BASIC ACCOUNTING

SOME NOTES ON ACCOUNTING

When a small business makes a financial transaction, they make a journal entry in their accounting journal in order to record that transaction. The transaction is recorded in the general journal or one of the special journals for the most active accounts. The most common special journals are the Sales Journal, the Purchases Journal, the Cash Receipts Journal, and the Cash Disbursements Journal.

An accounting journal is a detailed record of the financial transactions of the business. The transactions are listed in chronological order, by amount, by accounts that are affected, and in what direction those accounts are affected. Depending on the size and complexity of the business, a reference number can be assigned to each transaction and a note may be attached explaining the transaction.

The accounting journal is the place where the details lie. The general ledger is where you look for the big picture. A sample accounting journal page has columns for the date, the account, the amount of the debit, and the amount of the credit.

When to use a Debit or Credit in a Journal Entry

One of the most difficult things to get a handle on when setting up your books is when to use a debit and when to use a credit. Here are some simple rules. If you will follow these rules, it will make your accounting life a lot easier.

·         You will always use both a debit and a credit for every journal entry. That is what the system of double-entry bookkeeping is based on. You have two columns in your journal entry. Each will have an equal entry - one for a debit, one for a credit.

·         Remember the format of the Accounting Equation where Assets = Liabilities + Owners Equity. The Asset side is the left side of the equation and the Liabilities + Owner's Equity is the right side of the equation. When you need to make a journal entry, refer to your Chart of Accounts to see if the account you need to use falls on the left or right side of the accounting equation.

·         If the account is on the Asset or left side, that is the Debit side. A debit will increase those accounts and a credit will decrease them. If the account is on the Liabilities and Owner's Equity or right side, that is the Credit side. A credit will increase those accounts and a debit will decrease them.

Journal Entries when Accounts have Normal Balances

One easy way to remember when to debit and when to credit an account is to remember the normal balances of the five types of accounts on the Chart of Accounts. The normal balance is what the account would have if increases are more than decreases. Here is a list of those accounts and their normal balances. If you remember this list, it will save you a lot of time.

·         Asset accounts - debit

·         Liability accounts - credit

·         Owner's equity - credit

·         Revenue accounts - credit

·         Expense accounts - debit

As an example, if you are recording an entry to the asset account, you would debit the asset account and credit some other account.

Example of a Journal Entry

Here is an example of a correct journal entry. This example is the journal entry you would make at the start of a new business. If an owner invested $20,000 in a new business, this would be the format of the journal entry. There would be an increase in assets, specifically the cash account, in the amount of $20,000 recorded as a debit and an increase to the owner's equity account would be a credit.

The Eight Steps of the Accounting Cycle

As a bookkeeper, you complete your work by completing the tasks of the accounting cycle. It’s called a cycle because the accounting workflow is circular: entering transactions, manipulating the transactions through the accounting cycle, closing the books at the end of the accounting period, and then starting the entire cycle again for the next accounting period.

The accounting cycle has eight basic steps, which you can see in the following illustration. These steps are described in the list below.

1.    Transactions

Financial transactions start the process. Transactions can include the sale or return of a product, the purchase of supplies for business activities, or any other financial activity that involves the exchange of the company’s assets, the establishment or payoff of a debt, or the deposit from or payout of money to the company’s owners.

2.    Journal entries

The transaction is listed in the appropriate journal, maintaining the journal’s chronological order of transactions. The journal is also known as the “book of original entry” and is the first place a transaction is listed.

3.    Posting

The transactions are posted to the account that it impacts. These accounts are part of the General Ledger, where you can find a summary of all the business’s accounts.

4.    Trial balance

At the end of the accounting period (which may be a month, quarter, or year depending on a business’s practices), you calculate a trial balance.

5.    Worksheet

Unfortunately, many times your first calculation of the trial balance shows that the books aren’t in balance. If that’s the case, you look for errors and make corrections called adjustments, which are tracked on a worksheet.

Adjustments are also made to account for the depreciation of assets and to adjust for one-time payments (such as insurance) that should be allocated on a monthly basis to more accurately match monthly expenses with monthly revenues. After you make and record adjustments, you take another trial balance to be sure the accounts are in balance.

6.    Adjusting journal entries

You post any corrections needed to the affected accounts once your trial balance shows the accounts will be balanced once the adjustments needed are made to the accounts. You don’t need to make adjustingentries until the trial balance process is completed and all needed corrections and adjustments have been identified.

7.    Financial statements

You prepare the balance sheet and income statement using the corrected account balances.

8.    Closing the books

You close the books for the revenue and expense accounts and begin the entire cycle again with zero balances in those accounts.

As a businessperson, you want to be able to gauge your profit or loss on month by month, quarter by quarter, and year by year bases. To do that, Revenue and Expense accounts must start with a zero balance at the beginning of each accounting period. In contrast, you carry over Asset, Liability, and Equity account balances from cycle to cycle.