Key Concepts
Every transaction affects one or more of the five accounting elements:
| Element | Definition | Nature | Examples |
|---|---|---|---|
| Assets | Things the business owns or is owed that have value and provide future benefit | Debit |
|
| Liabilities | Amounts the business owes to others that must be paid in the future | Credit |
|
| Equity (Capital) | The owner's claim on the net assets of the business — what is left of the assets after deducting liabilities | Credit |
|
| Income | Money earned by the business from its activities | Credit |
|
| Expenses | Costs incurred by the business to earn income | Debit |
|
Additional capital and income increase equity; expenses and drawings decrease equity.
Drawings refers to business assets taken out by the owner for personal use (e.g. cash withdrawn, or goods taken). It normally carries a debit balance (debit to increase, credit to decrease).
Some of these accounts are covered in later chapters. Here is what each one means, so the list makes sense now:
| Account | What it means |
|---|---|
| Fixtures and fittings | Items installed in the shop or office, such as shelving, counters and lighting. The business keeps and uses them, so they are assets. |
| Bank overdraft | The business has spent more money than it has in its bank account. The bank covers the shortfall, so the business owes the bank. That makes it a liability. |
| Mortgage loan | A long-term loan backed by something the business owns, usually property. If the loan is not repaid, the lender can take that asset. The business owes the money, so it is a liability. |
| Discount received | A discount the business receives from a supplier for paying early. The business pays less than it owed, so it is income. |
| Discount allowed | A discount the business gives a credit customer for paying early. It reduces what the business collects, so it is an expense. |
| Interest expense | The cost of borrowing — the lender's charge for letting the business use its money. It is a cost of running the business, so it is an expense. |
How to Classify an Item
| Ask yourself… | Element / Account |
|---|---|
| Is it something the business owns or is owed? | Assets |
| Is it something the business owes to others? | Liabilities |
| Is it money/resources put in by the owner, or profit earned? | Equity |
| Is it revenue earned from business activities? | Income |
| Is it a cost of running the business? | Expenses |
| Is it money or goods taken out by the owner for personal use? | Drawings |
Most Commonly Confused Items
| Item | Element / Account | Why |
|---|---|---|
| Drawings | Drawings | Business assets taken out by the owner for personal use — reduces the owner's share in the business |
| Capital | Equity | Owner's contributions to the business |
| Cost of sales | Expenses | refers to cost of goods sold, not an asset |
| Trade receivables | Assets | The business sold goods but has not yet received cash — the customer owes the business money |
| Trade payables | Liabilities | The business bought goods but has not yet paid — the business owes the supplier money |
Memory trick:Trade receivables are customers who owe the business money — an asset. Trade payables are suppliers the business owes money to — a liability. Receivables = business will Receive; Payables = business must Pay.
Context-Dependent Classification
The same item can belong to different elements depending on how the business uses it.
Example:A motor vehicle is an asset for most businesses — but for a car dealer, unsold cars are inventory (goods held for sale), not assets.
Always ask: how does this business use this item? — not just what the item is. Scenario questions often flip the context to test whether students are thinking or just memorising.
Use DEAD CLIC to remember which accounts normally carry a debit balance and which normally carry a credit balance:
| Debit balance | Credit balance |
|---|---|
| Expenses | Liabilities |
| Assets | Income |
| Drawings | Capital (Equity) |
To classify any item, ask: is it something the business owns or is owed? Is it earned income? A cost incurred? The owner's contribution or withdrawal?
- Cash in hand — $2,000
- Trade payables — Ravi — $800
- Capital — Anand — $5,000
- Sales revenue — $3,500
- Salaries expense — $900
- Anand withdrew $200 cash for personal use
| Item | Element / Account | Debit or Credit |
|---|---|---|
| Cash in hand | Assets | Debit |
| Trade payables — Ravi | Liabilities | Credit |
| Capital | Equity | Credit |
| Sales revenue | Income | Credit |
| Salaries expense | Expenses | Debit |
| Cash withdrawn by Anand | Drawings | Debit |
Classifying drawings as an expense. Drawings are the owner taking business assets for personal use — they reduce the owner's equity, but are not business operating costs. Drawings are recorded in the Drawings account, not expenses. Because Drawings reduces equity (which is credit-natured), Drawings is debit-natured — debit to increase, credit to decrease.
Classifying a new piece of equipment as an expense. If the business still benefits from it in future periods, it is an asset.
- Equipment provides future benefit to the business — it is an asset.
- An expense is a cost whose benefit is already used up (e.g. rent paid for the month, electricity consumed).