1.3: The Mechanics of the Accounting Process
1.3.1 The Journal
Financial statements are key goals of the accounting process. In order to prepare them at the end of an accounting period, individual financial transactions must be analyzed, classified, and recorded all throughout the period. This initially takes place in a record book called the journal , where financial events called transactions are recorded as they happen, in chronological order.
When a transaction occurs, two or more accounts are affected. There is also a dollar amount associated with each of the accounts. Determining which accounts are impacted, and by how much, is the first step in making a journal entry.
This is a sample of a few rows in a journal. It has five columns: Date, Account, Post. Ref., Debit, Credit.
| Date | Account | Debit | Credit | |
In the journal, the column heading Debit means “left” and Credit means “right.” There are other familiar interpretations of these words, so don’t be confused: the terms here only have to do with whether a dollar amount is entered in the left or the right number column.
These words may also be used as verbs: To “debit an account” means to enter its amount in the left column. To “credit an account” means to enter its amount in the right column.
1.3.2 Rules of Debit and Credit
Whether a particular account should be debited or credited is based on (1) the type of account it is and (2) whether the account is increasing or decreasing.
for Cash and Revenue and Expense accounts
| Debit CASH when you receive it | Cash increases |
| Credit CASH when you pay it out | Cash decreases |
| Debit EXPENSES when you incur them | Expenses increase |
| Credit REVENUE when you earn it | Revenue increases |
1.3.3 Journalizing Transactions
We now will come to one of the most important procedures in the recordkeeping process : journal entries . It involves analyzing and writing down financial transactions in a record book called a journal . Financial events are evaluated and translated into the language of accounting using the process of journalizing .
Select two accounts and, according to the rules of debit and credit for cash, revenue, and expense accounts, decide which account to debit (left column) and which to credit (right column). The debit entry is always listed first. No dollar signs are required in the journal.
Journalizing involves the following steps:
- Select two (or more) accounts impacted by a transaction.
- Determine how much, in dollars, each account is affected. Often times the amounts are given; other times the amounts must be calculated based on the information provided.
- Based on the rules of debit and credit, decide which account(s) is debited and which is credited.
- Enter the date on the first line of the transaction only.
- Enter the account that will be debited on the first line of the transaction. Enter its amount in the Debit column on the same line.
- Enter the account that will be credited on the second line of the transaction. Enter its amount in the Credit column on the same line. NOTE: Indent the credit account name three spaces.
On 6/1, a company paid rent of $2,000 for the month of June.
| Date | Account | Debit | Credit | PARTIAL TRANSACTION | |
| 6/1 | Rent Expense | 2,000 | ▲ Rent Expense is an expense account that is increasing . Therefore, it is debited . The account with the debit amount is entered first. | ||
| Date | Account | Debit | Credit | COMPLETE TRANSACTION | |
| Credit | Rent Expense | 2,000 | ▼ Cash is an asset account that is decreasing . Therefore, it is credited . The account with the credit amount is entered next. | ||
| Cash | 2,000 | ||||
On 6/5, a customer paid $800 cash for services the company provided.
| Date | Account | Debit | Credit | PARTIAL TRANSACTION | |
| 6/5 | Cash | 800 | ▲ Cash is an asset account that is increasing . Therefore, it is debited . The account with the debit amount is entered first. | ||
| Date | Account | Debit | Credit | COMPLETE TRANSACTION | |
| 6/5 | Cash | 800 | ▼ Fees Earned is a revenue account that is increasing . Therefore, it is credited . The account with the credit amount is entered next. | ||
| Fees Earned | 800 | ||||
In practice, each transaction follows immediately after the previous one, as shown here.
| Date | Account | Debit | Credit | |
| 6/1 | Rent Expense | 2,000 | ||
| Cash | 2,000 | |||
| 6/5 | Cash | 800 | ||
| Fees Earned | 800 | |||
| 6/8 | Wages Expense | 500 | ||
| Cash | 500 | |||
| 6/10 | Cash | 600 | ||
| Fees Earned | 600 |
The same journal continues on from period to period. You do not start a new journal for a new accounting period (month or year).
1.3.4 Ledger
The ledger is the second accounting record book that is a list of a company’s individual accounts list in order of account category. While the journal lists all types of transactions chronologically, the ledgers separate this same information out by account and keep a running balance of each of these accounts.
Each account has its own ledger page. The account name appears across the top. The ledger form has six columns: Date, Item, Debit, Credit, Debit, Credit. The first set of Debit and Credit columns are where amounts from the journal transactions are copied . The second set of Debit and Credit columns are where the account’s running total is maintained. An account’s running balance typically appears in either the Debit or the Credit column, not both.
The following is a sample ledger for the Cash account.
| Cash | |||||
| Date | Item | Debit | Credit | Debit | Credit |
| 6/1 | 12,000 | 12,000 | |||
| 6/2 | 2,000 | 14,000 | |||
| 6/3 | 3,000 | 11,000 | |||
| Copy amounts from journal (use either column) | BALANCE columns (use one of the two) |
IMPORTANT: Information entered in the ledger is always copied from what is already in the journal.
1.3.5 Posting
The process of copying from the journal to the ledger is called posting . It is done one line at a time from the journal. Here are step-by-step instructions for doing so.
- Take note of the account name in the first line of the journal. Find that ledger account.
- Copy the date from the journal to the first blank row in that ledger.
- Leave the Item column blank in the ledger at this point.
- Take note of the amount on the first line of the journal and the column it is in.
- Copy that amount to the same column in the ledger on the same line where you entered the date.
-
Update the account’s running balance. Take note of the previous balance in the last two columns of the ledger, if there is one. Do one of the following, based on the situation.
- If there is no previous balance and the entry is a Debit, enter the same amount in the Debit balance column.
- If there is no previous balance and the entry is a Credit, enter the same amount in the Credit balance column.
- If the previous balance is in the Debit column and the entry is a Debit, add the two amounts and enter the total in the Debit balance column.
- If the previous balance is in the Debit column and the entry is a Credit, subtract the credit amount from the balance and enter the difference in the Debit balance column. *
- If the previous balance is in the Credit column and the entry is a Credit, add the two amounts and enter the total in the Credit balance column.
- If the previous balance is in the Credit column and the entry is a Debit, subtract the debit amount from the balance and enter the difference in the Credit balance column. *
* Note: The only exception to the above is the rare occasion when one of the calculations above results in a negative number. No negative amounts should appear in the ledgers. Instead, the balance will appear in the opposite balance column.
- Go back to the journal and enter an “x” or checkmark in the PR column to indicate that you have posted that line item.
- Repeat the process for the next line in the journal.
Every time an account appears on a line in the journal, its amount is copied to the proper column in that account’s ledger. A running total is maintained for each account and is updated every time an amount is posted.
The example that follows shows a journal with five transactions that involve Cash . On each row where Cash appears in the journal, the amount on the same line is copied to the same column in the Cash ledger, in either the first Debit or the first Credit column. Superscripts are used here to match each Cash amount in the journal to its posting in the ledger. For example, the first debit to Cash in the journal for $6,000 is copied to the debit column in the ledger (#1). The next time Cash appears in the journal is a credit for $2,000, so that is copied to the first credit column in the ledger (#2).
| Date | Account | Debit | Credit | |
| 6/1 | Cash | x | 6,000 1 | |
| Fees Earned | 6,000 | |||
| 6/2 | Rent Expense | 2,000 | ||
| Cash | x | 2,000 2 | ||
| 6/3 | Wages Expense | 1,000 | ||
| Cash | x | 1,000 3 | ||
| 6/4 | Cash | x | 5,000 4 | |
| Fees Earned | 5,000 | |||
| 6/5 | Wages Expense | 1,000 | ||
| Cash | x | 1,000 5 | ||
| Date | Item | Debit | Credit | Debit | Credit |
| 6/1 | 6,000 1 | 6,000 | |||
| 6/2 | 2,000 2 | 4,000 | |||
| 6/3 | 1,000 3 | 3,000 | |||
| 6/4 | 5,000 4 | 8,000 | |||
| 6/5 | 1,000 5 | 7,000 | |||
As shown in the previous example, the first entry in the ledger indicates which of the two final columns will normally be used to maintain the accounts running balance. For the Cash account, the first entry is in the first Debit column, so the running balance begins accumulating in the second Debit column. On the first row, the amounts in the two Debit columns will be the same. In this case, the amount is $6,000 in both. After the first entry in the ledger, subsequent debit entries are added to the previous debit balance, and subsequent credit entries are deducted from the previous debit balance.
You can go to an ATM to withdraw cash from your checking account. The first steps are to insert your debit card into the ATM machine and select the amount you would like to receive. If that is all you do, no money will come out no matter how long you stand there. In order to get the job done, you also need to enter your PIN. The goal is to withdraw cash, and if you do not complete that step, it is not going to happen.
Similarly, there is a goal to preparing the journal and ledgers – to maintain a running balance of each account your business has. If you enter a transaction in the journal, you are off to a good start, but if you don’t complete the step of posting the journal entry to the ledgers, the correct balances are not going to happen.
1.3.6 Normal Balance
The last two Debit and Credit columns in the ledger are where a running total (balance) is maintained for each account. An account’s running balance will accumulate in EITHER the Debit balance column OR Credit balance column (two far right columns), but rarely both. The normal balance is also whatever it takes to increase that type of account, either Debit or Credit. The normal balance for an account is the column in which its running total is maintained.
An example of a journal and ledgers follows. Try to follow how the numbers from the journal on the left appear in the ledgers on the right and how the running balances in the ledgers are determined.
| Date | Account | Debit | Credit | |
| 6/1 | Cash | x | 2,000 | |
| Fees Earned | x | 2,000 | ||
| 6/2 | Supplies Expense | x | 300 | |
| Cash | x | 300 | ||
| 6/3 | Cash | x | 500 | |
| Fees Earned | x | 500 | ||
| 6/4 | Supplies Expense | x | 200 | |
| Cash | ||||
| 6/5 | Cash | x | 800 | |
| Fees Earned | x | 800 | ||
| 6/6 | Supplies Expense | x | 400 | |
| Cash | x | 400 | ||
| 6/7 | Cash | x | 600 | |
| Fees Earned | x | 600 | ||
| Cash | |||||
| Date | Item | Debit | Credit | Debit | Credit |
| 6/1 | 2,000 | 2,000 | |||
| 6/2 | 300 | 1,700 | |||
| 6/3 | 500 | 2,200 | |||
| 6/4 | 200 | 2,000 | |||
| 6/5 | 800 | 2,800 | |||
| 6/6 | 400 | 2,400 | |||
| 6/7 | 600 | 3,000 | |||
| Fees Earned | |||||
| Date | Item | Debit | Credit | Debit | Credit |
| 6/1 | 2,000 | 2,000 | |||
| 6/3 | 500 | 2,500 | |||
| 6/5 | 800 | 3,300 | |||
| 6/7 | 600 | 3,900 | |||
| Supplies Expense | |||||
| Date | Item | Debit | Credit | Debit | Credit |
| 6/2 | 300 | 300 | |||
| 6/4 | 200 | 500 | |||
| 6/6 | 400 | 900 | |||
The first entry in each ledger, either Debit or Credit, dictates whether the running balance will appear in the Debit or the Credit balance column. If the first entry is a Debit, the running balance accumulates in the Debit balance column. A debit is the “positive” for this type of account; any subsequent debit entries are added and credit entries are subtracted from the running balance. Conversely, if the first entry is a Credit, the running balance accumulates in the Credit balance column. A credit is the “positive” for this type of account; any subsequent credit entries are added and debit entries are subtracted from the running balance.
The grayed column above in each ledger represents the balance column that will normally remain blank.
The total of all the Debit balances in the ledgers MUST EQUAL the total of all the Credit balances in the ledgers. If this is not the case, there is a recording error that must be located and corrected. In the example above, the ledgers balance: 3,000 + 900 (debit balances) = 3,900 (credit balance).
The same ledgers continue on from period to period. You do not start new ledgers for a new accounting period (month or year).
To summarize the two record books, the journal first records all types of transactions chronologically, in time sequence order. The ledgers separate the same information out by account and keep a balance for each of these accounts.
IMPORTANT: If you are making entries in the ledgers, you must be COPYING from the journal.
I have a great recipe for chocolate chip cookies. Here are the ingredients
At this point you must be confused, or think I am crazy. The cookies could not possibly be the result of those ingredients—the input does not match the output. Anyone who knows anything about cookies can see that.
It is the same with the accounting process. It is not possible to have a correct ledger and/or financial statement balances if the input in the journal has errors. Yet some students “know,” or copy from others, what the correct results should be in spite of incorrect journal entries. This violates the process of posting to the ledgers, which is carrying over what is in the journal.
It is more correct for an error to carry through to all parts than for one part to be incorrect and subsequent parts to be correct. To your accounting instructor, a correct balance based on a faulty journal is as unlikely an outcome as is chocolate chip cookies from taco ingredients. It just can’t happen!
If there is an error in the journal, procedurally the mistake should carry through to the ledgers and the financial statements.
1.3.7 Trial Balance
The total of all the debit balances in a company’s ledger accounts must always equal the total of all the credit balances. A trial balance is a list of all a business’s accounts and its current ledger balances (copied over from the ledger accounts). A trial balance may be generated at any time to test whether total debits equals total credits. It is simply a worksheet to check for accuracy before preparing financial statements. If both of the Total columns do not equal, there is an error that must be found and corrected.
The example that follows is for a company with only four accounts. The trial balance on the left lists these accounts and their corresponding balances at the end of the month, which are copied over from the ledgers on the right.
| Account | Debit | Credit |
| Cash | 3,000 | |
| Common Stock | 2,000 | |
| Fees Earned | 1,900 | |
| Supplies Expense | 900 | |
| TOTAL | 3,900 | 3,900 |
LEDGERS
| Date | Item | Debit | Credit | Debit | Credit |
| 6/1 | 2,000 | 2,000 | |||
| 6/2 | 300 | 1,700 | |||
| 6/3 | 500 | 2,200 | |||
| 6/4 | 200 | 2,000 | |||
| 6/5 | 800 | 2,800 | |||
| 6/6 | 400 | 2,400 | |||
| 6/7 | 600 | 3,000 | |||
| Date | Item | Debit | Credit | Debit | Credit |
| 6/1 | 2,000 | 2,000 | |||
| Date | Item | Debit | Credit | Debit | Credit |
| 6/3 | 500 | 500 | |||
| 6/5 | 800 | 1,300 | |||
| 6/7 | 600 | 1,900 | |||
| Date | Item | Debit | Credit | Debit | Credit |
| 6/2 | 300 | 300 | |||
| 6/4 | 200 | 500 | |||
| 6/6 | 400 | 900 | |||