The purpose of the debtors journal is to record all credit sales of the business. Credit sales occurs when the business sells goods now, but will only receive payment in the future. As money is owed to the business an asset debtors control is created. As more money is owed the asset debtors control increase and therefore have to be debited. The contra entry is sales. According to the double entry principle therefore sales have to be credited with debtors control as contra entry. As the sales column total is involved the posting occurs at month end.
The debtors journal also contains the cost of sales column to keep track of profit made on each item sold for credit. Before selling the trading stock it was the possession of the business and hence an asset. When the sale occurs therefore the asset trading stock decrease. As assets decrease trading stock have to be credited. The contra entry is cost of sales. According to double entry principle the cost of sales account should be debited with trading stock as contra entry. Since cost of sales is a column total the posting occurs at month end.
The purpose of this journal is to record all the transaction where cash ends up in the business bank account.
Bank is an asset as the money belongs to the business. Furthermore this asset increases as money is received. Assets increase on the debit side. Thus bank account should be debited with the total amount of the bank column in the journal at the end of the month. Since the amount received during the month is made up of various types of transactions such as sales, rent received, interest received, etc a collective name “total receipts” is used rather than the usual practice of an account name as contra entry.
Many other accounts will be credited when the double entry principle is applied. All these accounts that are credited should ad up to the bank amount for the month. Some will be credited at month end namely column totals such as sales whereas others namely those in sundry accounts such as rent received are credited on the day of transaction. The contra entry for all these accounts are bank.
Finally the non-cash columns cost of sales and discount allowed should be considered:
The cost of sales column is present to track the profit made by considering the value of the original purchase price of trading stock and do not form part of bank total. Trading stock belongs to the business before it is sold and is therefore an asset. When it is sold assets decrease by the cost price. Thus trading stock is credited as assets decrease on the credit side. The contra entry is cost of sales. According to double entry principle cost of sales should be debited with contra entry trading stock. As column totals are involved this posting occurs at month end.
Discount is allowed to encourage early payment by debtors that owes the business money. What the business thus receive from debtors into the bank account is less than what is owed. The difference between what is received and owed is called discount allowed. The discount allowed therefore do not form part of bank total. Debtors owe the business however less money. In fact the sum of what they paid as well as the discount allowed. If money is owed to the business it is an asset as the business has a right to receive the money in future. Assets decrease as the debtors owe now less money. Debtors control need to be credited as assets decrease on credit side. The contra entry is bank and discount allowed as there are two legs that together resulted in less debt. According to double entry principle discount allowed will be debited with debtors control as contra entry. Bank was already addressed at top. As column totals are involved the posting date is month end.
Lets get our hands dirty by revisiting our example where the business buys for cash equipment R5 000 and stationary R250.
After the transaction the business will have R5 250 less cash. Before the transaction the cash belonged to the business and hence was its asset. Therefore the asset Bank decrease by R5 250. Furthermore we visualise that assets decrease on the credit side and that bank should be credited by R5 250.
From the double entry principle we however know that we now need corresponding debits that adds up to R5 250. Equipment and stationary will therefore have to be debited each with R5 000 and R250 respectively for a combined amount of R5 250.
In return for the cash the business now receives equipment. The equipment is now the possession of the business and hence nothing other than its asset. Therefore the asset equipment increase by R5 000. Furthermore we visualise that assets increase on the debit side. This is the beauty of accounting. We just confirmed what we already know namely that a debit entry is required according to the double entry principle.
The business also received stationary. Stationary however will be consumed fairly quickly in usual business operations. Equipment on the other hand will be used for years with the purpose to generate income for the business. Assets have a long life time whereas expenses are consumed within a short period of time. The more expenses, all other things equal, the less will the profit be. Lower profit is negative for the owner. The result is that equity reduces due to the stationary expense that increase. We visualise that expenses that increase are debited and decrease equity. This again confirms what we knew all along from the double entry principle.
In accounting equation analysis form:
In accounting equation T-account form:
Expenses are linked to a decrease in assets or an increase in liabilities. When a business for example have to pay for stationary it could either pay it in cash which results in a decrease of the asset bank OR will have to pay in future resulting in the increase of a liability creditors.
Expenses have the effect of decreasing what the business owes the owner(s) and hence reduces equity. Examples include: stationary, cost of sales, rent paid, interest paid, advertising, telephone, etc.
Income is closely linked to increases in assets OR a decrease in liabilities. If a business sell goods or render services it will immediately receive cash or the future right to the cash i.e. debtors. Both cash and debtors are assets. When third parties i.e. creditors encourage the business to settle debt as soon as possible an income discount received will result which have the effect of reducing liabilities. Examples of income includes: Sales, Services Rendered, Rent Received, Interest Received, etc.
Income increases the equity of the owner(s). The more the income, the more the business owes the owner(s).
Drawings is what the owner(s) takes out of or remove from the business. It has the effect of reducing what the business owes the owner(s). In other words it reduces the equity. Other than cash the owner could remove stock or stationary out of the business for own use.
Capital is what the owner(s) contribute to the business and forms part of equity as the business owes this to the owner(s). The capital could be contributed in the form of cash or assets.
Equity is what the business owes to the owner/s. Similar as for liabilities the business owes, the only difference is that it is to the owner/s rather than to third parties. Included in equity is capital, drawings, all forms of income and expenses.
Liabilities are what the business owes to third parties. In other words it represent the debt of the business. Examples include: loans and creditors.
An asset is what a business own or have ownership rights over. It is the possessions of the business. It will be used primarily to earn an income for the business. Examples include: vehicles, equipment, bank, debtors, etc.