Double entry bookkeeping

You've already seen the secret in the expanded accounting equation. Every transaction has two faces, a resource face and a claim face, or else it trades one resource or claim for another. No economic event touches only one account, because every event answers two questions at once. What changed? And where did it come from, or where did it go?

• Borrow from a bank: cash arrives (what changed) and an obligation arises (where it came from).
• Buy a van for cash: a van arrives and cash departs.
• Earn revenue: an asset arrives (cash or receivable) and the owners' claim grows.
• Pay rent: cash departs and the owners' claim shrinks.

What is double entry bookkeeping?

Double-entry bookkeeping is the habit of recording both faces, always, with equal amounts. That's it. Its huge practical payoff is that the books check themselves. Every entry adds equal amounts to both sides of the recording system, so the totals must always agree, and a single omitted or lopsided entry shows up in the trial balance. Before Pacioli's Venetian merchants systematized this, a bookkeeper's error could hide forever. After it, errors ring a bell.

This bell isn't perfect. You can make balanced errors, like recording a correct-looking entry in the wrong accounts, and a fraudster's entries balance beautifully. Double-entry catches sloppiness. Dishonesty is what Phase 2 is for.

One more habit of mind. Accountants track all this in accounts, one running record per item. Cash has an account. Inventory has an account. Each supplier's dues go in accounts payable. Revenue has accounts. Think of an account as a bucket with a history: everything that ever increased it, everything that ever decreased it, and the running balance. A company's full set of buckets is its ledger, and the master list of bucket names is the chart of accounts.

Debits and credits, demystified: derive the rule, never memorize it

Most courses lose people here, so read slowly. We're going to derive the debit/credit rules from the equation. Once you've seen the derivation, you can rebuild the rules on the back of an envelope for the rest of your life.

Step 1: the words mean nothing but "left" and "right." Debit (Dr) means the left column of an account. Credit (Cr) means the right column. And that's all they mean. They don't mean plus or minus. They don't mean good or bad either. And they don't mean what your bank means when it "credits your account." The bank is keeping its books, and your deposit is the bank's liability. So when it credits your account, it's raising a liability on its own books. That banking usage runs backwards from your intuition, and it's the biggest single source of confusion, so put it out of your mind now. Five hundred years ago Italian bookkeepers needed names for the two columns, and debito and credito stuck. Treat them as arbitrary column labels, like port and starboard.

Step 2: one convention, chosen once. This system needs a single arbitrary choice, and everything else follows from it. Assets increase on the left (debit) side. Why left? Because assets sit on the left of the equation as it's usually written. There's no deeper reason. It could have gone the other way, and the only change would be that every ledger on earth was mirrored.

Step 3: the equation forces everything else. Say assets increase by debit, and every entry is recorded on two sides. Then liabilities and equity must increase on the credit (right) side to keep the equation balanced, since they sit on the opposite side of the equation and take the opposite convention. Check it by borrowing ₹4,00,000. Cash goes up, so that's a debit. But the loan goes up too, and it has to go in the other column, so it's a credit. Equal debits and credits, and the equation is intact. Every account decreases on the side opposite to where it increases.

Why do expenses and dividends increase with debits?

Step 4: expand equity, and the "weird" rules become obvious. Go back to the expanded equation and move the negative items, expenses and dividends, to the left with flipped signs:

Assets = Liabilities + Share Capital + Retained Earnings + Revenues − Expenses − Dividends

Assets + Expenses + Dividends = Liabilities + Share Capital + Retained Earnings + Revenues

Look at that rearranged line. Everything on the left behaves like an asset and increases by debit. Everything on the right behaves like a liability and increases by credit. So:

• Expenses increase with debits. An expense isn't "an asset." It reduces equity, and you reduce a credit-natured thing with a debit. Paying rent debits Rent Expense, which is equity shrinking, recorded on the left. It credits Cash, an asset shrinking, recorded on the right.
• Dividends increase with debits by the same logic, since a dividend is a direct reduction of equity.
• Revenues increase with credits, because revenue grows equity, and you grow a credit-natured thing with a credit.

What are the debit and credit rules?

The rule, derived. An account's normal balance is the side on which it increases, which is also the side its balance normally sits on:

Two classroom mnemonics squeeze the table into a word. You've derived it now, so you can safely use them to check yourself.

• DEALER: Dividends, Expenses, Assets are debit-normal | Liabilities, Equity, Revenue are credit-normal.
• DEAD CLIC: Debits increase Expenses, Assets, Dividends/Drawings. Credits increase Liabilities, Income, Capital.

One mechanical law has no exceptions, ever: in every journal entry, total debits = total credits. An entry can hit three or five accounts, which is called a "compound entry," but the two column totals always agree. It's the equation, enforced one transaction at a time.

Here's a warm-up: narrate, classify, then post. "Meridian pays ₹36,000 of April salaries in cash." First narrate the two faces. Equity shrinks by ₹36,000 of expense, and the asset cash shrinks by ₹36,000. Then classify. Salaries Expense is an expense, so it increases by debit. Cash is an asset, so it decreases by credit. Write it:

Dr  Salaries Expense        36,000
    Cr  Cash                        36,000
(April salaries paid)

You'll do every entry this week with that three-step ritual: narrate the economics, classify each account, apply its rule. Speed comes later. The ritual comes first.

T-accounts and the ledger

A T-account is the back-of-envelope picture of one ledger account. Draw a big T and put the account name on top. Debits go on the left and credits on the right, with the balance at the bottom on its normal side.

                 Cash
   ---------------------------------
   Dr (increases)  |  Cr (decreases)
   10,00,000 (1)   |  1,80,000 (3)
    4,00,000 (2)   |  2,40,000 (4)
    2,40,000 (6)   |  3,00,000 (8)
                   |     36,000 (11)
   ----------------|----------------
   Balance c/d: (computed below in the Meridian example)

Posting is clerical work. Copy each journal-entry line into its account's proper column, tag it with the transaction number so you can trace it back, and total up when needed. The self-check comes back at scale, because the sum of all debit balances across the ledger equals the sum of all credit balances. And the report that proves it is the trial balance.