three basic rules of bookkeeping

Basic Rules of Double Entry System

The founding father of double entry bookkeeping was a Franciscan monk called Luca Pacioli. He did not invent it, but in 1493 he wrote down the principles of the system being used by him and others. Given his calling he must have been a man of considerable education and wide-ranging interests. His work has stood the test of time because the fundamental principles are timeless. If he was able to visit a modern accounts office, once computers had been explained to him he would recognize that his principles were still being applied.

The bookkeeping system (the ledger) will contain a number of accounts, perhaps just a few or perhaps many thousands. The previous section of this web gave an example of double entry system for a cheque for £5,000 paying an insurance premium.

This resulted in postings to the Insurance Account and the Bank Account. Each account has a separate page in the ledger, though in practice the records are likely to be computerized. In a manual system the layout of each account will be the same.

[wphtmlblock id=”2830″]

Example of Double Entry Bookkeeping for Insurance Voucher

The following show the two entries resulting from the payment of the insurance premium.
Example of Insurane Account's double entry bookkeeping

As you look at these accounts please keep in mind:

• They might seem rather cramped, but in reality the paper would almost certainly be considerably wider than this book.

• In double entry, Debit is often abbreviated to ‘Dr’ and Credit is often abbreviated to ‘Cr’.
• The entry may incorporate a folio reference. This is not shown but it enables each entry to be cross-referenced to the correct input document.

It is time now to list and explain three fundamental rules that apply today and which Luca Pacioli would undoubtedly recognize.

[wphtmlblock id=”2830″]

3 Basic Rules

1. Debit columns on the left, Credit on the right

Why this way round? It does not matter so long as everyone does it the same way. It is rather like driving – it does not matter which side of the road we drive so long as everyone follows the same law or convention. A long
time ago most people did it this way, so that’s the way we all do it. On my first morning as a trainee accountant I was told that debit was nearest the window and that it was best not to talk to the boss until he had had a cup of tea. I found both pieces of advice invaluable, but I always sat with my left shoulder next to the glass.

2. Debit receives the benefit, Credit gives the benefit

Quick Example: When any account get money, it will be debit and reverse.
Again, why this way round? Again, because it was decided a long time ago and that’s the way it is. The rule may be hard to grasp and it is probably the opposite of what you would instinctively expect. After all your bank
statement is credited when money is paid into your bank account. But look at it from the bank’s point of view, and it is the bank that issues the statement. The bank’s records are a mirror image of your records, so a credit for the bank is a debit for you, and vice versa. It may help you to remember the rule if you keep in mind that assets in the balance sheet and costs in the profit and loss account are both debits. So if you buy a new factory or if you buy some postage stamps, the appropriate accounts will be debited. Liabilities in the balance sheet and income in the profit and loss account are both credits. So if you buy something on credit, the amount is credited to the supplier’s account. This is because it is a liability.

Similarly, if you make a sale, the amount is credited to sales account and it will eventually contribute to revenue in the profit and loss account. It is all explained further in the next chapter.

3. For Every Debit there must be a Credit

This is a fundamental and implicit consequence of double entry bookkeeping, and there are no exceptions. One account gives the benefit and one account receives the benefit (Debit & Credit rules). Scientists sometimes help themselves remember
the rule by thinking of the law of physics: ‘for every action there is an equal and opposite reaction’. We have already seen how this works in relation to the insurance premium payment of £5,000, but it is not always so straightforward. In fact it may be exceedingly complicated. A batch of postings may include a large number of debits and credits, but the total of the debits must always equal the total of the credits.
If they do not, a mistake has been made. As an example consider the entries resulting from an approved expense claim. The amounts are large, so perhaps the expenses were incurred by a senior manager or just possibly a journalist. 

individual accounts in bookkeeping

Five individual accounts would be debited with a total of £6,499.

One account would be credited with £6,499.

So please remember the first fundamental rule of double entry bookkeeping: ‘for every debit there must be a credit’. There are no exceptions and it ranks alongside ‘The sun always rises in the east’, ‘Water does not flow uphill’ and ‘A Government initiative to cut bureaucracy always creates extra work’.