Double entry recording for a trading business (VCE Accounting Unit 3)

What this dot point is asking

VCAA wants you to record financial data for a trading business using a double entry system. You must explain the role of source documents, the General Journal, the General Ledger and inventory cards, apply the rules of debit and credit correctly, and handle GST and perpetual inventory.

The double entry framework

The accounting equation underpins everything:

Assets = Liabilities + Owner's Equity

Every transaction affects at least two items and keeps the equation in balance. This is why each entry has equal debits and credits.

Source documents

Source documents are the verifiable evidence that a transaction occurred. They satisfy the qualitative characteristic of faithful representation and the assumption that records should be supported by evidence. Common documents include:

• Sales invoices and purchase invoices for credit transactions of inventory.
• Receipts and EFT records for cash received.
• Cheque butts and bank statements for cash paid.
• Memos for internal events such as the owner taking inventory for personal use (drawings).

The General Journal

The General Journal is the book of original entry. It records the accounts to be debited and credited, the amounts, and a narration explaining the transaction. Recording in the journal first means the ledger is built from a clear, dated, cross-referenced record rather than directly from documents.

The General Ledger

The General Ledger holds an account for every asset, liability, owner's equity, revenue and expense item. Journal entries are posted to these accounts. Each ledger account is balanced and the closing balances feed the reports. A running record of debits and credits in each account lets the business prepare a trial balance to check that total debits equal total credits.

GST and the GST Clearing account

The Goods and Services Tax is collected on sales and paid on purchases. GST is not revenue or an expense. GST charged on sales is a liability owed to the Australian Taxation Office (a credit to GST Clearing). GST paid on purchases reduces that liability (a debit to GST Clearing). The net balance is either remitted to or refunded by the ATO.

Inventory cards

Under the perpetual inventory system, a separate inventory card tracks each line of stock by quantity, unit cost and total cost. Cards are updated at the time of every purchase and sale. The First In First Out (FIFO) assumption means the earliest units purchased are assumed to be sold first, so the cost of sales uses the oldest cost layers and the closing balance uses the most recent costs.

Recording common transactions

Credit sale of inventory. Two entries are needed because the business records both the selling price and the cost of the goods given up:

• Debit Accounts Receivable, Credit Sales, Credit GST Clearing (at selling price plus GST).
• Debit Cost of Sales, Credit Inventory (at cost price).

Credit purchase of inventory. Debit Inventory, Debit GST Clearing, Credit Accounts Payable.

Cash drawings of inventory by the owner. Debit Drawings, Credit Inventory at cost. No GST and no profit is recorded because the owner is not a customer.

Why this matters for reports

Accurate recording flows directly into the reports. Sales and Cost of Sales determine gross profit in the Income Statement. The Inventory balance and Accounts Receivable appear as current assets in the Balance Sheet. GST Clearing is reported as a current liability or current asset depending on whether it is owed or refundable. Errors in recording cascade into misstated profit and a misleading financial position.