Introduction to Accounting-Part 1: Basics of Financial
Statements Double-entry Accounting 1 Professor R. Narayanaswamy
Hello, in this class, you will learn the mechanics of the accounting system. As you would know, an account is an individual record of increases and decreases in an item which is likely to be of interest or importance. Accounts are the building blocks of the accounting system.
We will now look at a well-known form of an account—the T account. The T account has three parts:
1. Title that describes the name of the account,
2. Left side or the debit side, and
3. Right side or the credit side.
Debit and credit mean the left side and the right side of an account. To debit an account is to enter an amount on the left side of an account. To credit an account is to enter an amount on the right side of an account. Note that in accounting, debit and credit do not have any value connotations, such as bad and good. Recall the following transactions from an earlier lecture:
1. Invests cash of 10,000 in the business,
2. Takes a bank loan of 40,000,
3. Provides services for cash of 8,000,
4. Pays salaries of 3,000,
5. Buys equipment on credit for 15,000,
6. Withdraws cash of 2,500 for personal purposes.
Let us now see how these transactions would look in a T account. As an illustration, we will record them in the cash account that records cash receipts and cash payments. We enter receipts on the debit or left side and payments on the credit or right side. You may have noticed that transaction 5 does not appear in the cash account. This is because the transaction did not involve cash receipt or cash payment. The cash account shows that the business received a total cash of 58,000, paid a total cash of 5,500, and had a cash balance of 52,500. Since the total of debits is more, this is a debit balance. We enter the balance on the side that has the larger total. The standard form of the account is the one that you may have seen in your bank statement. In this form, there is a separate column for balance.
We will now develop the rules for recording transactions in T accounts. We will begin with the accounting equation. Assets equal liabilities plus equity. The rules for debit and credit are as follows. Assets: Debit increase in asset to asset account. Credit decrease in asset to asset account. Liabilities and equity: Credit increase in liability or equity to liability or equity account. Debit decrease in liability or equity to liability or equity account.
You may recall the following expanded equation: Assets equal liabilities plus capital plus revenues minus expenses minus dividends (or drawings). For convenience, we will re-write the equation as
Introduction to Accounting-Part 1: Basics of Financial Statements Double-entry Accounting 1 Professor R. Narayanaswamy
assets plus expenses plus dividends (or drawings) equal liabilities plus capital plus revenues. We can now extend the rules for recording increase and decrease in equity to revenues, expenses, drawings, and dividends. Thus, we credit revenues to increase them, we debit expenses, drawings, and dividends to increase them. We can now summarize the rules for debit and credit.
Let us now look at two major accounting records —journal and ledger. The journal is a chronological record of transactions. So, transactions would appear in the journal as they occurred. The journal has columns for date, description, debit amount, and credit amount. Journalizing is the process of recording transactions in the journal. Posting is transferring information from the journal to the ledger.
