In this article I will discuss the proper
procedures to follow when using the double entry accounting process. In
accounting we generally record transactions involving two parties. We
have transactions with external parties such as customers, creditors,
or financial institutions. In addition to external parties we also have
internal transactions. These transactions involve exchanges between
divisions within a company or payments to employees.
You first begin the accounting process by
analyzing the source documents. For example, let's say you are on a
business trip and you purchase food or pay for a hotel. When you make
the purchase you receive a receipt. If you want the company to
reimburse you for the meal and hotel expense you must present evidence
of your expenditure. This evidence takes the form of the source
document, which is your receipt. After identifying a business
transaction, we record it in a journal in chronological order by date
of occurrence. At the end of the accounting period, usually at the end
of a month, the transactions in a journal are posted to a ledger
account. This is a systematic process of transferring information from
the journal to the ledger. The ledger groups transactions by the
accounts impacted. For example, all transactions that result in an
increase or decrease in the cash account will be posted to the cash
ledger account. Finally, after all transactions have been posted, then
we prepare a trial balance. The purpose for the trial balance is to
make sure that all information is transferred correctly and is correct.
We all know the following basic accounting
equation is assets = liability + equity. If we look at the expanded
accounting equation equity is broken down into four parts; common
stock, less dividends, plus revenues, and less expenses. We should also
be familiar with T-accounts which are used to represent a general
ledger account. The left side of the T-account is called the debit side
and the right side of the T-account is called the credit side.
Let us now establish the mathematics of the double
entry system. Equity and liability accounts have the opposite sign of
asset accounts. This is because liability accounts were moved to the
left side of the equation, the equation would read assets – liabilities
= equity. Therefore, a debit to an asset account will increase the
account while a credit decreases the asset account. The remaining math
is easy because liability and equity accounts have the opposite sign of
asset accounts therefore, a debit to a liability or equity means a
decrease and a credit means an increase.
In the expanded accounting formula equity is
common stock, less dividends, plus revenues, and less expenses.
Revenues increase equity so it should be recorded like a common stock
account. A credit is an increase in revenues and a debit is an increase
in expenses. Hence, common stock and revenue accounts are both
increased with a credit and decreased with a debit. Since expense and
dividend accounts have opposite signs, they are increased with a debit
and decreased with a credit.
Let us apply the procedures to follow in using the
double entry accounting process with an example. Let's say on November
1st a shareholder invest ten thousand dollars to start a company called
Star Bright. After reading the previous steps you should know that the
cash account and the common stock account should increase. Therefore,
we debit/increase the cash account for ten thousand and we
credit/increase the common stock account. Your double entry should look
like the following:
Cash $10,000
Common Stock 10,000
Our books are in balance because total assets are
equal to total liabilities plus equity. Let us look at a second
transaction. Star Bright buys office supplies for seventeen thousand
five hundred dollars in cash. In doing so Star Bright exchanged one
asset, cash, for another asset, supplies. The cash account will
decrease but the supply account will increase. In this example, you
should increase the supply account with a debit and decrease cash
account with a credit. The double entry should look like the following:
Supply $17,500
Cash 17,500
I hope you have a better understanding of the
double entry process. Basic terminology and the basic accounting
equation are the foundation of accounting and should be mastered in
order to further improve your knowledge in any accounting field.
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Juan Magana | 