TOPIC 4: Recording Financial Transactions Flashcards
Lecture 9, Chapter Appendix A (22 cards)
What is double-entry bookkeeping and why is it used?
Double-entry bookkeeping is an accounting system where every financial transaction affects at least two (or more) accounts: one debit and one credit.
The dual nature of increase and decrease will guide how one prepares an account.
This system ensures that the accounting equation (Assets = Liabilities + Equity) remains balanced, providing a complete and accurate record of financial activities.
Why is double-entry bookkeeping important?
- Increased and ensured accuracy: By recording each transaction in at least two accounts (one debit and one credit), double-entry bookkeeping helps ensure accuracy in financial records.
- Easier financial reporting: Double-entry bookkeeping provides a systematic way to organise financial information, making it easier to prepare financial statements such as the balance sheet, income statement, and cash flow statement.
- Fraud prevention: Double-entry bookkeeping reduces the risk of fraud by requiring transactions to be recorded in multiple accounts.
- Supporting decision making: Accurate and reliable financial information resulting from double-entry bookkeeping allows businesses to make informed decisions.
- Legal compliance: Many regulatory bodies and tax authorities require businesses to maintain accurate financial records in accordance with specific accounting standards.
Define ‘Debit’ and ‘Credit’.
Debits and credits are notations used to record the increases or decreases in account balances. They describe the two sides of a single transaction in T-accounts.
Debits (Dr) are recorded as left-hand entries, representing increases in assets and expenses (and losses), and decreases in liability and equity, and revenues (and gains).
Credits (Cr) are recorded as right-hand entries, representing increases in liability and equity and revenues (and gains), and decreases in assets and expenses (and losses).
What is a T-account and what is its purpose?
A T-account is a simple tool used to visualize debits and credits for each account.
The left side is for debits, and the right side is for credits. It helps track how individual accounts are affected by transactions.
What is an account (generally)?
A record of one or more transactions relating to a particular item.
What are the five major types of accounts used in double-entry bookkeeping?
The five account types are:
- Assets: Resources owned by the business - e.g. cash account.
- Liabilities: Amounts owed to outsiders - e.g. amount payable account.
- Equity: Owner’s interest in the business (book value of the business = assets - liabilities) - e.g. equity account.
- Revenue (income): Income earned from operations - e.g. sales revenue account.
- Expenses: Costs incurred to earn revenue - e.g. wages account, rent account and utilities account.
What is the rule of debit and credit for each account type?
Asset
- Increase with Debit
- Decrease with Credit
Liability
- Increase with Credit
- Decrease with Debit
Equity
- Increase with Credit
- Decrease with Debit
Revenue (Income)
- Increase with Credit
- Decrease with Debit
Expense
- Increase with Debit
- Decrease with Credit
Define the steps in recording financial transactions.
- Step 1 - Identify transaction: What accounts are affected (e.g. cash, inventory, sales).
- Step 2 - Classify accounts: Are they assets, liabilities, equity, revenue, or expenses?
- Step 3 - Apply debit and credit rules: Assets and expenses increase with debit, and liabilities, equity and revenue increase with credit.
- Step 4 - Record in T-accounts: Post entries such that one account is debited and another is credited.
- Step 5 - Blanace ledger accounts: Calculate totals and find Balance c/d and Balance b/d.
- Step 6 - Create trial balance: List all account balances, and ensure that total debits = total credits.
- Step 7 - Prepare financial statements: Income statement from revenue and expenses, and balance sheet from assets, liabilities and equity.
What condition must be met at the end of recording a transaction to ensure it is correct?
The total sum of debits must equal the total sum of credits.
This confirms that the entry is balanced.
What if an account only has one entry?
It does not have to balance!
What are ‘Balance c/d’ and ‘Balance b/d’ in ledger accounts?
Balance c/d (carried down) refers to the closing balance at the end of an accounting period, which is carried forward to the next period.
- It’s the last entry in an account for the period.
- It becomes the opening balance of the next period.
Balance b/d (brought down) refers to the opening balance at the start of a new accounting period, which is brought down from the closing balance of the previous period.
- It’s the first entry in an account for the period.
They ensure continuity of account balances over time.
General rule: For one account, the closing balance of debit will be the opening balance of credit for that account and vice versa.
Explain the process of balancing using Balance c/d and Balance b/d.
- Add up the total of the debit and credit sides of the account.
- Identify which side has the greater total.
- Calculate the Balance c/d by subtracting the smaller total from the larger total.
- Enter the Balance c/d on the side with the smaller total to make both sides equal.
- In the next period, bring the same amount down as Balance b/d on the opposite side, continuing the account with the correct opening balance.
What does ‘Income Statement’ mean as an entry?
Writing “Income statement” in an account represents the step where the account is closed at the end of a period by transferring that amount to the Income Statement (also called the Profit and Loss Account).
Explain the difference between Balance c/d and ‘Income Statement’ (as an entry in an account).
Balance c/d (Carried Down) is the closing balance of an account at the end of a period.
- It is used when something continues into the next period.
- Example: Prepaid rent, bank balance, trade receivables — these balances carry forward.
- Think: “We’re not done with this account yet — this part continues into next month.”
Income Statement (entry in account) is not a balance; it’s a transfer.
- It is used to close income and expense accounts at the end of a period.
- It sends the total income or total expenses into the ‘Income Statement’, so we can calculate profit or loss.
- Think: “We’re done with this account for now — move the total to the profit calculation.”
What is a trial balance and why is it important?
A trial balance is a report listing all accounts with their ending debit or credit balances.
It’s used to verify that total debits equal total credits - a key check for ensuring accurate recording under the double-entry system.
What happens to balance c/d and balance b/d after the trial balance?
If adding all the debit balance brought down and compare it with the sum of the credit balance brought down, it should be equal!
What happens if the trial balance doesn’t balance?
It indicates errors in recording transactions, such as omissions, incorrect entries, or unequal debits and credits, that must be investigated and corrected.
Why is balancing an account important before preparing statements?
Balancing ensures accurate totals for each account, which are then used to construct the trial balance and financial statements.
What comes after posting transactions and preparing the trial balance?
Once the trial balance is confirmed to balance:
- Prepare the income statement from revenue and expenses to find net profit/loss.
- Prepare the balance sheet from assets, liabilities, and equity to show financial position.
What are the main financial statements that result from recording transactions?
- Income Statement (Statement of Profit or Loss - Financial Performance)
- Balance Sheet (Financial Position)
- Cash Flow Statement (Cash Movements)
What is the basic accounting equation used to balance the balance sheet?
Assets = Liabilities + Equity
This equation must always balance and reflect the financial position of the business.
How can the accounting equation be extended to reflect performance?
Assets = Equity + (Revenues – Expenses) + Liabilities
Or
Assets + Expenses = Equity + Revenues + Liabilities
This incorporates the income statement into the balance sheet structure.
