Business Activity is really a series of financial events for example,paying loans or buying stock.
These events are called Transactions.
Every transaction has two sides.
This follows from the Accounting Equation in that any change to one item must be reflected elsewhere in the Equation for it still to Balance.
Let's examine some transactions to see how this works,
1. Say the owner introduces $10000 cash to start the business.
The Asset 'Cash' increases by $10,000 and the Owners Equity increases by $10,000 also, therefore| Assets = | Liabilities | +Owner's Equity |
| +$10,000 = | 0 | +10,000 |
2. Say the business borrows $20,000 from the bank.
The Asset 'Cash' again increases by $20,000 and| Assets = | Liabilities | +Owner's Equity |
| +$20,000 = | +$20,000 | +0 |
The net effect of both transactions is
| Assets = | Liabilities | +Owner's Equity |
| $30,000 = | $20,000 | +$10,000 |
Furthermore, and this is critical to your understanding of Accounting,
The total of all the DEBITS remains Equal to the total of all the CREDITS.
TOTAL DEBITS = TOTAL CREDITS
Exercise
Can you work out what happens to the equation if we say, buy an Office Desk
for $200 cash ?
The double entry approach has been used by accountants for centuries and forms the basis for many accounting control techniques.
For example the Trial Balance report, which we will examine later, attempts to check the accuracy of the double entries.
Practice Exercises
1.Test yourself on the Double Entry Tutor
2.You should attempt exercise 1.6