Double-Entry and Debit/Credit
Debit and credit mean left and right in the recording system. They do not mean good and bad.
| Account type | Increase | Decrease | Usual balance |
|---|---|---|---|
| Asset | Debit | Credit | Debit |
| Expense or distribution | Debit | Credit | Debit |
| Liability | Credit | Debit | Credit |
| Equity or income | Credit | Debit | Credit |
The four-step method
- Describe the event without accounting vocabulary.
- Identify each account and its type.
- Decide whether each account increases or decreases.
- Apply debit/credit and verify equal totals.
Northstar’s first week
These selected transactions use a perpetual inventory system: purchases increase Inventory and each sale also transfers the goods' cost to Cost of sales. The £4,000 customer collection relates to an opening receivable; the list is not a complete set of opening balances.
| No. | Business event | Debit | Credit |
|---|---|---|---|
| 1 | Owners contribute £100,000 cash | Cash 100,000 | Share capital 100,000 |
| 2 | Bank advances a £60,000 loan | Cash 60,000 | Bank loan 60,000 |
| 3 | Equipment bought for £70,000 cash | PPE 70,000 | Cash 70,000 |
| 4 | Components bought on credit for £24,000 | Inventory 24,000 | Trade payables 24,000 |
| 5a | Bikes sold for £15,000 cash | Cash 15,000 | Revenue 15,000 |
| 5b | Components in those bikes cost £8,000 | Cost of sales 8,000 | Inventory 8,000 |
| 6 | £5,000 paid to suppliers | Trade payables 5,000 | Cash 5,000 |
| 7 | £4,000 collected from an earlier credit customer | Cash 4,000 | Trade receivables 4,000 |
Events 5a and 5b record the two sides of a sale: the amount received from the customer and the cost of the inventory consumed. Recording the sale in full therefore requires more than one entry.
A T-account answers “what is the balance?”
Northstar’s cash ledger is:
| Debit entries | £ | Credit entries | £ |
|---|---|---|---|
| Owner contribution | 100,000 | Equipment | 70,000 |
| Loan | 60,000 | Supplier payment | 5,000 |
| Cash sale | 15,000 | ||
| Receivable collection | 4,000 | ||
| Total | 179,000 | Total | 75,000 |
These entries increase cash by £104,000. With zero opening cash, closing cash is a £104,000 debit balance; otherwise add the opening balance. A ledger balance includes the opening position as well as the period's entries.
Why the inventory convention matters
Under a periodic system, purchases go to Purchases during the period and cost of sales is calculated at period-end using opening inventory, net purchases and counted closing inventory. Do not also post entry 5b for each sale under that convention: mixing the two systems can count the same cost twice. Compare the complete periodic-inventory case after finishing this chapter.
Three entries students commonly misread
Collect a receivable
Dr Cash £4,000
Cr Trade receivables £4,000
The sale was recognised earlier, so collecting the receivable creates no new revenue.
Receive a customer advance
Dr Cash £12,000
Cr Contract liability £12,000
The business has received cash but still owes the customer the promised goods or services.
Repay loan principal
Dr Bank loan £5,000
Cr Cash £5,000
Repaying principal reduces the loan liability rather than creating an expense. Interest is recorded separately.
Error test
Equal debits and credits do not establish that an entry is correct. Check its meaning as well as its arithmetic:
- Do the account names describe the event?
- Is the period correct?
- Is an estimate or second entry missing?
- Does the narration point to source evidence?
Quick check
Northstar receives a £10,000 supplier invoice for components already delivered, then pays it next month. Give both entries.