I know many of you have been requesting for some posts to cover basic accounting for dummies topic, so here I am coming with the very basic accounting post. Learning accounting could be a significant monetary cost if you take accounting course for sure. Don’t worry, that is not the purpose of this site. Things that you really need to learn accounting, here, are 2 Ps: (1) patience; and (2) practices.
Through this post, you can learn the very basic of debit-and-credit concept, famously known as “double entry accounting system”. It means you are just about to learn:
- What is account?
- How are debit, credit, and balance made? (what is the rule?)
- What is chart of account and why is it needed?
The start of all of these is the basic accounting equation:
Assets = Liabilities + Capital (A = L + C)
Assets = Liabilities + Owner’s Equity (A = L + OE)
To make it more logical, you can read the above equation as:
“Company’s assets come from loans of other parties called liability AND capital/owner’s equity“.
However, preparing a new equation A = L + C after each transaction would be cumbersome and costly, especially when there are a great many transactions in an accounting period. Also, information for a specific item such as cash would be lost as successive transactions were recorded. This information could be obtained by going back and summarizing the transactions, but that would be very time-consuming. Let’s start the lesson with the account…
What is Account?
An account may be defined as: a record of the increases, decreases, and balances in an individual item of asset, liability, capital, income (revenue), or expense.
The simplest form of the account is known as the “T” account because it resembles the letter “T.” The account has three parts:
- The name of the account and the account number
- The debit side (left side)
- The credit side (right side)
The increases are entered on one side, the decreases on the other. The balance (the excess of the total of one side over the total of the other) is inserted near the last figure on the side with the larger amount.
Debit side should be equal the credit side
Debit = Credit
Debits and Credits
When an amount is entered on the left side of an account, it is a debit, and the account is said to be “debited“. And, when an amount is entered on the right side, it is a credit, and the account is said to be “credited“. The abbreviations for debit and credit are ‘Dr.” and “Cr.”
Whether an increase in a given item is credited or debited depends on the category of the item. By convention, asset and expense increases are recorded as debits, whereas liability, capital, and income increases are recorded as credits. Asset and expenses decreases are recorded as credits, whereas liability, capital, and income decreases are recorded as debits.
Here are the basic debit and credit rule, in graphics:
[Info_Box]An account has a debit balance when the sum of its debits exceeds the sum of its credits; it has a credit balance when the sum of the credits is the greater.[/Info_Box]
In double-entry accounting, which is in almost universal use, there are equal debit and credit entries for every transaction. Where only two accounts are affected, the debit and credit amounts are equal. If more than two accounts are affected, the total of the debit entries must equal the total of the credit entries.
For further lesson, then you need to know what transaction is grouped as an asset, expense, liabilities, capital and income/revenue. More on this, you can read “Basic knowledge to prepare bookkeeping system“.
What is Ledger?
The complete set of accounts for a business entry is called a “ledger“. It is the “reference book” of the accounting system and is used to classify and summarize transactions and to prepare data for financial statements. It is also a valuable source of information for managerial purposes, giving, for example, the amount of sales for the period or the cash balance at the end of the period.
What Is Chart of Accounts?
It is desirable to establish a systematic method of identifying and locating each account in the ledger. The chart of accounts, sometimes called the “code of accounts,” is a listing of the accounts by title and numerical description.
[Info_Box]In some companies, the chart of accounts may run to hundreds of items.[/Info_Box]
In designing a numbering structure for the accounts, it is important to provide adequate flexibility to permit expansion without having to revise the basic system. Generally, blocks of numbers are assigned to various groups of accounts, such as assets, liabilities, and so on. There are various systems of coding, depending on the needs and desires of the company.
What is Trial Balance?
As every transaction results in an equal amount of debits and credits in the ledger, the total of all debit entries in the ledger should equal the total of all credit entries.
At the end of the accounting period, we check this equality by preparing a two-column schedule called a trial balance, which compares the total of all debit balances with the total of all credit balances.
The procedure is as follows:
- List account titles in numerical order.
- Record balances of each account, entering debit balances in the left column and credit balances in the right column.
- Add the columns and record the totals.
- Compare the totals. They must be the same.
- If the totals agree, the trial balance is in balance, indicating that debits and credits are equal for the hundreds or thousands of transactions entered in the ledger.
[Info_Box]While the trial balance provides arithmetic proof of the accuracy of the records, it does not provide theoretical proof.[/Info_Box]
If the purchase of equipment was incorrectly charged to Expense, the trial balance columns may agree, but theoretically the accounts would be wrong, as Expense would be overstated and Equipment understated.
In addition to providing proof of arithmetic accuracy in accounts, the trial balance facilitates the preparation of the periodic financial statements.
Generally, the trial balance comprises the first two columns of a worksheet, from which financial statements are prepared (I will post the worksheet procedure later in another other post.)
To classify and summarize a single item of an account group, we use a form called an “Account“.
The accounts make up a record called a “Ledger“.
The left side of the account is known as the “Debit“, while the right side of the account is known as the “Credit“.
Expenses are debited because they decrease “Capital“.
The schedule showing the balance of each account at the end of the period is known as the “Trial Balance“.
Further, you may want to read “Basic knowledge to prepare bookkeeping system” as well.