Understanding how to decode worded transactions is one of the most difficult hurdles for basic accounting students. Many learners struggle with translating everyday business language into clear, structured journal entries and ledger postings. This article breaks down that process, helping students confidently navigate this foundational stage in accounting.
Let’s explore how to interpret worded scenarios using ALICE accounts and bridge the gap between theory and practical application.
What are ALICE accounts?
ALICE is an acronym that helps students remember the five main types of accounts in accounting:
- A – Assets
- L – Liabilities
- I – Income
- C – Capital
- E – Expenses
Understanding which accounts to debit or credit depends on whether the account increases or decreases. Here’s a simple rule to remember:
- Debit: Increase in Assets and Expenses
- Credit: Increase in Liabilities, Income, and Capital
When these accounts decrease, the reverse occurs.
The confusion with increases and decreases
It’s easy for students to visualise an increase in cash, stock, or equipment—these are tangible. But many struggle with expenses like electricity, rent, or fees, because these are services, not items you can see or touch.
Think of expenses as costs the business must pay to operate. When the business incurs these costs, expenses increase, and you debit the expense account.
How to decode worded transactions using ALICE
Let’s break down commonly confusing scenarios:
1. “Owner started business with cash from personal savings.”
➡ The business received an asset (cash), and the owner’s contribution increases capital.
- Dr Cash (Asset increased)
- Cr Capital (Capital increased)
🔍 Tip: “Started the business” or “invested in the business” usually signals an increase in capital.
2. “Owner used cash from the business to buy personal groceries.”
➡ Business funds used for personal reasons are drawings, which reduce capital.
- Dr Drawings (Capital decreased)
- Cr Cash (Asset decreased)
🔍 Don’t confuse this with an expense. Drawings are not business expenses—they’re withdrawals.
3. “Purchased machinery on credit from ABC Ltd.”
➡ Machinery is an asset, and “on credit” means Accounts Payable increased.
- Dr Machinery (Asset increased)
- Cr Accounts Payable: ABC Ltd (Liability increased)
🔍 Only items bought for resale go into the Purchases account, not fixed assets like machinery.
4. “Purchased goods with cheque.”
➡ Buying goods for resale is a business expense; paying by cheque affects the bank account.
- Dr Purchases (Expense increased)
- Cr Bank (Asset decreased)
🔍 Cheque = payment from bank. Always match the payment method with the correct asset.
5. “Borrowed cash from the bank.”
➡ Borrowed funds mean cash increases (asset) and loan increases (liability).
- Dr Cash (Asset increased)
- Cr Loan (Liability increased)
🔍 Just because the bank is involved doesn’t mean you post to the Bank account. Think: What’s happening? You’re increasing liabilities.
6. “Sold goods on credit to XYZ Ltd.”
➡ Goods for resale sold on credit create an accounts receivable and sales income.
- Dr Accounts Receivable: XYZ Ltd (Asset increased)
- Cr Sales (Income increased)
🔍 “On credit” always means a receivable or payable is created.
7. “Customer brought back goods purchased because they were damaged.”
➡ Returned goods = Returns Inwards, which is treated as an expense.
- Dr Returns Inwards (Expense increased)
- Cr Accounts Receivable (Asset decreased)
🔍 We don’t reverse Sales. Use Returns Inwards to track this separately.
8. “Paid rent in advance for the next 3 months with a cheque.”
➡ This is not an expense yet—it’s a Prepaid Expense, which is an asset.
- Dr Prepaid Rent (Asset increased)
- Cr Bank (Asset decreased)
🔍 If the benefit will come in the future, it’s not an expense now.
9. “Received invoice for electricity but haven’t paid yet.”
➡ An expense is incurred, but not paid—this creates a liability.
- Dr Electricity Expense (Expense increased)
- Cr Accrued Expenses / Accounts Payable (Liability increased)
🔍 When we owe for an expense that was incurred, we record it as a liability.
10. “Received a prepayment in cash from customer for preordered goods.”
➡ Cash (asset) increasesand Prepaid Revenue (liability) also increases.
- Cash
- Prepaid Revenue
🔍 It’s not a sale now, so it’s recorded as a liability as the business owes goods.
11. “Paid wages owing from last month with a cheque.”
➡ The expense was recorded last month; now you’re just settling the liability.
- Dr Accrued Expenses (Liability decreased)
- Cr Bank (Asset decreased)
🔍 A debit decreases the liability and the credit decreases the asset. Once your remember the rule, posting is easy.
Tips to decode worded transactions
- Underline the key terms: “borrowed”, “purchased”, “sold on credit”, “paid”, “received”, etc.
- Identify what accounts are affected: Use the ALICE framework.
- Decide if each account increased or decreased.
- Apply debit and credit rules accordingly.
- Check: Does the transaction make sense in business terms?
Why this step is so important
If students can’t decode a basic transaction, they’ll struggle with:
- Preparing journal entries
- Posting to the ledger
- Balancing accounts
- Understanding financial statements
- Completing the accounting cycle
This gap becomes even wider when students move from sole trader accounts to complex structures like Partnerships, Companies, Cooperatives, NGOs, and Manufacturing Accounts.
Final thoughts
Mastering the decoding of worded transactions is the foundation of all accounting. It’s where students build their understanding of how business activities affect the financial position of a company. With ALICE as a guide and consistent practise, this once-frustrating process becomes second nature.
Teachers: Encourage students to verbalise transactions using ALICE.
Students: Practise daily with real-world examples and break down each sentence like a puzzle.
When you can confidently decode any transaction, you unlock the true language of accounting—and that’s the first step to mastering the entire accounting cycle.
Ready to decode? Start with ALICE and make journal entry count.
See also:
Why students struggle with source documents and worded problems in accounting: Tips to help
What accounting teachers assume students already know (but often don’t)
ALICE: Assets, Liabilities, Income, Capital, Expenses
Master the Accounting Cycle steps: Your guide to tracking business finances like a pro
Accounting Cycle: Complete basic accounting in 7 steps
Goods for resale: Stock, Purchases, Sales, Carriages and Returns
Debit and Credit: Simple view of in and out
Increase and decrease of ALICE accounts
Expenses: Spending that’s direct, indirect, operating and non-operating