Basic Principles of Accounting and Finance

Double - Entry Accounting

• Each transaction affects at least two accounts
• Each transaction is recorded with at least one debit and one credit
• Total debts must = total credits
• For example, by purchasing supplies by cash, this transaction decreases cash at the bank and increases supplies. A purchase on credit increases supplies and increases accounts payable.
• All transactions have at least two effects on the entity

The T - Account

The account format used most widely is called the T account because it takes the form of the capital letter “T”. The vertical line of the T divides the account into its left and right sides. The account title rests on the horizontal line.

Decreases and Increases in the Accounts

• Increases in assets are recorded on the left (debit) side of the account
• Decreases in assets are recorded on the right (credit) side
• Increases in liabilities and owners equity are recorded by credits
• Decreases in liabilities and owners equity are recorded by debits
• Assets are on the opposite side of the equation from liabilities and owner's equity
• Liabilities and owners equity are therefore, on the same side of the equal sign

• The process of creating a new T account in preparation for recording a transaction is called “opening the account.”

Recording Transactions in the Journal

Accountants record transactions in a journal - a list in chronological order of all the transactions for a business. The journalizing process follows four steps:

1. Identify the transaction from source documents, such as sales and sales receipts
2. Specify accounts affected by the transaction and classify it by type (asset, liability or owner's equity)
3. Determine whether each account is increased or decreased by the transaction. Using the rules of debit or credit the account to record its increase or decrease
4. Enter the transaction in the journal, including a brief explanation for the journal entry

The journal entry includes:

1. The date of the transaction
2. The title of the account debited
3. The title of the account credited
4. The dollar amounts of the debt, then credit
5. A short explanation of the transaction
6. Posting from the Journal to the Ledger

Ledger - A collection of all accounts utilized by an entity during an accounting period. Includes:

• Loose leaf pages
• Bounded books
• Computer printouts
• Cards

Posting - copying the amounts from the journal to the accounts in the ledger.

• Each journal entry posted to the ledger is keyed by date or by transaction number
• In this way, any transaction can be traced from the journal to the ledger and back to the journal. This linking allows you to locate any information you may need for decision-making.

The Trial Balance

• A list of all the accounts with their balances - assets first, followed by liabilities and then owner's equity - taken from the ledger
• Before computers, it provided a check on accuracy by showing whether total debits equal total credits

Locating and Correcting Trial Balance Errors

In a trial balance, the total debts and total credits should be equal. If they are not, then accounting errors exist.

1. Search the trial balance for a missing account. Trace each account from the ledger to the trial balance and you will locate the missing account.
2. Divide the difference between total debts and total credits by 2
3. Check journal postings
4. Review accounts for reasonableness