Basic Principles of Accounting: The Double Entry, and What an Account Is

In one line

Every transaction has two sides, and accounting is the practice of writing both of them down.

In exam wording: the basic principles of accounting are the accounting equation, the classification of accounts, the rules of debit and credit, and the double entry system, under which every transaction is recorded in at least two accounts with equal debits and credits.

What an account is

An account is a record of all the changes in one thing.

That is the whole idea. Choose a thing you care about, cash, or the amount a particular client owes you, or the rent you pay, and keep a running record of everything that increases it and everything that decreases it. That record is an account.

Accounts are traditionally drawn in a T shape, and the two sides have names that are the source of most beginners' confusion.

• The left side is called debit, abbreviated Dr.
• The right side is called credit, abbreviated Cr.

Debit and credit mean left and right. They do not mean good and bad, and they do not mean increase and decrease. Whether a debit increases or decreases a thing depends on what kind of account it is, which is the next section. A student who fixes this one point has removed the main obstacle.

The accounting equation

Everything rests on one identity.

Assets = Liabilities + Capital

• Assets are what the practice owns or is owed: cash, the balance in the office bank account, a computer, fees billed but not yet received.
• Liabilities are what the practice owes to outsiders: an unpaid electricity bill, a loan, and, importantly for an advocate, money held for clients.
• Capital is what the proprietor has in the business: what he put in, plus profits earned, minus what he has taken out.

The equation is true by construction. Everything the practice has came from somewhere: either from an outsider, which is a liability, or from the owner, which is capital.

For a lawyer the equation has a peculiar feature worth noticing at once. Money received from a client for court fees is cash, an asset, and it is simultaneously a liability, because it is owed back to the client or must be spent on his behalf. It never touches capital, because it is not income. That is the accounting expression of the legal proposition in chapter [Accountancy for Lawyers: Why a Lawyer Keeps Accounts at All]: client money is not the advocate's money.

The five kinds of account

Every account belongs to one of five classes, and the class decides which side increases it.