Business Book-Keeping Part 3

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 1^st January, the transactions would be as follows:

 

 

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:

 

 

That’s a simple Balance Sheet for the start of our business – done! Let’s do some business.

 

On the 31^st 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.

 

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:

 

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:

 

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:

 

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

Articles in the Same Category

What Is Profit?
Business Book-Keeping Part 1
Business Book-Keeping Part 2
Business Book-Keeping Part 4

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