Double-entry principles - Debit and credit rules by account

Learning Outcomes

After reading this article, you will be able to describe the double-entry bookkeeping principles and accurately determine when to use debits and credits for different account types. You will identify the impact of common business transactions and correctly apply the debit and credit rules to assets, liabilities, capital, income, and expense accounts, as required for the ACCA Maintaining Financial Records (FA2) exam.

ACCA Maintaining Financial Records (FA2) Syllabus

For ACCA Maintaining Financial Records (FA2), you are required to understand and apply the core rules of double-entry bookkeeping as they relate to different account types. Specifically, you should be able to:

• Explain the double-entry bookkeeping system and why it is used.
• Distinguish between assets, liabilities, capital, income, and expense accounts.
• Apply the rules for debits and credits to common transactions.
• Record double-entry transactions accurately in the general ledger.
• Use the rules to prepare ledger accounts and identify transaction impacts.

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. Which side (debit or credit) increases the balance of an asset account?
2. When a business pays rent in cash, which accounts are debited and credited?
3. True or false? Credit entries always represent an increase in income or liabilities.
4. What is the double-entry to record the purchase of goods on credit?

Introduction

Double-entry bookkeeping is at the core of financial accounting. Every transaction affects at least two accounts and must be recorded using the correct combination of debits and credits. These rules ensure the accounting equation (Assets = Capital + Liabilities) always balances.

This article explains the debit and credit rules as they apply to different account types, such as assets, expenses, liabilities, income, and capital. Command of these fundamentals is essential for answering ACCA FA2 exam questions and preparing accurate accounts.

Key Term: double-entry bookkeeping
The accounting system where every transaction is entered twice: once as a debit in one account and once as a credit in another account.

The Duality Principle and Double-entry Basics

Every transaction has two effects on the accounts of a business. For example, buying inventory increases both assets (inventory) and decreases assets (bank) or increases liabilities (payables if bought on credit).

The dual effect is always recorded using two entries:

• A debit (Dr) in one account
• A credit (Cr) in another account, for an equal amount

Key Term: debit (Dr)
A left-side entry in an account, used to record increases or decreases depending on the type of account.

Key Term: credit (Cr)
A right-side entry in an account, used to record increases or decreases depending on the type of account.

Debit and Credit Rules by Account Type

The rules for whether a debit or credit increases or decreases an account depend on the classification of the account.

This can be summarized using the following rule:

• Increase Assets and Expenses with a debit; increase Liabilities, Income, and Capital with a credit.

Worked Example 1.1

A business owner introduces $2,000 cash into the business as capital. What is the double-entry?

Answer:

• Debit: Cash at bank $2,000 (asset increases)
• Credit: Capital $2,000 (capital increases)

Asset and Expense Accounts

• Asset and expense accounts are increased on the debit side.
• They are decreased on the credit side.

Typical debits (increase): buying inventory, paying rent, buying equipment.

Liability, Capital, and Income Accounts

• Liability, capital, and income accounts are increased on the credit side.
• They are decreased on the debit side.

Typical credits (increase): taking a bank loan (liability), recording sales income, capital introduced by owner.

Key Term: asset
A resource owned by the business with future economic benefit.

Key Term: liability
An obligation to pay an external party in the future as a result of past events.

Key Term: capital
The owner's claim on the assets of the business after all liabilities are settled.

Key Term: income
Money earned by the business from its primary activities, such as sales.

Key Term: expense
Costs incurred in the process of generating income.

Applying the Rules in Practice

Accurately applying debit and credit rules is critical for reliably recording transactions. Always:

1. Identify the accounts involved and their type.
2. Determine whether each account increases or decreases.
3. Apply the correct rule for debit or credit.
4. Ensure debits and credits are for the same amount.

Worked Example 1.2

A business buys office equipment for $500 cash. What is the double-entry?

Answer:

• Debit: Office equipment $500 (asset increases)
• Credit: Cash at bank $500 (asset decreases)

Worked Example 1.3

The business sells goods on credit to a customer for $300. What are the entries?

Answer:

• Debit: Receivables $300 (asset increases)
• Credit: Sales revenue $300 (income increases)

Exam Warning

Be careful not to assume that "debit" always means "increase" or "credit" always means "decrease." The effect depends on the account type.

Revision Tip

Use the mnemonic "DEAD CLIC":

• DEbit increases: Assets, Drawings, Expenses
• Credit increases: Liabilities, Income, Capital

Common Double-entry Transactions Table

Summary

Double-entry bookkeeping records every transaction using debits and credits according to account type. Always increase assets and expenses with debits, and increase liabilities, income, and capital with credits. Understanding these rules ensures accurate and error-free accounting records for all business transactions.

Key Point Checklist

This article has covered the following key knowledge points:

• The duality principle: every transaction has two effects recorded using double-entry.
• Debit and credit rules by account type (asset, expense, liability, income, capital).
• Application of double-entry rules in practical bookkeeping scenarios.
• Importance of accurately identifying account type and transaction effect.
• Using the DEAD CLIC mnemonic to remember debit and credit increases.

Key Terms and Concepts

• double-entry bookkeeping
• debit (Dr)
• credit (Cr)
• asset
• liability
• capital
• income
• expense