Accounting Cycle: formula sheet

Key formulas

Personal account rule

Debit the receiver; Credit the giver

Applies to persons, firms, companies and banks. The person who receives a benefit is debited.

Real account rule

Debit what comes in; Credit what goes out

Applies to assets such as cash, goods, furniture and machinery.

Nominal account rule

Debit all expenses and losses; Credit all incomes and gains

Applies to rent, wages, interest paid, commission received, discount received and similar items.

Modern rule for assets and expenses

Increase in assets or expenses = Debit; Decrease = Credit

Asset and expense accounts normally have debit balances.

Modern rule for liabilities, capital and income

Increase in liabilities, capital or income = Credit; Decrease = Debit

These accounts normally have credit balances.

Double entry principle

Total debits = Total credits

Every journal entry must balance.

Cash book sides

Debit side = receipts (cash in, bank in). Credit side = payments (cash out, bank out)

Cash cannot go negative, so the cash column always shows a debit balance or nil.

Discount rule

Discount allowed = on debit side (loss). Discount received = on credit side (gain)

Discount columns are only totalled, not balanced. Debit total goes to Discount Allowed A/c, credit total to Discount Received A/c.

Contra entry

Cash deposited in bank: Bank column Dr, Cash column Cr. Cash withdrawn: Cash column Dr, Bank column Cr

Marked 'C' in the folio column. Both entries are on opposite sides.

Bank balance

Favourable balance = debit balance. Overdraft = credit balance

The bank column can show a credit balance, which means an overdraft.

Net purchases and sales

Net purchases = Purchases − Purchase returns. Net sales = Sales − Sales returns

Returns are kept in separate books and deducted at the end.

Imprest reimbursement

Amount received = Total petty expenses for the period. Closing petty cash = Imprest amount

Opening balance + amount received − expenses = closing balance, which equals the imprest.

Imprest to be received

Amount to be received = Imprest − Cash balance in hand (at period end)

Used when the question gives the closing cash in hand.

Posting rule

Debit amount → debit side of the debited account; Credit amount → credit side of the credited account

Particulars column names the other account in the entry.

Balance of an account

Balance = Total of higher side − Total of lower side

The balance is written on the smaller side as c/d so that both sides total equally.

Debit balance

Total debits > Total credits

Typical for assets, expenses, losses and debtors.

Credit balance

Total credits > Total debits

Typical for liabilities, capital, income and creditors.

Bring down rule

Balance c/d on one side = Balance b/d on the opposite side

A debit balance is carried down on the credit side and brought down on the debit side, and vice versa.

Closing cash or bank

Closing balance = Opening balance + Receipts − Payments

Useful for quick checks on Cash account.

Basic agreement rule

Total of debit balances = Total of credit balances

If true, the trial balance agrees. It does not prove the books are error-free.

Debit balances

Assets (excluding closing stock) + Expenses + Losses + Drawings + Opening stock + Purchases + Sales returns

These items go in the debit column.

Credit balances

Capital + Liabilities + Incomes + Gains + Sales + Purchase returns + Provisions

These items go in the credit column.

Difference in totals

Difference = |Total Dr − Total Cr|

Shows the amount to place in a suspense account if the difference cannot be traced.

Two-sided error rectification

Reverse the wrong entry, then pass the correct entry (or pass a single net entry)

Suspense Account is not used because the trial balance was not affected.

Suspense when debit total is less

Difference is debited to Suspense Account

Done so that the trial balance tallies. Credits exceed debits.

Suspense when credit total is less

Difference is credited to Suspense Account

Debits exceed credits.

Rectifying a one-sided error

Debit or credit the affected account, with the opposite side to Suspense Account

Applies where a suspense account was opened for the trial balance difference. If the account should have been debited but was not, debit it and credit Suspense.

Wrong total or wrong posting of an amount

Rectify by the difference between the correct and wrong amount

Example: a debit posted ₹500 short needs a further debit of ₹500, with credit to Suspense.

Compensating errors

Rectify each error separately, or pass the net effect on each account

Suspense is not needed if the errors fully offset each other.

Effect on profit

Rectifying an error changes profit only if a Profit and Loss item (expense or income) is involved

Personal and real account errors alone do not change profit.

Starting from a favourable cash book balance

Passbook balance = Cash book balance + Cheques issued but not presented − Cheques deposited but not yet credited + Bank credits not in cash book − Bank debits not in cash book

Use this when the cash book shows money in the bank (debit balance). The cash book here is the balance before bank-only items are entered. It reaches the passbook balance.

Starting from a favourable passbook balance

Cash book balance (before bank-only items are entered) = Passbook balance + Cheques deposited but not yet credited − Cheques issued but not presented + Bank debits not in cash book − Bank credits not in cash book

Use this when the passbook shows money in the bank (credit balance). It is the exact reverse of the first formula. Bank-only items are already in the passbook, so you take them out to reach the cash book as it stands.

Overdraft rule

For an overdraft, treat the balance as negative and apply the normal signs. Or keep it as a positive overdraft and reverse the sign of every adjustment. Never do both.

The same list of items is used. The adjustments do not change direction because of an overdraft; the starting balance is simply negative. Both methods give the same answer. Using both together gives a wrong answer.

Items that raise the cash book

Direct deposits, interest and dividends collected by bank, bank interest credited

Credited by the bank, not yet in the cash book. Adjust the cash book upward.

Items that lower the cash book

Bank charges, interest on overdraft, insurance premium or EMI paid by standing order, dishonoured cheques

Debited by the bank, not yet in the cash book. Adjust the cash book downward.

Timing items need no entry

Cheques issued not presented and cheques deposited not cleared

They only appear in the BRS. They never need a cash book entry.

Gross profit

Gross profit = Sales (net of returns) − Cost of goods sold

Cost of goods sold = Opening stock + Purchases (net of returns) + Direct expenses − Closing stock.

Net profit

Net profit = Gross profit + Other incomes − Indirect expenses

Includes depreciation, bad debts and provisions as expenses.

Outstanding expense

Expense charged = Paid + Outstanding at end − Outstanding at start

Outstanding at end is added to the expense and shown as a current liability.

Prepaid expense

Expense charged = Paid − Prepaid at end

Prepaid is shown as a current asset.

Accrued income

Income credited = Received + Accrued at end

Accrued income is a current asset.

Income received in advance

Income credited = Received − Advance part

The advance part is a current liability.

Straight line depreciation

Depreciation = (Cost − Scrap value) ÷ Life in years

Reduce for part-year use only if the question says so.

Reducing balance depreciation

Depreciation = Rate % × Book value at start of the year

Book value is cost less depreciation already charged.

Provision for doubtful debts

Provision = Rate % × (Debtors − Further bad debts)

Charge only the increase over the old provision. A decrease is a gain.

Closing capital

Closing capital = Opening capital + Net profit + Additional capital − Drawings

Net loss is deducted instead of added.

Quick revision

• Personal account: debit the receiver, credit the giver. Real account: debit what comes in, credit what goes out. Nominal account: debit expenses and losses, credit incomes and gains.
• Assets and expenses increase on the debit side. Liabilities, capital and incomes increase on the credit side.
• Every transaction has two effects, so total debits always equal total credits.
• The cash book is both a journal and a ledger for cash and bank transactions.
• A trial balance that agrees does not prove the books are free of errors.
• Complete omission of a transaction, errors of principle and compensating errors do not affect trial balance agreement. Partial omission or one-sided posting does disturb it. An error of commission that posts the correct amount on the correct side to a wrong account of the same type (for example, the wrong personal account) does not affect agreement. A wrong amount on one side, wrong totalling or wrong balancing does.
• Differences in a trial balance that cannot be found at once are placed in a suspense account until located.
• In a bank reconciliation, start from either balance and add or subtract items in the right direction, then reach the other balance.
• Cheques issued but not yet presented, and cheques deposited but not yet cleared, are common reconciling items.
• Outstanding expenses are added to the expense and shown as a liability. Prepaid expenses are deducted from the expense and shown as an asset.
• Gross profit comes from the Trading Account and net profit from the Profit and Loss Account.
• Every adjustment has a double effect: one in the Profit and Loss Account or Trading Account and one in the Balance Sheet.

Common mistakes

• Debiting the giver and crediting the receiver in personal accounts Fix: Remember that the receiver is debited. When you sell goods on credit to Ravi, Ravi receives goods, so Ravi A/c is debited.
• Treating drawings as an expense Fix: Drawings reduce capital. Debit Drawings A/c and credit Cash A/c. It is not a nominal expense.
• Recording a credit purchase of furniture in the Purchases Book. Fix: Purchases Book is only for credit purchases of goods meant for resale. Furniture and machinery go in the Journal Proper.
• Adding discount to the cash or bank amount. Fix: Cash and bank columns show only the money that moved. Discount sits in its own column.
• Choosing the side from the words To/By instead of from debit/credit Fix: The side is decided by debit or credit. "To" is written on the debit side and "By" on the credit side, before the name of the opposite account.
• Writing the wrong account name in the particulars column Fix: In each account, always name the opposite account of that entry.
• Putting drawings in the credit column Fix: Drawings reduce capital but are a debit balance. Always place them in the debit column.
• Including closing stock in the trial balance Fix: Closing stock is given outside the trial balance as an adjustment. Opening stock is the one in the debit column.
• Using Suspense Account for a two-sided error such as a wrong head of account. Fix: Use suspense only when one side of an entry is wrong or missing and the trial balance disagreed.
• Debiting suspense when it should be credited. Fix: Remember: if debits were short, suspense was debited at the start. When the error is found, the rectifying entry credits suspense, with the real account corrected on the other side.

Exam tips

• Most MCQs test one decision: which account is debited or credited. Classify the account first, then apply the rule. This takes seconds.
• Watch for cash discount, drawings, bad debts and outstanding items. These are common trap transactions.
• In compound entry options, check that debits equal credits before reading further. Often this removes two options.
• Do not record trade discount. If a question gives list price and trade discount, use the net amount.
• With no negative marking, answer every question. If unsure, eliminate options that debit an income or credit an expense and guess from the rest.
• Questions on book identification are common. Always check two things: is it credit, and is it goods for resale.
• In cash book MCQs, check for contra entries first. They are the most common trap.
• Remember that the discount column is totalled, not balanced. Options that show a discount balance are wrong.