Introduction to accounting

2 BASIC RULES OF DOUBLE ENTRY BOOKKEEPING

Section overview

„ Debit and credit entries, and T accounts

„ The rules of debits and credits
„ Double entry book-keeping and the cash account

2.1 Debit and credit entries, and T accounts

The following rules apply to the accounts in the main ledger (nominal ledger or general ledger).
‰ Every transaction is recorded twice, as a debit entry in one account and as a credit entry in
another account.
‰ Total debit entries and total credit entries must always be equal. This maintains the
accounting equation.
It therefore helps to show accounts in the shape of a T, with a left-hand and a right-hand side. (Not
surprisingly this presentation is known as a T account). By convention:
‰ debit entries are made on the left-hand side and
‰ credit entries are on the right-hand side.

Illustration:

Account name

Debit side (Dr) Rs. Credit side (Cr) Rs.

Debit transactions entered Credit transactions entered on

on this side this side Amount

Enter reference to the Enter reference to the account

account where the matching where the matching debit
credit entry is made X entry is made X

By convention, the terms ‘debit’ and ‘credit’ are shortened to ‘Dr’ and ‘Cr’ respectively. Alternative
presentation
Accounts might also be presented in columnar forms. If this presentation is used care must be
taken over the meaning of debit and credit in the context of the account. For example, a debit in a
credit account would be shown as a deduction. In other words, it is easier to make mistakes with
this format. However, it can be useful when you want to show a single account or use a single
account as a working. You will see examples of this presentation in later chapters but for now we
will only use T accounts.

© Emile Woolf International 90 The Institute of Chartered Accountants of Pakistan

 Chapter 4: Double entry bookkeeping

2.2 The rules of debits and credits

In the main ledger, there are accounts for assets, liabilities, equity, income and expenses. The
rules about debits and credits are as follows:

Illustration:

Account name
Debit side (Dr) Credit side (Cr)
Record as a debit entry: Record as a credit entry:
An increase in an asset A reduction in an asset
An increase in an expense A reduction in an expense

A reduction in a liability An increase in a liability

A reduction in income An increase in income
A reduction in capital An increase in capital
(drawings, losses) (capital introduced profit)

You need to learn these basic rules and become familiar with them. Remember that in the main
ledger, transactions entered in the debit side of one account must be matched by an offsetting
credit entry in another account, in order to maintain the accounting equation and record the dual
nature of each transaction.

Example
A purchase invoice is received for electricity charges for Rs. 2,300
The double entry is:
Debit: Electricity charges (= increase in expense)
Credit: Total trade payables (= increase in liability)

Electricity expense
Rs. Rs.
Trade payables 2,300

Expenses payables
Rs. Rs.
Electricity expense 2,300

This can be written as:

Dr Electricity expense 2,300
Cr Expenses payables 2,300
This is known as a journal entry (or journal for short). Journal entries are covered
in more detail later in this chapter.

© Emile Woolf International 91 The Institute of Chartered Accountants of Pakistan

Introduction to accounting

2.3 Double entry book-keeping and the cash account

An entity would usually keep separate accounts to record cash. One is for cash in hand and the
other for cash at bank.
It might help to learn the rules of double entry by remembering that transactions involving the
receipt or payment of cash into the cash at bank account (or cash in hand account) are recorded
as follows:
‰ The cash at bank account is an asset account (money in the bank is an asset).
‰ Receipts of cash are recorded as a debit entry in the cash at bank account, because receipts
add to cash (an asset).
‰ Payments of cash reduce cash, so these are recorded as a credit entry in the cash at bank
account.

Illustration:

Cash at bank

Debit side (Dr) Credit side (Cr)

Record as a debit entry: Record as a credit entry:

Transactions that provide an INCREASE Transactions that result in a REDUCTION in cash

in cash

The matching credit entry might be to
(1) a sales account for cash sales
(2) the total trade receivables account
for payments received from credit
customers1
(3) the capital account for new capital
introduced by the owner in the form
of cash
The matching debit entry might be to
(1) an expense account, for payments of cash
expenses
(2) the total trade payables account, for
payments to suppliers for purchases on
credit/amounts owing
(3) a payment in cash for a new asset,
(4) a drawings account, for withdrawals of
profit by the business owner

Example: Abbas revisited

1 Abbas introduces Rs. 30,000 cash as capital.
2 Abbas borrows Rs. 40,000 to purchase a van.
3 Abbas buys a market stall for Rs. 5,000 cash.
4 Abbas buys inventory for Rs. 18,000 on credit.
5 Abbas pays his supplier Rs. 10,000.
6 Abbas sells inventory for Rs. 12,000 cash.
7 Abbas sells inventory for Rs. 9,000 on credit.
8 Abbas repays Rs. 10,000 of the loan.
9 Abbas pays his trade suppliers Rs. 6,000.
10 Abbas receives Rs. 8,000 of the money owed to him by the customer (trade receivable).
11 Abbas purchases another Rs. 2,500 of shirts, on credit.
12 Abbas drew Rs.4,000 cash out of the business and also took inventory which cost 2,500
for his own use.
Post all transactions to ledger accounts.

© Emile Woolf International 92 The Institute of Chartered Accountants of Pakistan

 Chapter 4: Double entry bookkeeping

Example: Abbas – Transaction 1

Abbas sets up a business by putting Rs. 30,000 into a bank account.
This increases the cash of the business, and its capital.
The double entry is:
Dr Bank (or cash) 30,000
Cr Capital 30,000

Capital
Rs. Rs.
(1) Bank 30,000

Bank
Rs. Rs.
(1) Capital 30,000

Note: The entry in each account shows the account where the matching debit or credit
entry appears.

Example: Abbas – Transaction 2

Abbas borrows Rs. 40,000 to purchase a van.
There are two separate transactions, the loan of cash and the purchase of the van.
The double entries are:
Dr Bank 40,000 Dr Van 40,000
Cr Loan 40,000 Cr Bank 40,000
Bank
Rs. Rs.
(1) Capital 30,000 (2b) Van 40,000
(2a) Loan 40,000

Loan
Rs. Rs.
(2a) Bank 40,000

Van
Rs. Rs.
(2b) Bank 40,000

© Emile Woolf International 93 The Institute of Chartered Accountants of Pakistan

Introduction to accounting

Example: Abbas – Transaction 3

Abbas buys a market stall for Rs. 5,000.
The double entry is:
Dr Stall 5,000
Cr Bank 5,000
Bank
Rs. Rs.
(1) Capital 30,000 (2b) Van 40,000
(2a) Loan 40,000 (3) Stall 5,000

Stall
Rs. Rs.
(3) Bank 5,000

The next transaction is a purchase of inventory. This is reflected in an account called purchases
rather than inventory.

Example: Abbas – Transaction 4

Abbas purchases inventory for Rs. 18,000 on credit.
The double entry is:

Dr Purchases 18,000

Cr Bank 18,000

Purchases

Rs. Rs.

(4) Trade payables 18,000

Trade payables

Rs. Rs.

(4) Purchases 18,000

Note on purchases of inventory

Notice that in this type of book-keeping system, there is no separate account for inventory.
Purchases of materials and goods for re-sale are recorded in a purchases account, which is an
expense account.
Inventory is ignored until such time as when the business wishes to calculate profit (usually the
end of an accounting period) when it is counted and valued. This value is then used in a calculation
of a cost of sale figure. (This will be demonstrated a little later in this chapter and the full inventory
double entry explained in chapter 11).

© Emile Woolf International 94 The Institute of Chartered Accountants of Pakistan

 Chapter 4: Double entry bookkeeping

Example: Abbas – Transaction 5

Abbas pays Rs. 10,000 to the supplier.
The double entry is:
Dr Trade payables 10,000
Cr Bank 10,000
Bank
Rs. Rs.
(1) Capital 30,000 (2b) Van 40,000
(2a) Loan 40,000 (3) Stall 5,000
(5) Trade payables 10,000
Trade payables
Rs. Rs.
(5) Bank 10,000 (4) Purchases 18,000

Example: Abbas – Transaction 6

Abbas sells inventory for Rs. 12,000 cash.
The double entry is:
Dr Bank 12,000
Cr Sales 12,000
Bank
Rs. Rs.
(1) Capital 30,000 (2b) Van 40,000
(2a) Loan 40,000 (3) Stall 5,000
(6) Sales 12,000 (5) Trade payables 10,000
Sales
Rs. Rs.
(6) Bank 12,000

Example: Abbas – Transaction 7

Abbas sells inventory for Rs. 9,000 on credit.
The double entry is:
Dr Trade receivables 9,000
Cr Sales 9,000
Trade receivables
Rs. Rs.
(7) Sales 9,000
Sales
Rs. Rs.
(6) Bank 12,000
(7) Trade receivables 9,000

© Emile Woolf International 95 The Institute of Chartered Accountants of Pakistan

Introduction to accounting

Example: Abbas – Transaction 8

Abbas repays Rs. 10,000 of the loan
The double entry is:
Dr Loan 10,000
Cr Bank 10,000
Bank

Rs. Rs.
(1) Capital 30,000 (2b) Van 40,000
(2a) Loan 40,000 (3) Stall 5,000
(6) Sales 12,000 (5) Trade payables 10,000
(8) Loan 10,000

Loan

Rs. Rs.
(8) Bank 10,000 (2a) Bank 40,000

Example: Abbas – Transaction 9

Abbas pays Rs. 6,000 to the supplier.
The double entry is:
Dr Trade payables 6,000
Cr Bank 6,000
Bank
Rs. Rs.
(1) Capital 30,000 (2b) Van 40,000
(2a) Loan 40,000 (3) Stall 5,000
(6) Sales 12,000 (5) Trade payables 10,000
(8) Loan 10,000
(9) Trade payables 6,000
Trade payables

Rs. Rs.
(5) Bank 10,000 (4) Purchases 18,000
(9) Bank 6,000

© Emile Woolf International 96 The Institute of Chartered Accountants of Pakistan

 Chapter 4: Double entry bookkeeping

Example: Abbas – Transaction 10

Abbas receives Rs. 8,000 from a customer.
The double entry is:
Dr Bank 8,000
Cr Trade receivables 8,000
Bank

Rs. Rs.
(1) Capital 30,000 (2b) Van 40,000
(2a) Loan 40,000 (3) Stall 5,000
(6) Sales 12,000 (5) Trade payables 10,000
(10) Trade receivables 8,000 (8) Loan 10,000
(9) Trade payables 6,000
Trade receivables

Rs. Rs.
(7) Sales 9,000 (10) Bank 8,000

Example: Abbas – Transaction 11

Abbas purchases inventory for Rs. 2,500 on credit.
The double entry is:
Dr Purchases 2,500
Cr Bank 2,500
Purchases
Rs. Rs.
(4) Trade payables 18,000
(11) Trade payables 2,500

Trade payables
Rs. Rs.
(5) Bank 10,000 (4) Purchases 18,000
(9) Bank 6,000 (11) Purchases 2,500

© Emile Woolf International 97 The Institute of Chartered Accountants of Pakistan

Introduction to accounting

Example: Abbas – Transaction 12

Abbas draws Rs. 4,000 cash and took inventory which cost Rs. 2,500 for his own use.
If an owner takes inventory for his own use it means that some of the purchases have not been for
the business. This is reflected in the double entry by reducing purchases.
There are two transactions but they can be combined into the following double entry:
Dr Bank 6,500
Cr Bank 4,000
Cr Purchases 2,000
Bank
Rs. Rs.
(1) Capital 30,000 (2b) Van 40,000
(2a) Loan 40,000 (3) Stall 5,000
(6) Sales 12,000 (5) Trade payables 10,000
(10) Trade receivables 8,000 (8) Loan 10,000
(9) Trade payables 6,000
(12a) Drawings 4,000

Purchases
Rs. Rs.
(4) Trade payables 18,000 (12b) Drawings 2,000
(11) Trade payables 2,500

Drawings
Rs. Rs.
(12a) Bank 4,000
(12b) Bank 2,000

© Emile Woolf International 98 The Institute of Chartered Accountants of Pakistan