Double-entry principles - Opening balances, capital, and dra...

Learning Outcomes

After reading this article, you will be able to explain the double-entry process for setting up opening balances, capital, and drawings in the accounting records. You will recognise how these items affect ledger accounts and the statement of financial position, differentiate between owner’s capital and drawings, and accurately prepare and interpret relevant T-accounts.

ACCA Maintaining Financial Records (FA2) Syllabus

For ACCA Maintaining Financial Records (FA2), you are required to understand the fundamental double-entry bookkeeping procedures for basic transaction types, including capital introduction, drawings, and the correct application of opening balances. For revision, pay particular attention to:

• The procedure for recording opening balances in ledger accounts at the start of an accounting period
• The correct treatment of capital introduced and capital withdrawn (drawings) by the business owner(s)
• Double-entry rules for assets, liabilities, capital, and drawings accounts
• The impact of capital and drawings on the statement of financial position for sole traders and partnerships

Test Your Knowledge

Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision.

1. In a newly started sole trader business, $12,000 is paid into a business bank account by the owner. What are the correct double-entry bookkeeping entries?
   1. Debit Capital, Credit Cash at Bank
   2. Debit Cash at Bank, Credit Capital
   3. Debit Drawings, Credit Cash at Bank
   4. Debit Purchases, Credit Capital
2. When preparing ledger accounts at the start of a new accounting year, what does the opening balance on the cash at bank account represent?
   1. Capital owed to the owner
   2. Bank overdraft
   3. Closing balance from the previous year
   4. Purchases yet to be paid

3. True or false? Drawings taken by the business owner reduce the capital in the statement of financial position.

4. Briefly state the effect of withdrawing inventory for personal use on the owner’s capital.

Introduction

Correctly recording opening balances, capital introduced, and drawings is fundamental to the double-entry bookkeeping system. These transactions ensure accurate reporting of the business’s financial position and are frequent topics in exam questions. This article explains how to perform and interpret the required entries for starting balances, owner’s injections and withdrawals, and their impact on the ledger accounts and the financial statements.

Key Term: double-entry bookkeeping
A method of accounting where every transaction impacts at least two ledger accounts, ensuring total debits always equal total credits.

OPENING BALANCES IN DOUBLE-ENTRY BOOKKEEPING

At the start of each accounting period, businesses must carry forward the balances from the previous period’s statement of financial position. These balances form the opening entries in the ledger accounts.

Recording Opening Balances

Each asset, liability, and capital account receives a balance brought forward ('b/f') entry. A debit balance ('b/f') is used for assets; a credit balance ('b/f') for liabilities and capital.

Example: If a business had cash at bank of $2,500 and a loan payable of $5,000 at the previous year-end, the opening entries are:

• Debit Cash at Bank $2,500 (asset)
• Credit Loan $5,000 (liability)

Key Term: opening balance
The amount carried into a ledger account at the start of a new accounting period, representing the closing balance from the prior period.

CAPITAL: OWNER INVESTMENT AND DRAWINGS

In unincorporated businesses (sole traders or partnerships), capital refers to the net amount invested by owners. Additional capital may be introduced during the year, and withdrawals (drawings) decrease this total.

Capital Introduced

When the owner injects cash or other assets into the business, capital increases. The double-entry is:

• Debit Asset account (e.g., Cash at Bank or Motor Vehicles)
• Credit Capital account

Key Term: capital
The residual interest owed to the owner after deducting all liabilities from assets.

Drawings

Drawings are withdrawals of cash or other assets by the owner for personal use. These reduce capital and are usually recorded in a separate drawings account during the year, then transferred to the capital account at year-end.

• Debit Drawings account
• Credit Asset account (e.g., Cash at Bank, Inventory)

At the end of the period:

• Debit Capital account
• Credit Drawings account (to close drawings to capital)

Key Term: drawings
Amounts withdrawn by the owner from the business for personal use, decreasing capital.

IMPACT ON THE STATEMENT OF FINANCIAL POSITION

Owner’s capital and drawings affect the equity section of the statement of financial position.

• Capital increases when more is introduced or business profits are earned.
• Drawings reduce capital.
• Opening capital is adjusted by adding profit and additional capital, then subtracting drawings to arrive at closing capital.

Worked Example 1.1

A business starts on 1 January. Jane invests $8,000 cash and transfers her personal laptop with a value of $1,000 into the business. During the year, she withdraws $500 cash and $200 inventory for personal use. What double-entry and statement of financial position movements are required?

Answer:

• Capital introduced: Debit Cash at Bank $8,000, Debit Computer Equipment $1,000, Credit Capital $9,000.
• Drawings: Debit Drawings $700 (cash $500 + inventory $200), Credit Cash at Bank $500, Credit Inventory $200.
• At year-end, Drawings are closed: Debit Capital $700, Credit Drawings $700.
• Statement of financial position: Capital = $9,000 – $700 = $8,300 (plus retained profits, if any).

BALANCING AND CLOSING ACCOUNTS

At period end, income and expense accounts are closed to determine net profit or loss, which is then transferred to the capital account. Asset, liability, capital, and drawings accounts are updated with their year-end balances (‘balance c/f’), which become the next period’s opening balances.

Worked Example 1.2

At year-end, Maria’s capital account shows an opening balance of $10,000. She made additional capital injections of $2,000 and withdrew $1,500 in drawings. The business made a net profit of $3,500.

Calculate her closing capital and show the required entries.

Answer:
Closing capital = $10,000 (opening) + $2,000 (new capital) + $3,500 (profit) – $1,500 (drawings) = $14,000. The closing entry for drawings: Debit Capital $1,500, Credit Drawings $1,500. The profit is transferred: Debit Income Summary (or Statement of Profit or Loss) $3,500, Credit Capital $3,500.

Summary

Opening balances ensure continuity between accounting periods by carrying forward assets, liabilities, and capital. Owner’s capital introduced increases the equity of the business; drawings reduce it. Accurate double-entry ensures the statement of financial position remains balanced and reflects the true financial position of the entity.

Key Point Checklist

This article has covered the following key knowledge points:

• The procedure for posting opening balances in double-entry bookkeeping
• The correct double-entry for capital introduced and for drawings by the owner
• The effect of drawings and capital on the statement of financial position
• The process for balancing and carrying forward ledger account balances
• The importance of accurate opening balances for financial statement accuracy

Key Terms and Concepts

• double-entry bookkeeping
• opening balance
• capital
• drawings