
3 Cash Asset Debit
4 Shyam (Debtor) Asset Debit
5 Purchases Expense Debit
6 Owners A/c Capital Credit
7 Sales Revenue Credit
8 Bank Overdraft Liability Credit
9 Salary Expense Debit

Basic Accounting (GMC) CA. (Dr.) K. M. Bansal and Dr. Ritu Gupta
Chapter 4 9 Double Entry System

TEST YOUR KNOWLEDGE

Objective Type questions

State whether the following statements are True (T) of False (F).
(1) A debit in an expense account means that the amount of expense incurred by
the firm A/c.
(2) Increase in external liability is favourable for the firm.
(3) Wages A/c is an example of personal A/c
(4) Prepaid wages is an example of Personal A/c.
(5) A credit in Income Account means the amount of income earned bt the firm
under that head of account.
[Answers: True:- 1,4,5 False:-2,3]
Theoretical Questions
1. Define Double Entry System. What are its advantages and disadvantages?
2. Explain the traditional classification of accounts.
3. Briefly explain the types of accounts under Modern System.
4. What are the golden rules of accounting for personal, real and nominal
accounts?

Practical Questions

Q.1 [Modern System] Classify the following into Assets, Liabilities, Capital,
Revenue and Expenses:
Plant, Rent, Carriage Inwards, Discount Received, Capital, Bank Loan, Sales,
Drawings, Bills Payable, Machinery, Carriage Outwards, Wages, Outstanding
Expenses, Accrued Income, Income received in advance, Debtor, Furniture,
Advance Income, Goodwill, Purchases, Salary and Cash.

Q.2 [Traditional System] Classify the following into Personal, Real and
Nominal:
(a) Debtors
(b) Interest Received
(c) Bad Debts
(d) Bad Debts Recovered
(e) Capital
(f) Drawings
(g) Salary
(h) Goodwill
(i) Plant and Machinery
(j) Amount due from Shyam
(k) Purchases
(l) Bad Debts
(m) Depreciation

Basic Accounting (GMC) CA. (Dr.) K. M. Bansal and Dr. Ritu Gupta