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Double Entry Book-Keeping

The principle of double entry book-keeping is profoundly important in the world of accounting. It is essential that students gain an understanding of this principle from the outset.

Essentially, the principle is that for every financial transaction there are two effects – one debit effect and one credit effect.

This best way to explain this principle is by giving example transactions from the books of the imaginary organisation called Lots of Fun Pty Ltd.

Example 1:

Lots of Fun Pty Ltd purchased a car for $5,000 using a loan from the bank, the two effects are:

Lots of Fun Pty Ltd acquires an asset worth $5,000 (the car) but at the same time it also incurs a liability to the bank of $5,000 (the bank loan).

Example 2:

Lots of Fun Pty Ltd received $30 cash from a customer for the hire of a tennis court, the two effects are:

Lots of Fun Pty Ltd has increased income (which we might call "Court Hire Fees") and as a result the bank account (and asset acccount) also increases by $30.

Example 3:

Lots of Fun Pty Ltd employs a book-keeper and pays that person a weekly wage of $500, the two effects are:

Lots of Fun Pty Ltd has increased expenses by $500 and simultaneously decreased cash assets of $500.

Example 4:

If Lots of Fun Pty Ltd pays a debt that it owes to a supplier of $1000, the two effects are:

The Liabilities (in particular Creditors, people you owe money to) of Lots of Fun Pty Ltd decrease by $1000 (the debt is now paid off) but its Bank Account (an Asset) also decreases by $1000.

Your job (as an accountant or a book-keeper) is to correctly record these transactions in the financial ledgers of the organisation. You have to record one debit affect and one credit affect.

Now let's introduce to you a diagram (figurte 1) that you must indelibly print into your brain! Your ability to remember this diagram might be the key to your success in book-keeping.

Okay, it does not make sense to you now but hopefully it will soon!

Remember, the principle is that for every financial transaction there are two effects – one debit effect and one credit effect.

In Figure 1, at the top, are the two abbreviations "Dr" and "Cr" which stand for "Debit" and "Credit" respectively.

You should note that Assets and Expenses appear on the Debit side while Liabilities and Income appear on the Credit side. The purpose of the diagram is to tell you when you should be debiting and when you should be crediting.Here goes!

This is only true however when the effect is to increase these accounts.

Therefore when an expense is increased as a result of a transaction, it will be debited. When the liability is increased as a result of a transaction, it will be credited.

However, if the effect of the transaction is to decrease the asset or the liability, then the mirror image of Figure 1 will appear.

In Example 1 given above, the acquisition of the car (the asset) gives rise to an entry on the debit side (of the asset account “Motor Vehicles”). This is because the assets of Lots of Fun Pty Ltd are increasing.  Simultaneously, the liabilities of Lots of Fun Pty Ltd are increasing as well, and so there will be a credit entry to the Bank Loan account.
 
This is how you record the transaction in the ledger:
   
Example 1 Lots of Fun Pty Ltd purchased a car for $5,000 using a loan from the bank
   
 
Dr
Cr

Motor Vehicles a/c

$5,000

  

Bank Loan a/c

  

$5,000
   

Motor Vehicles (an Asset Account) is debited because it is increasing (you have more asset that you did before).

Bank Loan ( a Liability Account) is credited because it is also increasing (you have more liability than you did before). A bank loan is a liability because it is a debt you owe the bank.

Note: The sum of the debits equals the sum of the credits – the entries balance
 
In Example 2 given above, the income (Court Hire Fees) of Lots of Fun Pty Ltd is increasing and as a result its Bank Account is also increasing.
   
This is how you record the transaction in the ledger:
   
Example 2 Lots of Fun Pty Ltd received $30 cash from a customer for the hire of a tennis court.
   
 
Dr
Cr
Bank a/c
$30
 
Court Hire Fees a/c
 
$30
   

Bank (an Asset Account) is debited because it is increasing (the money received will be deposited into the bank)

Court Hire Fees (an Income Account) is credited because it is increasing.
     
    Note: The sum of the debits equals the sum of the credits – the entries balance
     
 
In Example 3 given above, Lots of Fun Pty Ltd has increased expenses (Wages) of $500 and simultaneously decreased cash assets (Bank) of $500.
     
This is how you record the transaction in the ledger:
     
   
 
Dr
Cr
Wages a/c
$500
 
Bank a/c
 
$500
   

Wages (an Expense Account) is debited because it is increasing.

Bank (an Asset Account) is credited because it is decreasing

Note: The sum of the debits equals the sum of the credits – the entries balance
   
In Example 4 given above, the liabilities (Creditors) of Lots of Fun Pty Ltd decrease by $1000 (the debt is now paid off) but its Bank Account also decreases by $1000.
     
This is how you record the transaction in the ledger:
   
 

Dr

Cr
Ceditors a/c
$500
 
Bank a/c
 
$500
   

Creditors (a Liability Account) is debited because it is decreasing.

Bank (an Asset Account) is credited because it is decreasing.
     
    Note: The sum of the debits equals the sum of the credits – the entries balance

Summary

For each transaction you follow three steps routinely.

They are:

Step 1 Determine which two accounts will be affected by the transaction?
Step 2 For each of the two accounts you identify in Step 1, you must determine whether it is a Asset, Liability, Expense or Income.
Step 3 For each of the two accounts you identify in Step 1, you must determine whether the account is increasing or decreasing.

By following these three steps, and using the diagram given above, you will be able to determine whether each account is debited or credited.