Financial Accounting: Double Entry, Adjustments and Reporting
The accounting equation and double entry
Every transaction preserves the accounting equation: Assets = Capital + Liabilities. Double entry records each transaction with equal debits and credits. Debits increase assets and expenses; credits increase liabilities, capital and income. A common trap is treating drawings as an expense - drawings reduce capital, they are not a business expense. Another is getting the direction of adjustments wrong: a prepayment (paid in advance) is a current asset, while an accrual (owed but unpaid) is a current liability.
Accruals, prudence and valuation
The accruals concept matches income earned with expenses incurred in the same period, regardless of cash movement. Prudence requires that profits are not overstated: inventory is valued at the lower of cost and net realisable value, and a provision for doubtful debts is created against receivables. Depreciation allocates the cost of a non-current asset over its useful life; it is not a cash fund for replacement. Capital expenditure (buying a machine) goes to the statement of financial position; revenue expenditure (repairs) goes to profit or loss.
Errors and reconciliation
Errors that leave the trial balance in balance - omission, commission, principle, original entry, reversal and compensating errors - still need journal correction. Bank reconciliation starts from the cash book or the bank statement and adjusts for unpresented cheques, uncredited deposits, bank charges and standing orders.
Worked example
A firm pays Ksh 24,000 on 1 September for 12 months' insurance; its year end is 31 December. Insurance expense for the year is 4 months (24,000 × 4/12) = Ksh 8,000, and the prepayment carried forward is Ksh 16,000, shown as a current asset. Rule of thumb: expense the part used, carry forward the part not yet used.