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Business Book-Keeping Part 3

By Paul Michael
27th October, 2009

Business Transactions

One of the first transactions in our business is to enter the value of the property and the mortgage as ‘opening balances’. The property is an asset, but is usually categorised as a Fixed Asset, also known as Tangible Assets or Long Term Assets. The mortgage is a liability but is usually categorised as a Long Term Liability, which is usually anything that will remain a liability after a trading year. Otherwise it would be a Short Term Liability.
 
Assuming we start the business on the 1st January, the transactions would be as follows:
 

Date
Item
Account / Ledger
Dr
Cr
01/01/20??
Property Value
Fixed Assets
100,000
 
01/01/20??
Property Value
Investments
 
-100,000
 
 
 
 
 
01/01/20??
Mortgage
Long Term Liabilities
 
-50,000
01/01/20??
Mortgage
Investments
50,000
 

 
This has provided a basic setup of our accounts and both sides of the equation are in balance. Dr is short for Debit and Cr for Credit. If we sum up each account this is what we can report:
 

Ledger
Dr
Cr
Fixed Assets
100,000
 
Current Assets
0
 
Long Term Liabilities
 
-50,000
Short Term Liabilities
 
0
Owner’s Equity
 
-50,000
Balance
100,000
-100,000

 
That’s a simple Balance Sheet for the start of our business – done! Let’s do some business.
 
On the 31st January we will receive some rent from our tenant. When we receive rent, or any business income, aside from it being considered revenue or sales, it is also an asset in the category of Current Assets. In this case it is cash that we either hold or might deposit in a bank.

Date
Item
Account / Ledger
Dr
Cr
31/01/20??
Rent Received
Bank (Current Assets)
600
 
31/01/20??
Rent Received
Rent (Revenue)
 
-600

 
So now we have increased the balance by 600 and we can see the effects of the double entry system. Every transaction is ‘for something’ that ‘comes from / goes towards something’, which splits what we might ordinarily consider a single transaction into two parts – a double entry.
 
Let’s see what happens when our tenant reports that the kitchen tap is leaking:

Date
Item
Account / Ledger
Dr
Cr
03/01/20??
ACE Plumbing
Maint (Expenses)
120
 
03/01/20??
ACE Plumbing
Trade Creditors
 
-120

 
So we have debited a maintenance account, which is linked to the Expenses ledger. The other side of the equation has been credited to Trade Creditors. This type of account is a category of Liabilities – Short Term Liabilities to be more precise. It is used where the expense has been incurred, but we haven’t paid the supplier as yet. However, we show it this way because, just by looking at the Trade Creditor account, we can see that we owe money to our creditors. Many businesses create an account for each supplier and the over-arching Trade Creditor account is said to be a ‘control account’. This setup enables reporting at the detailed or summary levels. In larger organisations, it is also known as Accounts Payable. We can treat trade customers (Debtors) in much the same way to determine who owes us money.
 
What about paying our plumber:

Date
Item
Account / Ledger
Dr
Cr
24/01/20??
ACE Plumbing
Trade Creditors
120
 
24/01/20??
ACE Plumbing
Bank (Current Assets)
 
-120

 
We have reduced the Trade Creditor account back to zero, implying that we no longer owe anything to our creditors. We then reduce our bank account by crediting the bank.
 
Using this system is a good way of noticing and resolving mistakes. If we entered singular records, we could easily overlook a supplier’s invoice entry, but then enter the bank payment transaction for that invoice at a later date. In the double entry system this error would cause an imbalance, alerting us to a problem. The balances provide us with a checking mechanism.
 
Finally, let’s do a few more transactions for our first month:

Date
Item
Account / Ledger
Dr
Cr
31/01/20??
Mortgage Intst
Loan Intst (Expense)
10
 
31/01/20??
Mortgage Intst
Bank (Current Assets)
 
-10
 
 
 
 
 
31/01/20??
Mortgage Princ
Long Term Liabilities
200
 
31/01/20??
Mortgage Princ
Bank (Current Assets)
 
-200
 
 
 
 
 
31/01/20??
Drawings
Drawings
100
 
31/01/20??
Drawings
Bank (Current Assets)
 
-100

 
Notice how we have split a mortgage payment into two aspects: Interest and Principal. The interest for loans is often dealt with separately in business for tax reasons, amongst others. However, the interest aspect does not diminish the liability, but the Principal aspect does. If our interest rate is fixed, we might enter transactions like these in bulk or batch for the whole year.
 
Finally we draw down 100 for our trouble.
 
In the 4th and final installment we will look at some basic business reports using the above figures

 

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