IS 5303 – Financial Management  

THE DOUBLE ENTRY SYSTEM OF BOOK-KEEPING

&
PREPARATION OF FINAL ACCOUNTS FROM A TRIAL BALANCE

The double entry system is one where transactions are recorded twice in the ledger: One on the debit of an
account and the other on the credit side if another account. The rules for recording transactions using double
entry system are:

1. Every transaction affects two accounts in the ledger: One account is debited and the other is credited.
2. Amount for debit entry is equal to amount for credit entry.
3. Details in one account is the name of the other account affected by the transaction.

The accounting equation and the recording of transactions in the ledger

Generally, accounts can be classified under one of the following:
i. Assets
ii. Liabilities
iii. Equity
iv. Revenues
v. Expenses

We have seen that assets, liabilities and equity (capital) form part of the accounting equation as follows:
Assets = Liabilities + Equity

Now, given that equity increases when the business earns profit and it decreases when the business makes
losses, we can derive the following extended accounting equation:
Assets = Liabilities + Equity + Profit(- loss)

We also know that profit and loss are calculated as follows:

Profit = Revenue – Expenses

In case expenses are greater than revenues a loss is incurred.

Replacing profit/ loss by the formula “revenue – expenses” in the above extended accounting equation
gives us the following new equation:
Assets = Liabilities + Equity + Revenue – Expenses

Making all items positive:

Assets + Expenses = Liabilities + Equity + Revenue

Now remember the format of the ledger:

Dr Ledger Cr
Date Details Amount Date Details Amount

Seventh Lecture 
 
 
IS 5303 – Financial Management  

It can be seen that if the equation “Assets + Expenses = Liabilities + Equity + Revenue” is compared with
ledger with the double line at the center of the ledger representing the equal sign of the equation, assets
and expenses represent the debit (Dr) side while liabilities, equity and revenue represent the credit (Cr)
side.
(Please note that the above comparison is simply made to help remember the principles of recording
transactions in the ledger and are not necessarily rules in accounting)
Rules for recording assets, liabilities, equity, revenue and expenses
Whether to debit or credit an account depends on what balance it usually has and this depends whether
the account is one that records an asset, a liability, equity, a revenue or an asset. Usually, an increase is
recorded on the same side as the balance and a decrease is recorded on the opposite side.
The table below shows what balance accounts under each category have and how to record increase and
decrease:
CATEGORY BALANCE INCREASE DECREASE
Assets Dr Dr Cr
Liabilities Cr Cr Dr
Equity Cr Cr Dr
Revenue Cr Cr Dr
Expenses Dr Dr Cr

Note from the table above that we record an increase in an account on the same side as it’s balance is. A
decrease is recorded on the opposite side.

Seventh Lecture 
 
 
IS 5303 – Financial Management  

Answer for Q 1. b. of August 2015

Income Statement of Mr. Kalhara ‐ Sole Proprietorship
For the Year Ended 31st March 2015
Rs. Rs. Rs.
Sales           960,000
Cost of Sales:
Opening Stocks        360,000
Purchases        650,000
Add: Carriage Inwards            3,500
Less: Damage Stocks        (21,000)
Stocks ready to sale          992,500
Closing Stocks        (280,000)
          712,500
Gross Profit           247,500
Other Income
Rent Income           225,000
Discount Received               8,400
Gross Profit with Other Income           480,900

Administrative Expenses
Depreciation on Buildings            37,500
Depreciation on Machinery            30,000
Depreciation on Furniture & Equipments            24,000
Electricity            18,500
Water               2,200
Advertising            12,000
Salaries          240,000
Insurance            28,000
Telephone Expenses               4,500
          396,700
Selloing & Distribution Expenses
Bad Debts Written Off            12,000
Depreciation on Motor Vehicle          240,000
Discount allowed               6,500
Selloing & Distribution Expenses               8,500
          267,000

Other Expenses
Stock Damages            21,000
Bank Loan Interest            50,000
            71,000

Net profit/(loss) for the Year         (253,800)

Seventh Lecture 
 
 
IS 5303 – Financial Management  

Fianacial Position Statement of Mr. Kalhara ‐ Sole Proprietorship
As At 31st March 2015
Rs. Rs. Rs.
Non‐Current Assets
Property Plant & Equipment Accumulated   Net Book 
Cost  Depreciation  Value 
Buildings        750,000          112,500           637,500
Machinery        150,000            90,000             60,000
Motor Vehicle    1,200,000          720,000           480,000
Furniture & Equipments        240,000            72,000           168,000
   2,340,000          994,500       1,345,500

Current Assets
Inventories          280,000
Trade Debtors          228,000
Prepayment Water               1,200
Prepayment Advertising               6,000
Cash at Bank          288,000
Cash in Hand          178,000
          981,200

Total Assets       2,326,700

Opening Capital       1,750,000
Profit /(loss)for the Year         (253,800)
Drawings           (26,000)
Closing Capital       1,470,200

Non‐Current Liabilities
Bank Loan (10%)          500,000
          500,000

Current Liabilities
Trade Creditors          320,000
Accrued Electricity               6,500
Rent Received in Advance            25,000
Bank Loan Interest Payable               5,000
          356,500
      2,326,700
                   ‐

Seventh Lecture