Overview of Double Entry - First Fintech Asia

What is the double entry for a cash sale?

I recently questioned a student in one of my final level lectures.

They gave me a silent look before saying, “eh?” Only if they could have spoken the language. (They were obviously ignorant of the fundamentals!)

The language of accounting is double entry, therefore learning how it functions is essential for both your academic work and future employment.

What are the Categories of transactions?

As a starting point it is important to be familiar with the different types of transaction that businesses can undertake. Most of the transactions that you see in your studies will fall into one of six basic categories:

Income

This generally relates to the revenue generated by making sales to customers but can also include interest received or dividends received.

Expenses

These are operating costs incurred by the business such as purchase costs, rent of premises or salaries.

Assets

These are things owned by the business such as vehicles, computer equipment or even cash in the bank.

Liabilities

These or things owed by the business to other people and include bank loans and trade payables owed to credit suppliers.

Capital

This represents amounts owed to the owner of the business (the sole trader) either for amounts invested in the business or for the profits earned by the business. Capital can be thought of as a specific type of liability.

Drawings

These are amounts withdrawn from the business by the owner and therefore reduce the capital balance.

The dual effect

Before even worrying about the double entry for a transaction it is really useful to consider the so-called ‘dual effect’ that it has on our accounting records. The dual effect says that any financial transaction will impact upon two balances in our accounts. This is actually a little simplified as some transactions will impact upon more than two balances, but you can perhaps think that the dual effect means that every transaction impacts upon at least two balances in our accounts.

For example, a cash sale to a customer has the following dual effect:

The balance of cash (an asset of the business) will increase
The value of sales made in the period (income for the business) will increase

A cash purchase from a supplier has the following impact:

The balance of cash (asset) will now decrease
The value of purchases made (an expense of the business) will increase

How about a transaction that does not affect the balance of cash; perhaps a credit purchase where we have not yet paid for the goods bought:

The value of purchases made (expense) will increase just like for the cash purchase above. It does not matter if you have not paid yet, you have still incurred a cost.
We need to recognise a trade payables balance (a form of liability) for the amount still owed to the credit supplier.

Double entry

Using our knowledge of the dual effect we can start to construct the double entry for any given transaction. ‘Double entry’ again suggests that each transaction impacts upon at least two balances in our accounts (‘dual’ and ‘double’ have a similar meaning here).

Double entry is a system of Debit and Credit entries to describe the dual effect of a transaction. Every double entry must balance, with equal values on the Debit and Credit sides.

A useful mnemonic to help you remember your double entry basics is DEAD CLIC.

DEAD	CLIC
Debits increase: Expenses Assets Drawings	Credits increase: Liabilities Income Capital

So for a cash sale to a customer we can follow on from our dual effect above as follows:

Increasing the balance of cash will require a Debit entry to the cash account since cash is an asset and included in DEAD.
Increasing the value of sales made will require a Credit to the sales account as sales are income and included in CLIC.

And that gives a balancing double entry of Debit Cash, Credit Sales.

Notice that DEAD CLIC reminds you of how to increase a category of transaction. To decrease them you do the opposite. So if you receive cash into your bank account (as shown above) you would Debit Cash, but if you pay cash out of the bank account you would need to Credit Cash.

Let’s construct the double entry for a cash purchase from a supplier:

Decreasing the balance of cash will now require a Credit entry to the cash account as we need to do the opposite of DEAD.
Increasing the value of purchases will require a Debit to the purchases account as it is an expense and included in DEAD.

This gives the balancing double entry of Debit Purchases, Credit Cash.