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In this particular episode, you will learn

  • Accounting Debits and Credits

Podcast transcript:

Debits and Credits Accounting System

The Double Entry System

Different Account Types

 

Increases and Decreases
Debits and Credits Accounting System

Debits and credits form the foundation of the accounting system. The mechanics of the system must be memorized. Once understood, you will be able to properly classify and enter transactions. These entries make up the data used to prepare financial statements, such as the balance sheet and income statement. While software has simplified entering daily transactions, debit and credit entries are always recorded in the background.

Learning about debits and credits requires a combination of memorization and application of the terms. Memorization of account types, as well as increase and decrease rules, is a good first step. Next, you must understand how transactions are recorded into the system. The goal is to be able to manually record and adjust transactions using debits and credits. Use all resources: lessons, flashcards, rap memory aid, practice sets, video, and Accounting Play – Debits & Credits game for iPhone and iPad. For video and downloads, please go to AccountingPlay.com.
Every accounting transaction involves at least one debit and one credit. The sum of debits and the sum of credits for each transaction and the total of all transactions are always equal. This equaling process is referred to as balancing. A list of all transactions appears in the general ledger and the sum of assets will equal the sum of liability and equity accounts on the balance sheet. Transactions are manually entered into the accounting record using adjusting journal entries (AJEs) which present debits before credits. Accountants may use a trial balance to summarize all accounts in debit and credit format so they can be further adjusted with AJEs.

Memorize rule: debits always equal credits

Memorize rule: debits before credits

 

The Double Entry System

The process of recording transactions with debits and credits is referred to as double entry accounting, because there are always at least two accounts involved. The result of using double entry accounting ensures that every transaction is classified and recorded.

The double entry system requires us to pick at least two accounts to record a transaction. Let's say a business receives $1,000 cash. To record the transaction, the cash account is increased $1,000. As a rule we need at least one other account to record the activity. The other account will help explain the source and purpose of the transaction. Cash can come from a variety of sources, such as: revenue, loans, investments, investors, or cash back from returning an item. In this example, the business was paid cash for services performed. The revenue account therefore also increases $1,000 the same time cash increases $1,000.

The double entry system is used to categorize all transactions in the accounting record. Let's say $200 cash is paid from the bank. Cash is decreased $200, which explains where the money came from. Another account is required to explain the destination and purpose of the transaction. Cash is used for a variety of things: equipment, investments, loan payments, expenses, and stock repurchases. In this example, the business paid a $200 phone bill in cash. The telephone expense account therefore increases $200. The combined entry will be to increase telephone expense and reduce cash for the same amount. The increase and decrease will be expressed on the accounting record as one debit and one credit.

The double entry system categorizes transactions using five account types: assets, liabilities, equity, income, and expense. The same account may be used if there is an increase and a decrease of the same category, such as a cash transfer. Assets, liabilities, and equity make up the balance sheet and form the accounting equation: Assets (A) = Liabilities (L) + Equity (E). Revenue and expenses make up the income statement and can generally be expressed as Revenue – Expenses = Income or Loss.

 

Different Account Types

Every account is classified in one of five different classifications: assets, liabilities, equity, revenue, and expense. Each account is increased or decreased with a debit or credit, depending on the classification.

Assets: cash and cash equivalents, accounts receivable, inventory, prepaid expense, investments, property, plant, and equipment, accumulated depreciation, intangible assets, accumulated amortization

Contra assets: allowance for doubtful accounts, accumulated depreciation, accumulated       amortization

Liabilities: accounts payable, notes payable, accrued expenses, deferred revenue, long-term bonds payable

Contra liability: bond discount

Equity: common stock, additional paid-in capital, retained earnings

Contra equity: treasury stock

Revenue: sales revenue, interest income, investment income

Expense: selling, general, and administrative, interest, repairs, depreciation