Debit and credit rules - Increase and decrease conventions b...

Learning Outcomes

After reading this article, you will be able to apply debit and credit rules to each element of the financial statements. You will distinguish how assets, liabilities, income, and expenses are increased or decreased using debits and credits, identify the conventions for each element, and accurately record transactions to general ledger accounts in accordance with ACCA FA1 requirements.

ACCA Recording Financial Transactions (FA1) Syllabus

For ACCA Recording Financial Transactions (FA1), you are required to understand how transactions impact different elements of the accounting system using debits and credits. This article addresses the following key syllabus points:

• The classification of assets, liabilities, income, and expenses
• The rules for increasing and decreasing each element using debits and credits
• How to record common business transactions correctly in the general ledger
• The application of the double-entry system in processing and summarising transactions

Test Your Knowledge

Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision.

1. When an expense, such as rent, is paid, which side of the expense account is used to record the increase?
   1. Debit
   2. Credit
2. If a business purchases new equipment for cash, how does this affect the assets in the accounts?
   1. Both increase (asset increases, cash decreases)
   2. Both decrease
   3. One increases, one decreases
3. Which type of account is increased using a credit entry?
   1. Asset
   2. Expense
   3. Liability

4. State whether the following accounts are increased with a debit or a credit entry: (i) Sales revenue (ii) Trade payables (iii) Wages expense (iv) Inventory.

Introduction

The double-entry bookkeeping system uses specific rules for recording increases and decreases in each element of the financial statements. Every transaction affects at least two accounts and is recorded as both a debit and a credit. Understanding which side—debit or credit—applies to each element is fundamental for accurate record keeping.

Key Term: double-entry bookkeeping
A system of recording transactions where each transaction affects at least two accounts, with equal debit and credit entries.

Debit and Credit Rules: Core Conventions by Element

All general ledger accounts are categorised as assets, liabilities, income, expenses, or capital. Each account type uses a set of debit and credit rules for recording increases and decreases.

The Debit and Credit Sides

Traditionally, ledger accounts are presented in a "T" format. The left side is the debit side; the right side is the credit side.

Key Term: debit (Dr)
The left side of a ledger account, used for recording increases in assets and expenses, and decreases in liabilities, income, or capital.

Key Term: credit (Cr)
The right side of a ledger account, used for recording increases in liabilities, income or capital, and decreases in assets or expenses.

Increase and Decrease Rules for Each Element

The method for recording increases and decreases depends on the type of account:

Key Term: asset
A resource owned by the business expected to provide future benefits.

Key Term: liability
An obligation of the business to pay or provide value to others as a result of past transactions.

Key Term: capital
The owner's residual interest in the business after liabilities are deducted from assets.

Key Term: income
Inflows of economic benefit arising from ordinary business activities, increasing capital.

Key Term: expense
Outflows or consumptions of economic benefit in the course of running the business, reducing capital.

Worked Example 1.1

A business pays $400 for insurance by cheque.

Question: Which accounts are affected, and are they recorded as debits or credits?

Answer:

• Insurance (an expense) increases: Debit $400
• Cash at bank (an asset) decreases: Credit $400

Worked Example 1.2

The business borrows $5,000 from the bank and receives the cash.

Question: Which side of each account records the increase?

Answer:

• Bank loan (a liability) increases: Credit $5,000
• Cash at bank (an asset) increases: Debit $5,000

Worked Example 1.3

Goods are sold to a customer for $1,200 on credit.

Question: How is the transaction recorded in the ledger accounts?

Answer:

• Trade receivables (asset) increase: Debit $1,200
• Sales (income) increases: Credit $1,200

Applying the Rules in Practice

To correctly record any transaction:

1. Identify which accounts are affected.
2. Determine whether each account increases or decreases.
3. Apply the debit or credit rule for that account type.
4. Total debits and credits must always be equal for every transaction.

Exam Warning

A common mistake is to assume all increases are debit entries. Remember, only assets and expenses increase on the debit side. Liabilities, income, and capital increase on the credit side.

Revision Tip

To remember these conventions, use the mnemonic "DEAD CLIC":

• Debit: Expenses, Assets, Drawings
• Credit: Liabilities, Income, Capital

Summary

• Each account element (asset, liability, capital, income, expense) has a specific rule for debit and credit entries.
• Increases in assets and expenses are debits; increases in liabilities, capital, and income are credits.
• Double-entry ensures every transaction has equal debits and credits.

Key Point Checklist

This article has covered the following key knowledge points:

• The meaning of debit and credit in ledger accounts
• The increase and decrease rules for assets, liabilities, capital, income, and expenses
• How to identify the correct side of the account for any transaction
• Why strict application of these rules is essential for double-entry bookkeeping

Key Terms and Concepts

• double-entry bookkeeping
• debit (Dr)
• credit (Cr)
• asset
• liability
• capital
• income
• expense