BAFS Study Notes: The Accounting Cycle - The Double-Entry System

Hey BAFS students! Welcome to one of the most important topics in accounting: the Double-Entry System. Think of it as the grammar of business language. Once you understand it, you'll be able to read and write the financial story of any company.

Don't worry if it sounds complicated. We're going to break it down into simple, easy-to-understand pieces. By the end of these notes, you'll understand how every business event is recorded accurately. Let's dive in!


The Foundation: The Accounting Equation

Everything in accounting starts with one simple, powerful idea called the Accounting Equation. It's the golden rule that must ALWAYS be in balance.

The Basic Equation

The equation is:

$$Assets = Liabilities + Capital$$

Imagine a balancing scale. On one side, you have the business's Assets. On the other side, you have the claims on those assets (from outsiders and the owner). Both sides must always be equal!

What do these terms mean?
  • Assets: These are the resources a business owns. They are things that have future economic value.
    Everyday Analogy: Your assets could be the cash in your wallet, your mobile phone, or your Octopus card balance.
    Business Examples: Cash, Bank balance, Inventory (goods for sale), Accounts Receivable (money owed by customers), Equipment, Buildings.

  • Liabilities: These are what a business owes to other people or businesses (outsiders). They are the company's debts.
    Everyday Analogy: If you borrow $20 from a friend for lunch, that $20 is your liability.
    Business Examples: Bank Loans, Accounts Payable (money owed to suppliers).

  • Capital (or Equity): This is what the business owes to its owner(s). It represents the owner's investment or stake in the business. It’s the "leftover" value after you subtract liabilities from assets.
    Everyday Analogy: The money you put into your own piggy bank from your savings.
    Business Examples: Cash invested by the owner, profits kept in the business.
How Transactions Affect the Equation

Let's see it in action. Every transaction will change the equation, but it will always stay balanced.

Example 1: The owner, Ms. Chan, starts a business by investing $50,000 cash.

  • The business's Cash (Asset) increases by $50,000.
  • The owner's stake, Capital, also increases by $50,000.
  • The equation: $50,000 (Assets) = $0 (Liabilities) + $50,000 (Capital). It balances!

Example 2: The business buys a computer for $8,000 cash.

  • The business's Equipment (Asset) increases by $8,000.
  • The business's Cash (Asset) decreases by $8,000.
  • The equation: One asset went up, and another went down by the same amount. The total assets are still $50,000, and the equation remains balanced.
The Expanded Accounting Equation

Businesses exist to make a profit. Profit comes from earning Revenue and paying for Expenses. These two elements directly affect Capital.

  • Revenue (or Income): Money the business earns from selling goods or providing services. Revenue increases Capital.
  • Expenses: Costs of running the business. Expenses decrease Capital.

This gives us the Expanded Accounting Equation:

$$Assets = Liabilities + Capital + Revenue - Expenses$$

Key Takeaway

The Accounting Equation is the backbone of accounting. It must always balance after every single transaction. Remember: What you own (Assets) is funded by either borrowing from others (Liabilities) or by the owner's investment (Capital).


The Core Principle: What is Double-Entry?

The double-entry system is a method where every transaction is recorded in at least two accounts. It's based on a simple idea: for every action, there is an equal and opposite reaction.

Think about buying a drink from a vending machine. You give cash, and you take a drink. There are two parts to this event. It's the same in business!

To record these two effects, we use the terms Debit (Dr) and Credit (Cr).

What are Debit and Credit?

This is SUPER important: Debit just means the LEFT side of an account, and Credit just means the RIGHT side. That's it! They DO NOT automatically mean 'increase' or 'decrease'.

The Golden Rule of Double-Entry: For any transaction, the total amount of debits must equal the total amount of credits.

$$Total Debits (Dr) = Total Credits (Cr)$$

Did you know? The words 'debit' and 'credit' come from the Latin words 'debere' (to owe) and 'credere' (to entrust). But for our purposes, just thinking 'left' and 'right' is much easier!

Key Takeaway

Every transaction has a dual effect. We record these two effects using Debits (Dr) and Credits (Cr). The total debits for any transaction must always equal the total credits, keeping the accounting equation in balance.


The Rules of the Game: Debit (Dr) and Credit (Cr)

So, if Dr and Cr don't always mean increase or decrease, how do we know when to use them? We use a set of rules based on the type of account.

This might be the trickiest part, but we have a fantastic memory aid to help you master it!

The Magic Mnemonic: DEAD CLIC

This is the best way to remember the rules of debit and credit. Say it out loud: "DEAD CLIC".

DEAD tells you what accounts are increased by a Debit.

  • Debit increases...
  • Expenses
  • Assets
  • Drawings (Money the owner takes out of the business)

CLIC tells you what accounts are increased by a Credit.

  • Credit increases...
  • Liabilities
  • Income (Revenue)
  • Capital
The Rules in a Table

Here are the complete rules. Notice that if an account is increased by a debit, it must be decreased by a credit (and vice-versa).

| Account Type | Increases with a... | Decreases with a... | Normal Balance | | :--- | :---: | :---: | :---: | | Asset | Debit (Dr) | Credit (Cr) | Debit | | Expense | Debit (Dr) | Credit (Cr) | Debit | | Drawings | Debit (Dr) | Credit (Cr) | Debit | | Liability | Credit (Cr) | Debit (Dr) | Credit | | Income (Revenue) | Credit (Cr) | Debit (Dr) | Credit | | Capital | Credit (Cr) | Debit (Dr) | Credit |

Quick Review Box: Feeling stuck? Just ask yourself two questions: 1. What type of account is it? (Asset, Liability, etc.) 2. Is it increasing or decreasing? Then, apply the DEAD CLIC rule!

Key Takeaway

Memorise DEAD CLIC! It is the key to knowing whether to debit or credit an account. Debits increase Expenses, Assets, and Drawings. Credits increase Liabilities, Income, and Capital.


Putting It All Together: Recording Transactions in Ledgers

A ledger is a collection of all the individual accounts of a business. We often visualise each account as a "T-account" because it looks like the letter T. The left side is for debits, and the right side is for credits.

A Step-by-Step Guide to Recording Transactions

Let's follow a simple 5-step process.

  1. Identify: Which two (or more) accounts are affected by the transaction?
  2. Classify: What type is each account? (Use A, L, C, I, E)
  3. Analyse: Is each account increasing or decreasing?
  4. Apply: Use the DEAD CLIC rule to decide which account to debit and which to credit.
  5. Record: Enter the amounts on the left (Dr) and right (Cr) sides of the T-accounts.
Let's Practice!

Transaction 1: On 1 Jan, the owner invested $100,000 cash into the business bank account.

  1. Identify: Bank and Capital.
  2. Classify: Bank is an Asset. Capital is Capital.
  3. Analyse: The Bank account is increasing. Capital is increasing.
  4. Apply:
    • Assets increase with a Debit (from DEAD). So, we Dr Bank.
    • Capital increases with a Credit (from CLIC). So, we Cr Capital.
  5. Record:
Bank (Asset)

Dr                             |                             Cr
1 Jan Capital   $100,000 |

Capital

Dr                             |                             Cr
                            | 1 Jan Bank   $100,000

Transaction 2: On 5 Jan, the business bought equipment for $20,000, paying by bank transfer.

  1. Identify: Equipment and Bank.
  2. Classify: Both are Assets.
  3. Analyse: Equipment is increasing. Bank is decreasing.
  4. Apply:
    • Assets increase with a Debit. So, we Dr Equipment.
    • Assets decrease with a Credit. So, we Cr Bank.
  5. Record: (We add this to our existing Bank account)
Equipment (Asset)

Dr                             |                             Cr
5 Jan Bank   $20,000   |

Bank (Asset)

Dr                             |                             Cr
1 Jan Capital   $100,000 | 5 Jan Equipment   $20,000

Transaction 3: On 10 Jan, the business earned $5,000 of sales revenue in cash.

  1. Identify: Cash and Sales Revenue.
  2. Classify: Cash is an Asset. Sales Revenue is Income.
  3. Analyse: Cash is increasing. Sales Revenue is increasing.
  4. Apply:
    • Assets increase with a Debit. So, we Dr Cash.
    • Income increases with a Credit. So, we Cr Sales Revenue.
  5. Record:
Cash (Asset)

Dr                             |                             Cr
10 Jan Sales   $5,000     |

Sales Revenue (Income)

Dr                             |                             Cr
                            | 10 Jan Cash   $5,000

Common Mistakes to Avoid
  • Forgetting the dual effect: Every entry must have a debit AND a credit. Never just one.
  • Thinking "Credit" is always good: Receiving cash (an asset) is a DEBIT. Getting a loan (a liability) is a CREDIT. Focus on the rules, not intuition!
  • Mixing up the rules: When in doubt, just write down DEAD CLIC and follow it carefully. Practice is the key!

Final Key Takeaway

Recording transactions is a logical process. By following the 5 steps and using the DEAD CLIC rule, you can accurately record any business event. The T-account helps you see the increases and decreases in each part of the business clearly.


Congratulations! You've covered the fundamentals of the double-entry system. This is a huge step in your accounting journey. Keep practicing with different transactions, and soon it will become second nature. You've got this!