Double-entry principles and accounting records

Double entry is the language of financial accounting. Every later topic in FA, from depreciation to consolidation, is written in debits and credits, so time spent here repays itself many times over. The exam tests it directly ("which entry records this transaction?") and indirectly in almost every calculation. This lesson shows where accounting data comes from, the documents that carry it, and the rules for recording it. By the end you should be able to record any simple transaction without hesitation.

How an accounting system works

Every transaction travels the same route:

The main types of transaction are sales and purchases (each either for cash or on credit), receipts from customers, payments to suppliers and for expenses, and returns of goods. An accounting system exists to capture all of them completely and accurately, to meet internal deadlines such as the month-end close and external ones such as filing tax returns, and to follow the business's policies, for example on who may authorise a payment.

Business documents

The documents chain together: a purchase order is matched to the goods received note and then to the supplier's invoice before payment is approved. This matching is one of the most important controls in any business.

Computerised accounting systems and the cloud

Most businesses use accounting software. Its key features are:

• One entry, both sides. The user records a transaction once and the software posts the debit and the credit.
• Automatic totals, balances and reports, from the trial balance to the financial statements, at any time.
• Linked modules for sales, purchases, payroll, inventory and the bank, all feeding the general ledger.
• Controls: passwords, access levels for different staff, and an audit trail showing who entered or changed each item.

Many systems are now in the cloud: the software and data sit on the provider's external servers and are reached through the internet. The benefits are access from anywhere, automatic backups and updates, and an accountant who can work on the same records at the same time. The risks are dependence on an internet connection and on the provider, and the security and privacy of data held outside the business.

Computers do not remove the need to understand double entry. Someone must still choose the right accounts, and errors of principle go straight through software unnoticed.

The rules of double entry

Every transaction has two equal effects (the duality concept). In each ledger account, the left side is the debit side and the right side is the credit side. For every transaction, total debits equal total credits.

Which side to use depends on the type of account and whether it is increasing or decreasing:

A memory aid: DEAD CLIC. Debits increase Expenses, Assets and Drawings; Credits increase Liabilities, Income and Capital.

This is the accounting equation in another form. Assets = Capital + Liabilities, and profit (income less expenses) and drawings change capital. Debit items sit on the left of the equation and credit items on the right, so if every transaction has equal debits and credits, the equation stays in balance.

A T-account is a ledger account drawn as a T: the account name across the top, debits on the left, credits on the right. Each entry names the other account in the transaction, so you can trace it.

Worked example

Kemi starts a tailoring business, Kemi Fabrics, as a sole trader. Her transactions in June 20X6 are below. Assume all the fabric bought was used for garments sold in June, so there is no closing inventory.

Step 1: decide the two accounts and the direction. For each line ask: which accounts change, are they assets, liabilities, capital, income or expenses, and are they going up or down? For example, on 5 June purchases (an expense) increase, a debit, and the amount owed to the supplier (a liability) increases, a credit.

Step 2: post the bank account. Every line that involves bank goes to the bank T-account, with the name of the other account.

Debits total 15,000 + 3,500 + 1,800 = $20,300; credits total 6,000 + 1,200 + 2,500 + 600 = $10,300. The difference, $10,000, is the balance: a debit balance, so the business has $10,000 in the bank. You will practise balancing every kind of account in the next lesson.

Step 3: check with the accounting equation. The other balances are: equipment $6,000; receivables 2,800 − 1,800 = $1,000; payables 4,000 − 2,500 = $1,500; sales 3,500 + 2,800 = $6,300; purchases $4,000; rent $1,200; drawings $600; capital $15,000.

Assets equal liabilities plus capital, so the double entry is complete and consistent.

Common mistakes

• Posting both sides of a transaction to the same side, or recording only one side.
• Crediting bank when money comes in. Money received is a debit to bank; money paid out is a credit.
• Treating drawings as an expense. Drawings are a debit, but they reduce capital, not profit.
• Recording quotations, purchase orders or delivery notes as transactions. Nothing is recorded until goods are invoiced or money moves.
• Writing the account's own name in a T-account entry instead of the other account's name.

Exam technique

For any "which entry?" question, do the two-step test before you look at the options: name the two accounts, then decide which is debited using DEAD CLIC and whether each account is increasing or decreasing. Then find your answer among the options. Options are often built by reversing the debit and credit, so a firm answer of your own protects you. For bank, remember that the business's bank account is debited when money comes in, which is the opposite of what your bank statement shows.

Study with AI

I am studying ACCA Financial Accounting (FA), double-entry bookkeeping. Give me ten
transactions for a small sole trader, one at a time, mixing cash and credit sales and
purchases, expenses, receipts, payments, capital and drawings. For each, I will give
the debit and the credit. Tell me if I am right and explain the rule. Use $ only.

AI assistants sometimes reverse debits and credits: check each answer against the rules table in these notes.

Lecturer's note: Students who struggle with double entry are usually trying to memorise entries. Do not. Ask the same two questions every time: what type of account is this, and is it going up or down? The rules table answers the rest. The bank account is the one that trips people up, because a bank statement is written from the bank's point of view; in your own books, money in is a debit, always.

Key points

• Data flows from business documents to books of prime entry, then to the general ledger, the trial balance and the financial statements.
• Only invoices, credit notes and actual receipts and payments are recorded; quotations, orders and delivery notes are not.
• Every transaction is recorded with equal debits and credits; debits increase assets, expenses and drawings, credits increase liabilities, income and capital.
• Double entry keeps the accounting equation in balance, which gives you a check on your work.
• Computerised and cloud systems post both sides automatically, but the user still has to choose the right accounts.

Quick check

1. A business buys goods for resale on credit for $2,000. What is the double entry?
2. A customer pays $750 that she owed. What is the double entry?
3. Which document does a customer send with a payment to show which invoices it covers?

Answers

1. Debit purchases $2,000; credit payables $2,000.
2. Debit bank $750; credit receivables $750.
3. A remittance advice.