Basic Financial Accounting – Recording Transactions – The Double Entry System – Video #6

Summary

This video explains the concept of double-entry bookkeeping using the fundamental accounting equation: Assets = Liabilities + Equity. It demonstrates that every business transaction affects at least two accounts to maintain balance. Examples include the owner contributing cash, obtaining a bank loan, and purchasing land, illustrating how increases and decreases in assets are offset by corresponding changes in liabilities or equity. By walking through these practical scenarios, the video clarifies how resources are acquired and obligations recorded, emphasizing the dual effect of each transaction and reinforcing the core principle of double-entry bookkeeping in accounting.

Takeaways

• 😀 The accounting equation is Assets = Liabilities + Equity.
• 😀 The asset side shows what resources the business owns, while the liability and equity side shows where the resources came from.
• 😀 Every business transaction has a dual effect and impacts at least two accounts.
• 😀 An increase in an asset account must be balanced by either an increase in a liability/equity account or a decrease in another asset account.
• 😀 Owner contributions are recorded as an increase in cash (debit) and an increase in capital (credit).
• 😀 Loans from banks increase cash (debit) and increase the loan liability (credit).
• 😀 Purchasing an asset, like land, with cash increases the land account (debit) and decreases the cash account (credit).
• 😀 Double-entry bookkeeping ensures that the accounting equation always remains balanced.
• 😀 Debits record increases in assets and decreases in liabilities or equity, while credits record increases in liabilities or equity and decreases in assets.
• 😀 Recording transactions accurately in at least two accounts reflects the source and use of funds in a business.

Q & A

What is the double entry system in accounting?

The double entry system in accounting is a method where every transaction affects at least two accounts. For example, when an asset increases, there is either a corresponding increase in another account or a decrease in one of the accounts on the same side of the equation.

What are the components of the accounting equation?

The accounting equation is: Assets = Liabilities + Equity. It shows what resources the business has (Assets) and where these resources came from (Liabilities and Equity).

How is an increase in an asset recorded in the double entry system?

When there is an increase in an asset account, it is recorded as a debit in the asset account. To maintain the balance of the accounting equation, a corresponding entry is made in another account, either on the opposite side of the equation or within the same side.

Can you give an example of a double entry in practice?

Yes. When Mr. Stick contributed $100,000 in cash to establish his business, the business recorded an increase in cash (debited to the cash account), and a corresponding increase in equity (credited to the capital account). This is an example of double entry bookkeeping.

What happens when a business takes out a loan?

When a business takes out a loan, it receives cash, which is an increase in an asset account (debit). At the same time, an obligation to repay the loan is created, which is recorded as a liability (credit). For example, a $50,000 loan from a bank would increase the cash account (debit) and increase the loan liability account (credit).

How are transactions involving purchases or payments of assets recorded?

When a business purchases an asset like land, the resource gained (land) is debited to the corresponding asset account. If the purchase is made with cash, the cash account is credited to reflect the decrease in cash. This ensures that both sides of the accounting equation remain balanced.

What is the purpose of the double entry system?

The purpose of the double entry system is to ensure that the accounting equation stays balanced by recording every transaction in two accounts: one that shows where the resource came from and one that shows what the business received.

Why is the double entry system important for businesses?

The double entry system is crucial because it provides a complete and accurate record of all transactions, helping ensure that the financial statements are balanced. This makes it easier to track financial health and detect any discrepancies or errors.

How do credits and debits work in the double entry system?

In the double entry system, debits and credits are used to record increases and decreases in accounts. Typically, assets are increased with debits and liabilities and equity are increased with credits. Similarly, a decrease in assets is recorded as a credit, while a decrease in liabilities or equity is recorded as a debit.

Is every business transaction recorded in two accounts?

Yes, in the double entry bookkeeping system, every business transaction must be recorded in at least two accounts. One account will show the inflow or outflow of resources, and the other will show the origin or destination of those resources.