Debits and Credits Pa r t 1 Introduction to Debits and CreditsIntroduction to Debits and Credits,...
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Transcript of Debits and Credits Pa r t 1 Introduction to Debits and CreditsIntroduction to Debits and Credits,...
Debits and Credits
Part 1
Introduction to Debits and Credits, What's an "Account"?, Double-Entry Accounting, Debits & Credits
Part
2
T–accounts, Journal Entries, When Cash Is Debited and Credited
Part
3
Normal Balances, Revenues & Gains are Usually Credited, Expenses & Losses are Usually Debited, Permanent & Temporary Accounts
Part
4
Bank's Debits & Credits, Bank's Balance Sheet, Recap
I
If the words "debits" and "credits" sound like a foreign language to you, you are more perceptive than you realize—"debits" and "credits" are words that have been traced
back five hundred years to a document describing today's double-entry accounting system.
Under the double-entry system every business transaction is recorded in at least two accounts. One
account will receive a "debit" entry, meaning the amount will be entered on the left side of that account. Another
account will receive a "credit" entry, meaning the amount will be entered on the right side of that account. The initial
challenge with double-entry is to know which account should be debited and which account should be credited.
What Is An Account?To keep a company's financial data organized,
accountants developed a system that sorts transactions into records called accounts. When a
company's accounting system is set up, the accounts most likely to be affected by the
company's transactions are identified and listed out. This list is referred to as the company's chart of accounts. Depending on the size of a company and the complexity of its business operations, the
chart of accounts may list as few as thirty accounts or as many as thousands. A company has the
flexibility of tailoring its chart of accounts to best meet its needs.
A chart of accounts is a listing of the names of the accounts that a company has identified and made available for recording transactions in its general ledger. A company has the flexibility to tailor its chart of accounts to best suit its needs, including adding accounts as needed.Within the chart of accounts you will find that the accounts are typically listed in the following order:
Balance sheet accounts
Assets Liabilities Owner's (Stockholders')
Equity
Income statement accounts Operating
Revenues Operating
Expenses Non-operating
Revenues and Gains
Non-operating Expenses and Losses
Within the categories of operating revenues and operating expenses, accounts might be further organized by business
function (such as producing, selling, administrative, financing) and/or by company divisions, product lines, etc. A company's organization chart can serve as the outline for its accounting chart of accounts. For example, if a company
divides its business into ten departments (production, marketing, human resources, etc.), each department will
likely be accountable for its own expenses (salaries, supplies, phone, etc.). Each department will have its own phone expense account, its own salaries expense, etc.
A chart of accounts will likely be as large and as complex as the company itself. An international corporation with several divisions may need thousands of accounts, whereas a small
local retailer may need as few as one hundred accounts.
Each account in the chart of accounts is typically assigned a name and a unique number by which it
can be identified. (Software for some small businesses may not require account numbers.) Account numbers are often five or more digits in
length with each digit representing a division of the company, the department, the type of account, etc.
As you will see, the first digit might signify if the account is an asset, liability, etc. For example, if
the first digit is a "1" it is an asset. If the first digit is a "5" it is an operating expense.
A gap between account numbers allows for adding accounts in the future. The following is a partial
listing of a sample chart of accounts.
Current Assets (account numbers 10000 - 16999)10100 Cash - Regular Checking10200 Cash - Payroll Checking
10600 Petty Cash Fund12100 Accounts Receivable
12500 Allowance for Doubtful Accounts13100 Inventory14100 Supplies
15300 Prepaid InsuranceProperty, Plant, and Equipment (account numbers 17000 - 18999)
17000 Land17100 Buildings
17300 Equipment17800 Vehicles
18100 Accumulated Depreciation - Buildings18300 Accumulated Depreciation - Equipment18800 Accumulated Depreciation - Vehicles
Current Liabilities (account numbers 20000 - 24999)20100 Notes Payable - Credit Line #120200 Notes Payable - Credit Line #2
21000 Accounts Payable22100 Wages Payable23100 Interest Payable
24500 Unearned RevenuesLong-term Liabilities (account numbers 25000 - 26999)
25100 Mortgage Loan Payable25600 Bonds Payable
25650 Discount on Bonds PayableStockholders' Equity (account numbers 27000 - 29999)
27100 Common Stock, No Par27500 Retained Earnings
29500 Treasury StockOperating Revenues (account numbers 30000 - 39999)
31010 Sales - Division #1, Product Line 01031022 Sales - Division #1, Product Line 02232015 Sales - Division #2, Product Line 01533110 Sales - Division #3, Product Line 110
Cost of Goods Sold (account numbers 40000 - 49999)41010 COGS - Division #1, Product Line 01041022 COGS - Division #1, Product Line 02242015 COGS - Division #2, Product Line 01543110 COGS - Division #3, Product Line 110
Marketing Expenses (account numbers 50000 - 50999)50100 Marketing Dept. Salaries
50150 Marketing Dept. Payroll Taxes50200 Marketing Dept. Supplies
50600 Marketing Dept. TelephonePayroll Dept. Expenses (account numbers 59000 - 59999)
59100 Payroll Dept. Salaries59150 Payroll Dept. Payroll Taxes
59200 Payroll Dept. Supplies59600 Payroll Dept. Telephone
Other (account numbers 90000 - 99999)91800 Gain on Sale of Assets96100 Loss on Sale of Assets
Within the chart of accounts the balance sheet accounts are listed first, followed by the income statement accounts. In other words, the accounts are organized in the chart of
accounts as follows:Assets
LiabilitiesOwner's (Stockholders') Equity
Revenues or IncomeExpenses
GainsLosses
Because every business transaction affects at least two accounts, our accounting system is known as a double-entry system. (You can refer to the company's chart of accounts to
select the proper accounts. Accounts may be added to the chart of accounts when an appropriate account cannot be found.)
For example, when a company borrows $1,000 from a bank, the transaction will affect the company's Cash account and the
company's Notes Payable account. When the company repays the bank loan, the Cash account and the Notes Payable account
are also involved.If a company buys supplies for cash, its Supplies account and its Cash account will be affected. If the company buys supplies on
credit, the accounts involved are Supplies and Accounts Payable.
If a company pays the rent for the current month, Rent Expense and Cash are the two accounts involved. If a
company provides a service and gives the client 30 days in which to pay, the company's Service Revenues account and
Accounts Receivable are affected.Although the system is referred to as double-entry, a transaction may involve more than two accounts. An
example of a transaction that involves three accounts is a company's loan payment to its bank of $300. This
transaction will involve the following accounts: Cash, Notes Payable, and Interest Expense.
(If you use accounting software you may not actually see that two or more accounts are being affected due to the
user-friendly nature of the software. For example, let's say that you write a company check by means of your
accounting software. Your software automatically reduces your Cash account and prompts you only for the other
accounts affected.)
Accountants and bookkeepers often use T-accounts as a visual aid for seeing the effect of the debit and credit on the two (or more) accounts. (Learn more about accountants and bookkeepers in our Accounting Careers area.) We will begin with two T-accounts: Cash and Notes Payable.
Cash (asset account)
DebitIncreases an assetReceived $
CreditDecreases an assetPaid $
Notes Payable (liability account)
DebitDecreases a liabilityRepaid loan
CreditIncreases a liabilityBorrowed more
Let's demonstrate the use of these T-accounts with two transactions:
On June 1, 2009 a company borrows $5,000 from its bank. This causes the company's asset Cash
to increase by $5,000 and its liability Notes Payable to also increase by $5,000. To increase the asset Cash the account needs to be debited. To increase the company's liability Notes Payable this account needs to be credited. After entering the debits and credits the T-accounts look like
this:
Cash (asset account)
DebitIncreases an assetReceived $
CreditDecreases an assetPaid $
June 1, 2009
ENTRY
5,000
Notes Payable (liability account)
DebitDecreases a liabilityRepaid loan
CreditIncreases a liabilityBorrowed more
5,000
ENTRY June 1, 2009
Whenever cash is received, the Cash account is debited (and another account is credited).Whenever cash is paid out, the Cash account is credited (and another account is debited).Normal BalancesWhen looking at a T-account for each of the account classifications in the general ledger, here is the debit or credit balance you would normally find in the account:
Account ClassificationNormal
Balance
Assets Debit
Contra asset Credit
Liability Credit
Contra liability Debit
Owner's Equity Credit
Stockholders' Equity Credit
Owner's Drawing orDividends Account
Debit
Revenues (or Income) Credit
Expenses Debit
Gains Credit
Losses Debit