Double-Entry Basics

Learning objectives

By the end of this chapter, you should be able to:

• Explain the accounting equation and normal balances: Describe how assets, liabilities and equity link together, and identify the usual (normal) debit or credit balance for common accounts.
• Distinguish between cash and credit transactions: Decide when to use Cash/Bank, Trade Receivables and Trade Payables, and when an accrual, prepayment or deferred income account is needed.
• Apply debit and credit rules to record transactions: Prepare accurate journal entries for common business events, including inventory purchases and sales.
• Interpret how transactions affect financial statements: Analyse the effect of entries on assets, liabilities, equity, income and expenses.
• Prepare journal entries for typical adjustments and financing events: Record settlement discounts, accruals, owner distributions, notes payable, interest accruals, and doubtful debts using an allowance.

Overview & key concepts

Double-entry bookkeeping records every transaction with equal total debits and credits. This keeps the accounting equation in balance:

Assets = Liabilities + Equity

Income and expenses also fit into this framework because they ultimately change equity: income increases equity and expenses reduce equity (after the period’s profit is transferred into retained earnings).

Key ideas used throughout the chapter:

• Debit (Dr)andCredit (Cr)are simply the left and right sides of accounts. Their meaning depends on the type of account.
• Trade receivablesarise from credit sales;trade payablesarise from credit purchases of goods and services from suppliers.
• Accrualsrecord expenses that relate to the current period but are unpaid at the reporting date.
• Deferred income (unearned revenue)records cash received before the related goods/services have been provided.

The Accounting Equation and Normal Balances

Using the accounting equation

Each transaction must leave the equation balanced. If one side increases, the other side must increase by the same amount (or there must be offsetting movements within the same side).

Examples:

• Purchase inventory on credit:Assets ↑ (Inventory)andLiabilities ↑ (Payables)
• Issue shares for cash:Assets ↑ (Cash)andEquity ↑ (Share capital)
• Pay a supplier:Assets ↓ (Cash)andLiabilities ↓ (Payables)

Normal balances (the practical shortcut)

Accounts tend to have a typical balance direction:

• Assets: normallydebit
• Expenses: normallydebit
• Liabilities: normallycredit
• Equity: normallycredit
• Income: normallycredit

How to apply this:

• If an account normally has adebitbalance, thendebits increase itandcredits decrease it.
• If an account normally has acreditbalance, thencredits increase itanddebits decrease it.

Cash vs Credit Transactions

The key question is when does cash move?

Cash transaction (immediate settlement)

If payment happens at the same time as the sale or purchase, Cash/Bank is used immediately.

• Cash sale:Dr Cash/Bank, Cr Revenue
• Cash purchase of an expense item:Dr Expense, Cr Cash/Bank

Credit transaction (settlement later)

If payment is delayed, use receivables or payables:

• Credit sale:Dr Trade receivables, Cr Revenue
• Credit purchase:Dr Inventory or Expense, Cr Trade payables

When cash is eventually received or paid, the receivable or payable is cleared.

Recording Purchases, Operating Expenses, and Inventory

Inventory vs operating expenses

• Inventoryis held for resale (or for use in producing goods for sale). It is recorded as anassetuntil sold.
• Operating expenses(rent, utilities, wages, advertising) are recognised asexpenseswhen they relate to the period (often as they are used or incurred).

Cost of sales (the second half of a goods sale)

A sale of goods has two separate effects:

1. it createsrevenue, and
2. it uses upinventory, which becomescost of sales.

So a typical credit sale of inventory requires two entries:

• Dr Trade receivables, Cr Revenue
• Dr Cost of sales, Cr Inventory

Under a periodic system, cost of sales is derived at period end rather than recorded per sale.

Deferred Income (Unearned Revenue)

When a customer pays before you’ve delivered the goods or carried out the service, you haven’t earned the sale yet. In bookkeeping terms, you’re holding the customer’s money while still owing them goods or services. So the receipt is recorded as a liability first, and only moved into revenue as you deliver what was promised.

Example:

• On receipt:Dr Cash/Bank, Cr Deferred income
• When earned later:Dr Deferred income, Cr Revenue

Settlement Discounts

A settlement discount is a reduction offered for prompt payment. The ledger treatment depends on whether you are the seller or the buyer.

Seller’s perspective (gross method)

Under the gross method, the sale is recorded at the full invoice amount. If the customer pays within the discount period, the discount is recorded at settlement.

Common account label: Discount allowed (often shown as an expense, or presented as a deduction from revenue—either presentation is acceptable if applied consistently).

• At sale:Dr Trade receivables, Cr Revenue(full invoice)
• At settlement within terms:
  • Dr Cash/Bank(amount received)
  • Dr Discount allowed(discount taken by the customer)
  • Cr Trade receivables(full invoice cleared)

Buyer’s perspective (gross method)

The buyer records the purchase at the full invoice amount. If the discount is taken, it is recorded when payment is made.

Common account label: Discount received (often shown as income, or as a reduction of purchase cost—either is acceptable if applied consistently).

Accruals for Unpaid Expenses

Expenses are recognised when they relate to the period, even if unpaid at the reporting date. Utilities are a common example.

Example (utility bill received, unpaid at period end):

• Dr Utilities expense, Cr Accrued expenses (accruals) / Other payables

Using an accrual prevents understating both expenses and liabilities.

Refunds and Overpayments

A refund should reverse the balance that caused the overpayment.

• If you overpaid a supplier earlier, you may have recorded asupplier prepayment/supplier receivable(asset). A refund reduces that asset.
• If a customer overpaid you, you may have acredit balanceon receivables or a separate refund liability; the refund clears that position.

Avoid defaulting to an expense account unless the refund is genuinely reversing a cost previously recorded as an expense.

Non-Current Asset Acquisition

Non-current assets (equipment, vehicles, computers) are initially recorded at cost.

Example (buy equipment for cash):

• Dr Equipment, Cr Cash/Bank

Depreciation is recorded later, over the periods of use.

Financing and Owner Transactions

Issuing shares

Issuing shares for cash increases resources and owner funding:

• Dr Cash/Bank, Cr Share capital
• (If share premium is relevant, it is credited separately.)

Owner distributions (dividends/drawings)

• For a company, a payable is recognised when the distribution is properly authorised under the entity’s governance and is no longer at management’s discretion.In exams, if the dividend is stated as “declared” or “authorised”, treat it as creating a payable.
• For an unincorporated business, withdrawals by the owner are normally treated asdrawings(an equity reduction), rather than “dividends”.

Notes Payable and Interest

Recording the note

A note payable records the principal borrowed:

• Dr Cash/Bank, Cr Notes payable

Recognising interest over time

Interest is recognised as it accrues. If interest has been incurred but not paid at period end:

• Dr Finance cost (interest), Cr Interest payable
• (orCr Notes payableif the terms add interest to principal.)

Allowance for Doubtful Debts

On credit sales, it’s normal that some customers pay late or not at all. Instead of waiting for a specific customer to fail, we estimate the portion of receivables that is unlikely to be collected and record that estimate in an ‘allowance’ account. When a particular balance is later confirmed as irrecoverable, we remove it from receivables and use the allowance—so we don’t charge the income statement twice for the same issue.

1) Creating or increasing the allowance (the estimation entry)

• Dr Irrecoverable debts expense / Impairment loss on receivables
• Cr Allowance for doubtful debts

This entry is usually based on experience, ageing analysis, and other information available at the reporting date.

2) Writing off a specific receivable

• Dr Allowance for doubtful debts, Cr Trade receivables

The write-off itself does not create a new expense if an allowance has already been recognised.

Core theory and frameworks

A practical journal-entry method

1. Identify the accounts affected.
2. Decide whether each account increases or decreases.
3. Apply normal balance logic to choose Dr/Cr.
4. Confirm total debits equal total credits.
5. Sense-check the result against the accounting equation.

Why goods sales often need two entries

If you only record revenue and ignore cost of sales, profit will be overstated and inventory will remain too high. A complete record of a goods sale requires both the revenue entry and the inventory-to-cost-of-sales entry.

Worked example

Narrative scenario

ABC Retailers records the following transactions during January 2026 (assume inventory is tracked on a perpetual basis).

Unless stated otherwise, opening balances are nil. Any prior-period balances needed to keep the accounting equation in balance are assumed to sit in opening retained earnings. The entity has the following opening balances brought forward:

• Trade receivables:$5,000(debit)
• Allowance for doubtful debts:$500(credit)
• Supplier prepayment (amount due back from a supplier):$200(debit)
• Retained earnings (balancing figure):$4,700(credit)

The allowance brought forward relates to the opening trade receivables balance.

Transactions during January 2026:

1. Purchase inventory on credit:$10,000.
2. Sell goods on credit for$15,000(cost of those goods:$9,000).
3. Receive a utility bill for$500, unpaid at month-end.
4. Issue shares for cash:$5,000.
5. Declare a dividend of$1,000, payable next month.
6. Purchase equipment for cash:$3,000.
7. Receive a cash refund of$200from a supplier relating to the prior overpayment.
8. A customer settles$1,000of their receivable within discount terms of2%.
9. Write off a customer balance of$300as uncollectible.
10. Borrow$2,000by issuing a note payable (interest will be accounted for in a later period).

Required

• Record the journal entries for each transaction.
• Calculate the ending balance forInventoryandTrade payables.
• Determine the impact on the accounting equation.
• Identify any discount taken and its effect on revenue.
• Explain the accounting treatment of the dividend declaration.

Solution

1) Purchase of inventory on credit

• Dr Inventory $10,000
• Cr Trade payables $10,000

2) Credit sale of goods (including cost of sales)

Revenue entry:

• Dr Trade receivables $15,000
• Cr Revenue $15,000

Cost entry:

• Dr Cost of sales $9,000
• Cr Inventory $9,000

3) Utility bill received, unpaid at month-end

• Dr Utilities expense $500
• Cr Accrued expenses (accruals) $500

4) Issue shares for cash

• Dr Cash/Bank $5,000
• Cr Share capital $5,000

5) Dividend declared (payable next month)

• Dr Dividends (equity) $1,000
• Cr Dividends payable $1,000

A payable is recognised when the distribution is properly authorised and no longer at management’s discretion. In exams, if it is stated as declared/authorised, treat it as creating a payable.

6) Purchase equipment for cash

• Dr Equipment $3,000
• Cr Cash/Bank $3,000

7) Supplier refund for prior overpayment

• Dr Cash/Bank $200
• Cr Supplier prepayment (supplier receivable) $200

8) Settlement discount taken on $1,000 receivable (2%)

Discount = $1,000 × 2% = $20
Cash received = $1,000 − $20 = $980

• Dr Cash/Bank $980
• Dr Discount allowed $20
• Cr Trade receivables $1,000

9) Write-off of uncollectible receivable using the allowance

• Dr Allowance for doubtful debts $300
• Cr Trade receivables $300

10) Issue a note payable for cash

• Dr Cash/Bank $2,000
• Cr Notes payable $2,000

Ending balances (selected)

Inventory

Opening inventory = $0

• Purchases = $10,000
• − Cost of sales = $9,000
• Closing inventory = $1,000

Trade payables

Opening trade payables = $0

• Inventory purchase on credit = $10,000
• Closing trade payables = $10,000

(Other liabilities also arise: accrued expenses $500, dividends payable $1,000, notes payable $2,000.)

Impact on the accounting equation

Net changes during January (movements from opening)

• Cash/Bank:+ $5,180(shares $5,000 + refund $200 + settlement $980 + note $2,000 − equipment $3,000)
• Inventory:+ $1,000(purchased $10,000, sold at cost $9,000)
• Equipment:+ $3,000
• Trade receivables (gross):+ $13,700(opening $5,000 → closing $18,700)
• Allowance for doubtful debts: credit balance decreases by$300(from $500 credit to $200 credit), increasing net receivables by $300(no P&L effect here)
• Supplier prepayment:− $200(refunded)
• Trade payables:+ $10,000
• Accrued expenses:+ $500
• Dividends payable:+ $1,000
• Notes payable:+ $2,000
• Equity movements:
  1. Share capital:+ $5,000
  2. Profit effect for January:+ $5,480(revenue $15,000 − cost of sales $9,000 − utilities $500 − discount allowed $20)
  3. Dividends declared:− $1,000

Closing position check (end of January)

• Net trade receivables:$18,700 − $200 = $18,500
• Total assets:Cash $5,180 + Inventory $1,000 + Equipment $3,000 + Net receivables $18,500 = $27,680
• Total liabilities:Trade payables $10,000 + Accruals $500 + Dividends payable $1,000 + Notes payable $2,000 = $13,500
• Total equity:$27,680 − $13,500 = $14,180(including share capital and retained earnings)

The equation balances because each journal entry has equal debits and credits.

Common pitfalls and misunderstandings

• Treating debits as “good” and credits as “bad”: debit/credit is a position in the account, not a value judgement.
• Mixing up cash and credit: if cash does not move today, use receivables/payables and clear them when cash settles.
• Recording only half of a goods sale: goods sales normally require both the revenue entry and the cost-of-sales entry.
• Using trade payables for all unpaid costs: utilities and similar unpaid running costs are usually recorded asaccrued expenses/other payables, not trade payables.
• Discount labels that confuse exam presentation: for the seller, “discount allowed” is common; for the buyer, “discount received”.
• Writing off receivables to expense when an allowance exists: write-offs use the allowance; the expense is recognised when the allowance is set or updated.
• Dividend timing: a payable is recognised only once properly authorised and no longer at management’s discretion.

Summary and further reading

Double-entry bookkeeping records each transaction in at least two accounts so the accounting equation stays in balance. Strong performance in exam-style questions comes from mastering (1) normal balances, (2) cash versus credit logic, and (3) the correct use of key accounts such as inventory, cost of sales, receivables, payables, accruals, deferred income, equity, notes payable and the allowance for doubtful debts. These foundations support later topics such as adjusting entries, control accounts and financial statement preparation.

FAQ

What is the significance of the accounting equation in double-entry bookkeeping?
It provides a structure that must always hold true: resources are financed either by obligations or by the owners’ interest. Correct double-entry keeps it balanced.

How do cash and credit transactions differ in accounting?
Cash transactions affect Cash/Bank immediately. Credit transactions affect receivables or payables first, and Cash/Bank later when settlement occurs.

Why are settlement discounts recorded only when taken under the gross method?
Because the discount depends on payment within a specified time. Until payment happens, the invoice amount remains the receivable (or payable).

What is the allowance method for doubtful debts, and why is it used?
It records a prudent estimate of likely non-collection as an allowance against receivables, and then uses that allowance to write off specific debts without double-counting the expense.

How are non-current asset acquisitions recorded in accounting?
They are recorded at cost as assets at purchase. Depreciation is recorded over the periods of use.

Summary (Recap)

This chapter explained how double-entry bookkeeping keeps records balanced through the accounting equation and the rules of debits and credits. It distinguished cash from credit transactions and showed how common events are recorded, including inventory purchases and sales (with cost of sales), operating expenses and accruals, settlement discounts, refunds and overpayments, acquisitions of non-current assets, owner funding through shares, owner distributions, notes payable and the allowance approach to doubtful debts. The worked example demonstrated journals, closing balances for inventory and trade payables, and a clear reconciliation of movements and closing positions.

Glossary

Accounting equation
A framework showing that a business’s resources are financed either by obligations to others or by the owners’ interest: Assets = Liabilities + Equity.

Normal balance
The usual balance direction of an account type: assets and expenses typically carry debit balances; liabilities, equity and income typically carry credit balances.

Cash/Bank
The account used to record money held in cash and in bank accounts.

Trade receivables
Amounts owed by customers arising from credit sales.

Trade payables
Amounts owed to suppliers arising from credit purchases.

Accrued expenses (accruals)
Amounts owed for expenses that relate to the period but have not yet been paid at the reporting date.

Deferred income (unearned revenue)
Cash received before goods or services are provided; recorded initially as a liability and recognised as revenue as delivery occurs.

Discount allowed
A settlement discount granted to a customer for prompt payment; commonly recorded by the seller when the customer pays within the discount terms (often shown as an expense or as a deduction from revenue).

Discount received
A settlement discount obtained from a supplier for prompt payment; commonly recorded by the buyer when payment is made (often shown as income or as a reduction of purchase cost).

Cost of sales
The expense representing the cost of inventory sold during the period.

Allowance for doubtful debts
A contra-asset account that reduces trade receivables to a prudent net amount, reflecting likely non-collection based on experience and available information.

Dividend declaration
A decision to distribute profits to owners that creates a payable once properly authorised and no longer at management’s discretion.

Notes payable
A written promise to repay borrowed funds, recorded as a liability at principal, with interest recognised over time.