Double Entry System
Double Entry System
Introduction
The Double Entry System is the foundation of modern accounting. Every financial transaction is recorded with at least two entries — a debit and a credit — ensuring that the accounting equation always remains balanced. For the JAIIB exam, mastering the rules of debit and credit, types of accounts, and the mechanics of recording transactions is essential.
The Fundamental Principle
Every debit has a corresponding credit.
This means every transaction affects at least two accounts. The total of all debits must equal the total of all credits at all times.
Accounting Equation: Assets = Liabilities + Owner's Equity
Types of Accounts
Traditional Classification
| Type | Rule |
|---|---|
| Personal Account | Debit the receiver, Credit the giver |
| Real Account | Debit what comes in, Credit what goes out |
| Nominal Account | Debit expenses and losses, Credit incomes and gains |
Modern Classification
| Category | Debit | Credit |
|---|---|---|
| Asset | Increase | Decrease |
| Liability | Decrease | Increase |
| Capital/Equity | Decrease | Increase |
| Revenue/Income | Decrease | Increase |
| Expense/Loss | Increase | Decrease |
Recording Transactions
Step-by-Step Process
- Identify the accounts affected
- Classify each account (personal, real, or nominal)
- Apply the debit and credit rules
- Record the journal entry
Common Journal Entries in Banking
1. Purchase of machinery by cheque (Rs 5,00,000)
| Debit | Credit |
|---|---|
| Machinery A/c Rs 5,00,000 | Bank A/c Rs 5,00,000 |
Real Account: Machinery comes in (Debit), Bank goes out (Credit)
2. Payment of salaries (Rs 50,000)
| Debit | Credit |
|---|---|
| Salaries A/c Rs 50,000 | Cash/Bank A/c Rs 50,000 |
Nominal Account: Expense is debited; Real Account: Cash goes out
3. Receipt of interest on investments (Rs 10,000)
| Debit | Credit |
|---|---|
| Bank A/c Rs 10,000 | Interest Received A/c Rs 10,000 |
4. Issue of shares at premium When a company issues 10,000 equity shares of Rs 10 each at a premium of Rs 2:
| Debit | Credit |
|---|---|
| Bank A/c Rs 1,20,000 | Share Capital A/c Rs 1,00,000 |
| Securities Premium A/c Rs 20,000 |
Books of Original Entry
Journal
- The first book of entry where transactions are recorded chronologically
- Contains: Date, Account Names, LF (Ledger Folio), Debit Amount, Credit Amount, Narration
Subsidiary Books (Books of Prime Entry)
| Book | Records |
|---|---|
| Cash Book | All cash and bank transactions |
| Purchase Book | Credit purchases of goods |
| Sales Book | Credit sales of goods |
| Purchase Returns Book | Goods returned to suppliers |
| Sales Returns Book | Goods returned by customers |
| Bills Receivable Book | Bills received from debtors |
| Bills Payable Book | Bills accepted in favour of creditors |
| Journal Proper | Entries not fitting other subsidiary books |
Key Point: Subsidiary books reduce workload by segregating recurring transactions. They do NOT replace ledgers and journals — they help organise and classify data for easier posting.
Petty Cash Book
- Records minor day-to-day expenses like postage, conveyance, stationery, and office supplies
- Operates on the Imprest System: A fixed amount is advanced, and the spent amount is replenished periodically
- Managed by a petty cashier, NOT by auditors
Ledger
The ledger is the principal book of account. All entries from the journal and subsidiary books are posted to respective ledger accounts.
Format of a Ledger Account (T-Account)
Dr. Account Name Cr.
Date | Particulars | Amount || Date | Particulars | Amount
Posting Rules
- Journal debit → Debit side of ledger account
- Journal credit → Credit side of ledger account
- Cross-reference using folio numbers
Trial Balance
A Trial Balance is prepared at the end of an accounting period to verify the arithmetic accuracy of the double entry records.
Features
- Lists all ledger account balances in debit and credit columns
- Total debits must equal total credits
- Prepared before final accounts (Trading, P&L, Balance Sheet)
What Trial Balance CAN Do
- Check arithmetic accuracy of posting
- Provide a summary of all ledger balances
- Serve as a basis for preparing financial statements
What Trial Balance CANNOT Do
- It does NOT guarantee error-free final accounts
- It cannot detect compensating errors, errors of principle, errors of omission, or errors of original entry
Types of Errors NOT Detected by Trial Balance
| Error Type | Description |
|---|---|
| Error of Omission | Transaction completely left out |
| Error of Commission | Correct amount but wrong account of same type |
| Error of Principle | Correct amount but wrong type of account |
| Compensating Errors | Two errors that cancel each other out |
| Error of Original Entry | Wrong amount in both debit and credit |
Principal Books of Account in Banking
As per the Banking Regulation Act, banks maintain:
- General Ledger: The master ledger
- Loan Ledger: Individual loan accounts
- RD Ledger: Recurring deposit accounts
- Investment Ledger: Securities and investments
- Profit and Loss Ledger: Income and expense accounts
Note: The Income Ledger is NOT classified as a core general ledger.
Balancing and Closing of Accounts
| Account Type | Balancing |
|---|---|
| Personal Accounts | Balanced periodically (monthly/annually) |
| Real Accounts | Balance carried forward to next period |
| Nominal Accounts | Closed at year-end; balance transferred to P&L |
Key Points to Remember
- Every debit has a corresponding credit — this is the core principle of double entry
- Three types of accounts: Personal (receiver/giver), Real (comes in/goes out), Nominal (expenses/incomes)
- Trial Balance checks arithmetic accuracy but does NOT guarantee error-free accounts
- Errors of omission, principle, commission, and compensating errors escape trial balance detection
- Subsidiary books segregate recurring transactions to reduce workload
- Petty cash book handles minor expenses on the imprest system
- When buying machinery by cheque: Debit Machinery, Credit Bank
- When issuing shares at premium: Debit Bank, Credit Share Capital + Securities Premium
- Principal books in banking: General Ledger, Loan Ledger, RD Ledger, Investment Ledger
- Income Ledger is NOT a core general ledger
- Nominal accounts are closed at year-end; real accounts are carried forward