Tom Clendon explains why this basic tenet of accountancy is all about accepting that rules are rules – simple as!
Whether you have just started studying accounting or whether you are about to sit your finals it is always useful to know your debits from your credits.
This is because all financial transactions can be boiled down and explained in these terms. In a complex world double entry bookkeeping is refreshingly binary and straightforward. For double entry bookkeeping is nothing more than the application of rules. Which is why it is so easily computerised.
There is no room for judgement or subjectivity in applying the double entry rules. So, in a strange way, please don’t try too hard to understand this aspect of accounting because it really is all about the accepting and application of these rules.
The five elements
In financial accounting five elements have been identified.
Three of these elements will be reported in the statement of financial position. These are assets (resources that are controlled, for example land), liabilities (obligations, for example trade payables) and equity (sometimes called capital – this is the ownership interest and examples include share capital and retained earnings).
Two elements are found in the statement of profit or loss. These are income (e.g. revenue from selling goods and services) and expenses (e.g. rent and wages).
• The duality rule: The duality rule states that for every single transaction there are always two effects on the elements. For example, when a business pays rent there is an increase in the element of expense that will be recorded in the rent account AND a reduction in the element of asset that will be recorded in the cash at bank account.
• The one debit and one credit rule: When a transaction is being recorded, one effect will always be recorded as a debit and the other effect will be recorded as a credit. Debits are traditionally considered first and appear on the left-hand side of an account. Credit entries are written up on the right-hand side.
• The when to debit and when to credit rule: There are two ways to remember when to debit and when to credit. One way is by reference to this table.
So, going back to that example of the business paying rent. Here, one effect is the increase in the element of expense, and this is a debit in the rent account. While the other effect is a reduction in the element of asset that will be recorded as a credit in the cash at bank account.
The other way is to recall the mnemonic DEAD CLIC, this identifies when to increase an account. The second D stands for drawings (or dividends) which represent a reduction in the equity due to payments being made to the owners. The second C stands for capital – which is another name for equity.
Examples of debits and credits
Q. What is the double entry when the business takes out a $20,000 loan?
A. Being aware of duality means that the money received will result in an increase in the element of asset – specifically the cash at bank account; but that in addition, as there is an obligation to repay the loan there will be an increase in the element of liability and a loan account.
An increase in an asset is the debit and the increase in the liability is the credit.
By convention this is often summarised in a journal form as follows.
|Debit||Cash at Bank account||$20,000|
Q. What is the double entry when a trade receivable for $800 goes bankrupt and the debt has to be written off as irrecoverable.
A. Being aware of duality means that recognising a bad debt increases the expense of bad debts and it will also result in a decrease in the element of asset, the receivable account.
An increase in an expense is the debit and the decrease in the asset is the credit.
Accordingly, the journal entry for writing off a debt as bad is as follows:
|Debit||Bad debt account||$800|
• Tom Clendon FCCA is an ACCA online SBR tutor with FME. See www.tomclendon.co.uk