The Double Entry System (Cambridge International AS Accounting)

Spec point — the principles of the double entry system to record business transactions

The double entry system

What is the double entry system?

• The double entry system is used by book-keepers

  • The double entry system is used to improve the accuracy of financial statements

• The double entry system is closely linked to the accounting equation

  • Assets = Liabilities + Capital

• The equation is always balanced

• Each transaction causes both sides of the equation to:

  • increase
  • or decrease
  • or remain the same

• Each transaction is entered into two accounts

  • One is called a debit entry
  • One is called a credit entry

What is the layout of a ledger account?

• Each account will be split into two sides

  • The debit entries appear on the left

    • This side is sometimes labelled as Dr

  • The credit entries appear on the right

    • This side is sometimes labelled as Cr

• When you make an entry you need to include:

  • The date of the transaction

  • The details of the transaction

    • This is normally the name of the other account involved

  • The value of the transaction

• These accounts are sometimes referred to as T accounts

Example of a ledger account

Debits & credits

Spec point — the principles of the double entry system to record business transactions

What is a debit entry?

• A debit entry is used to:

  • increase the value of an asset

    • The left-hand side of the accounting equation increases

  • decrease the value of a liability or the capital

    • The right-hand side of the accounting equation decreases

What is a credit entry?

• A credit entry is used to:

  • increase the value of a liability or the capital

    • The right-hand side of the accounting equation increases

  • decrease the value of an asset

    • The left-hand side of the accounting equation decreases

Debit and credit entries achieve specific purposes depending on the type of account

Which accounts should I debit?

• Debit an asset account when its value is increasing

  • You receive cash

    • Debit the cash account

  • A customer buys goods on credit

    • Debit their trade receivables account

• Debit a liability account when its value is decreasing

  • You make a repayment on a bank loan

    • Debit the bank loan account

  • You pay an invoice to a credit supplier

    • Debit their trade payables account

• Debit other accounts when the transaction decreases the capital

  • You take assets from the business for personal use

    • Debit the drawings account

  • You pay an expense which decreases the profit

    • Debit the relevant expense account
    • Such as purchases, rent paid, discount allowed, etc

Which accounts should I credit?

• Credit a liability account when its value is increasing

  • You take out a bank loan

    • Credit the bank loan account

  • You buy goods on credit from a supplier

    • Credit their trade payables account

• Credit an asset account when its value is decreasing

  • You pay rent by bank transfer

    • Credit the bank account

  • A credit customer pays their invoice

    • Credit their trade receivables account

• Credit other accounts when the transaction increases the capital

  • You put more personal assets (such as money) into the business

    • Credit the capital account

  • You receive income which increases the profit

    • Credit the relevant income account
    • Such as sales, rent received, discount received, etc

How do I enter the transactions into the accounts using the double-entry system?

• STEP 1 Identify the accounts involved in the transaction

  • One is usually cash, bank, trade receivables or trade payables

• STEP 2 Identify whether each account affects the assets, liabilities or capital

  • Usually this is cash, trade receivables or trade payables

• STEP 3 Determine whether the value of each account is increasing or decreasing

• STEP 4 Debit or credit the account

  • Debit the account if:

    • It is an asset account and its value is increasing
    • It is a liability or the capital account and its value is decreasing

  • Credit the account if:

    • It is an asset account and its value is decreasing
    • It is a liability or the capital account and its value is increasing

Examples where assets increase and liabilities or capital increase

Examples where assets decrease and liabilities or capital decrease

Examples where assets increase and decrease

Examples where liabilities or capital increase and decrease

Worked Example Hina is a sole trader.

Complete the table below to show the accounts that Hina should debit and credit for each of the following transactions.

Transaction	Account to be debited	Account to be credited
Hina sells goods on credit to Priya
Hina receives a cash payment from Priya
Hina pays an electricity bill by cheque
Hina buys goods on credit from Dida
Hina repays some of a bank loan by bank transfer
Hina takes ownership of a company vehicle for her own use
Hina puts some of her own money into the business bank account

Answer:

Transaction	Account to be debited	Account to be credited
Hina sells goods on credit to Priya	Final answer: Priya - Priya is a trade receivable (she owes money to Hina) - A trade receivable is an asset - Priya owes more money - The assets are increasing	Final answer: Sales - Sales increasing profit - Increasing profit increases the capital - The capital is increasing
Hina receives a cash payment from Priya	Final answer: Cash - Hina receives cash - Cash is an asset - The assets are increasing	Final answer: Priya - Priya is a trade receivable (she owes money to Hina) - A trade receivable is an asset - Priya owes less money - The assets are decreasing
Hina pays an electricity bill by bank transfer	Final answer: Electricity - Electricity is an expense - Expenses reduce the profit - Decreasing profit decreases capital - The capital is decreasing	Final answer: Bank - The cheque pays money from the bank - The money is the bank is an asset - The assets are decreasing
Hina buys goods on credit from Dida	Final answer: Purchases - Purchases are an expense - Expenses reduce the profit - Decreasing profit decreases capital - The capital is decreasing	Final answer: Dida - Dida is a trade payable (Hina owes money to her) - A trade payable is a liability - Dida is owed more money - The liabilities are increasing
Hina repays some of a bank loan by bank transfer	Final answer: Bank loan - The bank loan is a liability (Hina owes money) - The amount Hina owes is reduced - The liabilities are decreasing	Final answer: Bank - Hina pays using money from the bank - The money is the bank is an asset - The assets are decreasing
Hina takes ownership of a company vehicle for her own use	Final answer: Drawings - Hina takes an asset from the business for personal use - This is a form of taking drawings - Drawings reduces the capital - The capital is decreasing	Final answer: Vehicles - Hina's business owns fewer vehicles - Vehicles are assets - The assets are decreasing
Hina puts some of her own money into the business bank account	Final answer: Bank - Hina's business receives money in the bank - The money is the bank is an asset - The assets are increasing	Final answer: Capital - Hina is introducing extra capital to the business - The capital is increasing

Exam Hint To remember which side of an account to record a transaction, you can use the acronym DEAD CLIC.

• The transaction is on the debit side for expense, asset, and drawings accounts if the account is increasing.
• The transaction is on the credit side for liability,income, and capital accounts if the account is increasing.
• If the account is decreasing then the transaction is recorded on the opposite side!

Another set of acronyms is:

• DIADL: Debits Increase** A**ssets or Decrease Liabilities
• CILDA: Credits** I** ncrease Liabilities or Decrease Assets

However, try to remember the connection to the accounting equation.