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Double Entry Accounting Process
In this article, I will discuss the proper procedures to follow when using the double-entry bookkeeping process. In accounting, we usually record transactions involving two parties. We have transactions with external parties such as customers, creditors or financial institutions. In addition to external parties, we also have internal transactions. These transactions involve exchanges between divisions within a company or payments to employees.
You first start the accounting process by analyzing the source documents. For example, suppose you are on a business trip and are buying food or paying for a hotel. When you make the purchase, you receive a receipt. If you want the company to reimburse you for meals and hotel expenses, you must submit proof of your expenses. This proof takes the form of the source document, which is your receipt. After identifying a business transaction, we record it in a journal in chronological order by date of occurrence. At the end of the accounting period, usually at the end of a month, transactions from a journal are posted to a general ledger account. It is a systematic process of transferring information from the journal to the general ledger. The general ledger groups the transactions by the impacted accounts. For example, all transactions that result in an increase or decrease in the cash account will be posted to the cash ledger account. Finally, once all transactions are recorded, we prepare a trial balance. The purpose of the trial balance is to ensure that all information is transferred correctly and is correct.
We all know that the following basic accounting equation is Assets = Liabilities + Equity. If we look at the expanded accounting equation, equity is broken down into four parts; common stock, less dividends, plus income, and less expenses. We should also be familiar with T accounts which are used to represent a general ledger account. The left side of the T-account is called the debit side and the right side of the T-account is called the credit side.
Now let’s establish the mathematics of the double-entry system. Equity and liability accounts have the opposite sign of asset accounts. This is because liability accounts have been moved to the left side of the equation, the equation would read assets – liabilities = equity. Therefore, a debit to an asset account will increase the account while a credit will decrease the asset account. The remaining calculation is easy because the liability and equity accounts have the opposite sign of the asset accounts. Therefore, a debit to a liability or equity means a decrease and a credit means an increase.
In the expanded accounting formula, equity is common stock minus dividends plus income minus expenses. Income increases equity, so it should be recorded as a common stock account. A credit is an increase in income and a debit is an increase in expenses. Therefore, the equity and income accounts are both increased by a credit and decreased by a debit. Since expense and dividend accounts have opposite signs, they are increased by a debit and decreased by a credit.
Let’s apply the procedures to follow using the double-entry bookkeeping process with an example. Let’s say that on November 1, a shareholder invests ten thousand dollars to start a company called Star Bright. After reading the previous steps, you should know that the cash account and the common stock account should increase. Therefore, we debit/increase the cash account by ten thousand and we credit/increase the common stock account. Your double entry should look like this:
Common shares $10,000
Our books are balanced because total assets equal total liabilities plus equity. Let’s look at a second transaction. Star Bright buys office supplies for seventeen thousand five hundred dollars in cash. In doing so, Star Bright exchanged one asset, money, for another asset, supplies. The cash account will decrease but the supply account will increase. In this example, you would increase the supply account with a debit and decrease the cash account with a credit. The double entry should look like this:
I hope you have a better understanding of the double entry process. Basic accounting terminology and the basic accounting equation are the foundation of accounting and should be mastered in order to further enhance your knowledge in any accounting field.
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