Welcome to the Heart of Accounting: The Double Entry Model
Hello there! Welcome to what many call the "language of business." If you have ever felt confused by why we record things twice or what on earth a "Credit" actually is, you are in the right place. In this chapter, we are going to explore the Double Entry Model. This is the foundation of everything else you will do in AQA A Level Accounting.
Don’t worry if this seems like a lot to take in at first. Think of it like learning to drive: it feels like too many things to do at once, but soon it becomes second nature. By the end of these notes, you will understand how a single transaction travels from a piece of paper (a receipt) into the final reports of a multi-million-pound company.
1. Where it All Starts: Source Documents
In accounting, we don't just make up numbers. Every entry in our books must be backed up by evidence. These pieces of evidence are called Source Documents.
Common Source Documents you need to know:
• Sales Invoices: Sent to customers when they buy on credit.
• Purchase Invoices: Received from suppliers when we buy on credit.
• Credit Notes: Sent or received when goods are returned (think of it as a "negative invoice").
• Cheque Counterfoils: The "stub" left in a chequebook after a payment.
• Till Rolls: Records of cash sales in a shop.
• Bank Statements: Used to record items like standing orders, direct debits, and bank interest.
Quick Tip: If you see "Inward" or "Outward" credit notes, just remember: an Inward credit note means goods came back into your business from a customer.
2. The "Diaries" of Business: Books of Prime Entry
Before we put transactions into the main accounts, we list them in "diaries" called Books of Prime Entry. This keeps the main accounts tidy.
The main books you must remember:
1. Sales Journal: For credit sales.
2. Purchases Journal: For credit purchases.
3. Sales Returns Journal: For goods customers sent back.
4. Purchases Returns Journal: For goods we sent back to suppliers.
5. Three-Column Cash Book: Records all Cash, Bank, and Discount transactions.
6. General Journal: For "unusual" things that don't fit elsewhere, like buying a delivery van on credit or correcting an error.
Key Takeaway: Books of Prime Entry are just lists. They are not part of the double-entry system itself; they are the "waiting room" before the double entry happens.
3. The Golden Rule: Duality and the Double Entry Model
The Duality Concept states that every transaction has two sides. If you spend £10 on petrol, you have £10 less in your bank (Side 1), but you have £10 worth of fuel in your tank (Side 2).
In accounting, we use Ledger Accounts (often called T-Accounts because they look like a "T").
• The Left side is the Debit (Dr) side.
• The Right side is the Credit (Cr) side.
The "DEAD CLIC" Mnemonic:
This is the easiest way to remember which side to use. If the following items increase, use these sides:
Debit:
• Expenses (e.g., Rent, Wages)
• Assets (e.g., Machinery, Cash, Debtors)
• Drawings (Money the owner takes out)
Credit:
• Liabilities (e.g., Loans, Creditors)
• Income (e.g., Sales revenue)
• Capital (The owner’s investment)
Example: If you buy a computer (Asset) for £500 using your bank account (Asset).
1. The Computer Asset increases: Debit Computer Account £500.
2. The Bank Asset decreases: Credit Bank Account £500.
Did you know? Double-entry bookkeeping was first codified by a monk named Luca Pacioli in 1494. He was a friend of Leonardo da Vinci!
4. Capital vs. Revenue: Don't Mix Them Up!
This is a favorite topic for examiners. You must distinguish between Capital and Revenue items.
Capital Expenditure: Spending on long-term items (Non-Current Assets) like buildings, vans, or machinery. This also includes costs to get the asset ready, like delivery fees or installation.
Revenue Expenditure: Spending on day-to-day running costs, like petrol, electricity, or repairing a broken window.
Capital Income: Money from selling a non-current asset or a loan.
Revenue Income: Money from the normal trading of the business (selling goods/services).
Analogy: Buying a pizza oven is Capital Expenditure (it lasts a long time). Buying the flour and cheese to make the pizzas is Revenue Expenditure (it’s used up quickly).
5. Handling Discounts and Debts
Transactions aren't always straightforward. Sometimes we give discounts or people don't pay us.
Trade Discount vs. Cash Discount:
• Trade Discount: A reduction in price given at the time of sale (e.g., a bulk buy discount). We never record this in the ledger accounts; we just record the final, lower price.
• Cash (Settlement) Discount: A reduction given if the customer pays quickly. We do record this in the "Discount" column of our Cash Book.
Irrecoverable Debts:
Sometimes a customer (a Receivable) cannot pay. When we are sure they won't pay, we must "write it off."
• Debit: Irrecoverable Debts Account (an Expense).
• Credit: The Customer’s Account (to show they no longer owe us).
Contra Entries:
This happens when you buy from and sell to the same person. Instead of both of you writing cheques to each other, you just "cancel out" the balance. You Debit the Payables Ledger and Credit the Receivables Ledger.
6. Adjustments: Getting the Timing Right
To make sure our profits are accurate, we must make Adjustments at the end of the year. This follows the Accruals Concept (recording expenses when they happen, not just when the cash moves).
Accruals: Expenses we have used but haven't paid for yet (e.g., electricity used in December but the bill arrives in January).
Prepayments: Expenses we paid for in advance (e.g., paying for 12 months of insurance in October).
Depreciation:
Non-current assets lose value over time. We record this as an expense.
1. Straight Line Method: The asset loses the same amount every year.
Formula: \(Depreciation = \frac{Cost - Residual Value}{Useful Life}\)
2. Reducing Balance Method: A fixed percentage is taken from the current value (Net Book Value) each year.
Formula: \(Depreciation = NBV \times Percentage\)
7. The Final Goal: Financial Statements
After we have balanced our T-accounts, we move the totals to the Financial Statements.
1. Income Statement: Shows if the business made a Profit or Loss. It lists all Revenue Income and Revenue Expenses.
2. Statement of Financial Position (Balance Sheet): A "snapshot" of what the business owns and owes on a specific day.
Standard Subheadings for the Statement of Financial Position:
• Non-Current Assets: Long-term items (Vans, Buildings).
• Current Assets: Items that will turn into cash within a year (Inventory, Receivables, Bank).
• Capital (Equity): The owner’s stake in the business.
• Non-Current Liabilities: Debts to be paid after one year (Long-term loans).
• Current Liabilities: Debts to be paid within a year (Payables, Overdrafts).
Quick Review Box:
• Every transaction affects two accounts.
• Debit = Left / Credit = Right.
• Assets + Expenses = Liabilities + Income + Capital (The expanded accounting equation).
• Capital Expenditure goes on the Balance Sheet; Revenue Expenditure goes on the Income Statement.
Don't worry if this feels tricky! The best way to master double entry is to practice drawing the T-accounts. Once you master the "DEAD CLIC" rule, you’ve unlocked the most important secret in accounting!