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The Accounting Recording/Bookkeeping Process Explained in 5 Minutes


This is part of a financial literacy blog series, check out the first part.

What an Account is, and How it Helps the Recording Process

For companies and financial institutions with large daily volumes of business transactions, the recording process is a very crucial part of keeping track of the company’s financial data. Problems arise all the time, an example of these problems is mistakes that occur while recording(remember the woman from Dallas who woke up one day, opened her personal bank account on her smartphone to find $37deposited by mistake?)

Here is the video for you in case you don’t know about it:

And that’s why, these companies need to record their transactions in simple, practical, and inexpensive way. Thus, to keep track of their transaction data, companies follow certain procedures and keep certain records.

The Account:

An account is an individual accounting record of increases and decreases in a specific asset, liability, or equity item.

Financial Accounting: IFRS 4th Edition

And so each company has an account separate for each item. So items that belong under assets like Cash, Accounts Receivables, Equipment, etc.. have their own account. Also, item that belong under liabilities, like Accounts Payable, Notes Payable, Wages Payable have their own accounts, and so on.

An account’s most basic form has three parts:

  • a title
  • a debit side (on the left)
  • a credit side (on the right)
a T-account used for simplify things for learners

=> This is also known as a T-account (because of its form where illustrated obviously).

Definition of Debits & Credits:

Debit and Credit are commonly abbreviated as Dr. and Cr. respectively.

However, be careful Debit and Credit should not be interpreted as either Increase nor Decrease. You only should understand them as to what side of the Account they affect.

Debit: describes entries made into the left side of the account.
Credit: describes entries made into the right side of the account.

=> Hence, come the terms Debiting and Crediting an account.
=> After comparing the totals of each side, the account will either show a Debit Balance or a Credit Balance.

Double-entry bookkeeping system requires that for each transaction, the debit amount must be equal to the credit amount.

Benefits/Pros of the The Double-entry system(claimed to be invented by many including, but not limited to the Koreans during the time of the Goryeo Dynasty but first used in Europe by Italian Florentine merchant Amatino Manucci):
Increases Accuracy
Reduces Errors and Facilitate their detection
Generally more efficient

Debit & Credit Entries Effects on Assets:
=> Debits: Increase Assets
=> Credits: Decrease Assets

Debit & Credit Entries Effects on Liabilities:
=> Debits: Decrease Liabilities
=> Credits: Increase Liabilities

And if you are wondering why the above effects are opposite, it will be beyond easy to understand why once you remember the basic accounting equation we’ve covered in part I of this series. Assets=Liabilities+Equity.

=>Hence whatever effects Debits have on assets, then they must have exactly the opposite of that on Liabilities.

=> Most of the time, Assets should have debit balances, and liabilities should have credit balances.

Effects of Debit/Credit entries on Equity Accounts (Share Capital—ordinary, Retained Earnings, Dividends, Revenues & Expenses):
Effects on Share Capital—Ordinary:
=> Debits Decrease it
=> Credits Increase it
Retained Earnings:
=> Debits Decrease it
=> Credits Increase it
Dividends:
=> Debits Increase it
=> Credits Decrease it
Revenues:
=> Debits Decrease it
=> Credits Increase it
Expenses:
=> Debits Increase it
=> Credits Decrease it

Now, of course, you may saying to yourself ‘Do I have to remember each Account’s specifics when it comes to Debits and Credits?’

Of course not! In fact, you only have to remember one account’s effects and understand well The Basic Accounting Equation, and you are good to go; You will be able to figure out how each of the accounts is affected by Debiting or
Crediting & its normal balance by simply looking at The Basic Accounting Equation.

The Basic Steps in The Recording Process:

There are 3 steps in the recording process:

  1. Each Transaction Gets Analyzed
  2. Transaction Gets Entered into THE JOURNAL
  3. That Transaction Entry into THE JOURNAL Gets further Transferred into THE LEDGER

What is a Ledger in Bookkeeping:

If you could think of the General Journal as a way to keep track of business transactions, then, the General Ledger is keeping track of all the accounts.

=>Journal: keeps tracks of events happening (business events=business transactions)
=>Ledger: keeps track of ‘state’ of accounts(increases, decreases, balance, etc..)

And, hence a Ledger is the set of all accounts maintained a company. The most common being the General Ledger.

a three-column account in the Ledger

The standard form of recording the state of an account within the Ledger is also known as the three-column form of account (it has three columns allocated for money: debits, credit, and balance)

What is a Journal in the Recording Process:

The Journal (aka the book of original entry) is a series of business transactions recorded in a chronological order, using the Double-Entry System. The whole process is also known as Journalizing.

Pros/Benefits of Jounalizing/Keeping a Journal:
It clearly portrays the effect of each business transaction
Its chronological nature helps the business identify certain trends, find errors easily, and keeping a historical record hustle-free

There are two kind of journal entries:
Simple Entries: involves two accounts only; one for debit, and the other for credit.
Compound Entries: usually a business transaction that involves more than two accounts

A good example of a compound entry is when your business buys new equipment to improve overall operations(lower cost, faster delivery, etc..) and when you don’t pay the full sum in cash. Let’s assume you got billed £79,000 British Pounds for the new line of equipment. And, you pay £30,000 in cash, and the remaining £49,000 on credit.
=>Then, this business transaction will be ‘journalized’ as a compound entry.

Usually, the Journal has columns for account title, explanations, references, dates, and two columns one for Debit and the other for Credit.

The General Journal in Recording/Bookkeeping

Within the account title and explanation section, the name of the account to be debited is written first and then beneath it, and a little bit indented, the name of the account to be credited.

Then, each corresponding Debit and Credit amount are recorded in their respective columns.

The Ref column is initially left empty, till the entries are transferred to the Ledger; At that time, it will be assigned a Reference number.

What is Posting in Bookkeeping?

Posting is simply the process of transferring the journal entries into the corresponding affected accounts in the Ledger.

The Trial Balance & Its Purposes:

This is a list that is usually prepared at the end of an accounting period. It lists all of the accounts and their balances at any given moment t. This is obviously directly fetched from the ledger. In fact, The Trial Balance lists all the accounts in that same order in which they appear within The Ledger.

Some FAQs:

  • Do Companies Report All of Equity Accounts in The Same Financial Report?
    => No.
    => Companies report Revenues and Expenses (as well as net them out to determine the resulting Net Income or Net Loss) in The Income Statement.
    => They report Share Capital—Ordinary & Retained Earnings in The Statement of Financial Position.
    => Then, they report Dividends (as well as Retained Earnings again in details) in The Retained Earnings Statement.
  • Do Companies only use one type of Journal?
    => No. They use a variety of Journals during the recording process. However, almost every company keeps the simplest and most basic form of a Journal aka The General Journal.
  • What is a Chart of Accounts?
    => This is simply a list of all of the Ledger’s accounts with their names and corresponding unique identifying number. And generally (this differs from one company to another) there is an allocated range or interval for recognizing specific types of accounts. Example: Asset accounts numbers between 101-199.

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