Capturing Economic Events

Accounting Cycle - sequence of procedures used to record, classify and summarize accounting information in financial reports, on a regular basis.

Steps in the Accounting Cycle
1) Record (journalize) transactions.
2) Post journal entries to Ledger accounts.
3) Prepare a Trial Balance.
4) Make adjusting entries.
5) Prepare an Adjusted Trial Balance.
6) Prepare financial statements.
7) Journalize and post closing entries.
8) Prepare After-Closing Trial Balance.

General Journal and Journal Entries
Every business transaction is recorded in the General Journal.
The General Journal is called the book of original entry.
A journal is a chronological record of transactions - they are in date order.
Each entry is called a journal entry, and represents a different business transaction. Each transaction is recorded once, and only once.
All journal entries follow the rules of debit and credit.

Journal entries should be made contemporaneously with the event they are recording, or reasonably soon after the event. Keep in mind that a journal is a chronological record of events. A contemporaneous writing is one that takes place at the same time as the event. This is the best time to record an event, because the facts and details are still fresh in our minds. Necessary documents, conversations, calculations, etc., are readily available to create a correct record of the event. If we wait too long, the event will be much more difficult to reconstruct.

In a legal sense, a contemporaneous writing carries much more weight than a writing made at a later date. And a writing carries much more weight than a mere
recollection of events, months or years after the event has taken place. The courts recognize that people's memories about events are much clearer right after the event has taken place. As to the sale of real estate, state laws require a contemporaneous writing, to establish the exact terms and conditions of the sale. In contract law, this is called a “meeting of the minds,” and must be present for a valid contract to exist.

We will use verifiable, tangible evidence whenever it exists. Tangible evidence has physical existence – we can touch it, fold, staple, copy and file the document. We will look for a check, invoice, purchase order, contract or other business document that is a record of the event, a confirmation of payment received and goods delivered, etc. These documents become the back-up documentation for our journal entry.

General Ledger
Transactions are classified into accounts appropriate to the business.
Accounts represent major classifications, or categories, organized according to the 5 account types covered in Chapter 2. The accounts are listed in a Chart of Accounts.

Posting - journal entries are copied to the accounts in the Ledger.
After posting, the balance in each account is updated. Accounts always carry the most current balance.

Balances in Ledger accounts ==become==> Financial Statements

Books & Bookkeeping
Journals and Ledgers were historically written in by hand. They were actual books, which is where many of the terms we use come from. Terms like bookkeeping, journal, balanced books, etc. all came from the days of manually recording entries in books.

Today we use computers to do the same job, but the terminology is usually the same. The concepts we follow are identical whether we use a manual or computer based accounting system. We will use the rules of debit and credit, enter transactions into the Journal, and post to the Ledger.

Debits and Credits
Journals and Ledgers can be viewed as pages of a book. Each page has lines and columns. A journal page has columns for the date, account name, and two columns for dollar amounts, referred to as the Debit and Credit columns.

Sample General Journal page

Date	Account	Debit	Credit

Debit = Left column Credit = Right column

We enter dollar amounts in the Debit and Credit columns.

The totals in the Debit and Credit columns must be equal.

Caution!! Do not confuse the concepts of debit and credit we use here, with what you read in your bank statement. Banks copy their records, and send them to you. It reflects your bank account, from the bank's perspective - which is opposite of your perspective, in an accounting sense.

Sample Ledger page
Account Title

Date	Description	Debit	Credit	Balance

The Ledger page has an additional column to calculate the balance in the account. The balance is updated after each entry.

A Credit balance is usually indicated by enclosing the number in parentheses:
$ (500) would indicate a $500 Credit balance.

Accounts Payable

Date	Description	Debit	Credit	Balance
Jan-1	Balance forward from Dec-31			(500)

The Dollar Sign $ is usually omitted in actual practice. We will always assume that we are using the US Dollar in all transactions, journals, ledgers and financial statements.

Entries are transferred (Posted) from the journal to the ledger pages on a regular basis.

When do we use Debit or Credit?
When to use a debit or credit to record a journal entry is one of the biggest problems for beginning accounting students. It doesn't have to be difficult, if you remember a few simple rules.

First, you will always use both a debit and credit. That's the idea of the double-entry system. You have two columns, so every journal entry will have an equal dollar amount in each column.

Remember the Accounting Equation?

Assets	=	Liabilities+Owners' Equity
Left side		Right Side
Debit side		Credit Side
Debit = Increase Credit = Decrease		Credit = Increase Debit = Decrease

Accounts on the Left side will INCREASE with a Debit (Left column) entry.
Accounts on the Right side will INCREASE with a Credit (Right column) entry.
They will each DECREASE with the OPPOSITE entry.

Refer to the Chart of Accounts to determine whether an account falls on the Left or Right side of the Accounting Equation. You will learn more about how this works as the course progresses. The textbook has many good examples.

Normal Account Balances
Accounts have a normal balance - the balance they would have if increases to the account are more than decreases to the account. If the account has a balance opposite its normal balance, we say the balance is negative, in relation to what it should be. Negative in this sense does not refer to debits or credits, but to a normal or negative balance, regardless of whether that is a debit or credit balance.

You will save a lot of time making journal entries if you remember the normal balance for the accounts.

account type	normal balance	example
Revenue accounts	credit	sales revenue
Expense accounts	debit	rent expense
Asset accounts	debit	cash, accounts receivable
Liability accounts	credit	accounts payable
Owners' equity accounts	credit	capital stock

If you are recording a sale, or other income transaction, you would credit the revenue account, and debit some other account (cash or accounts receivable). If you are recording an expense, you would debit the expense account, and credit some other account.

Many transactions are so common it's easier to remember them, rather than try and think them through each time you have to record them. If you remember how to record one side of the journal entry it is fairly easy to figure out the other side from the information given, e.g.. cash sale v. credit sale.

Type of entry	Do this
Record a sale	credit a revenue account
Record an expense	debit an expense account
Record a credit sale	debit Accounts Receivable
Record a cash sale	debit Cash
Buy supplies on credit	credit Accounts Payable

If you refer to these charts in the beginning it will writing journal entries much easier. Soon you won't have to refer to your charts any more.