Accounting: The Language of Business - Vol. 2 (Intermediate: Part 26)

The American business man cannot consider his work done when he views the income balance in black at the end of an accounting period. It is necessary for him to trace the social incidence of the figures that appear in his statement and prove to the general public that his management has not only been profitable in the accounting sense but salutary in terms of popular benefits.

Colby Mitchell Chester

Review of the Accounting Cycle (Part C)

by

Charles Lamson 

Step 2: Journalize the Transactions

After analyzing the transaction (see part 25), the second step in the accounting cycle is to journalize the transaction by formally recording the transaction in the accounting system. We will explain the journalization process, including the specific accounts, debit and credit, and journal entries.

 

Accounts

A company records each transaction in specific accounts, not just broad groupings such as assets and liabilities. An account is an individual record of increases and decreases in specific asset, liability, and stockholders' equity items. Exhibit 4.5 provides examples of asset, liability, and stockholders' equity.

EXHIBIT 4.5 Account Examples

A company's accounting system assigns each account a unique account number shown in the chart of accounts, a numerical listing of the account names and numbers that assists in locating the account in the ledger. The accounts are typically numbered in balance sheet order: assets, liabilities, equity, and the components of stockholders equity including dividends, revenues, gains, expenses, and losses. Exhibit 4.6 presents a sample chart of accounts.

EXHIBIT 4.6 Sample Chart of Accounts

Debits and Credits: A Review

Companies use debits and credits to journalize transactions. The terms debit and credit simply mean the left and the right side of the an account, respectively---they do not imply increases or decreases. Conventions related to the type of account determine whether a debit or credit increases or decreases an account. Regardless of the accounts used to record the economic event, all transactions will result in debits being equal to credits. Just as assets equal liabilities plus stockholders' equity, debits always equal credits. This simple fact that debits equal credits forms the foundation of the double entry system of accounting. Exhibit 4.7 presents the conventions for debits and credits in terms of increasing and decreasing accounts.

EXHIBIT 4.7 Debits and Credits

Asset accounts, such as cash and inventory, increase with a debit and decrease with a credit. When a company makes a sale of $400 and collects cash, it debits cash by $400. When a company pays employees, cash decreases, so it credits the cash account.

In general, liabilities and stockholders' equity increase with a credit and decrease with a debit. When a company purchases inventory on account, it credits accounts payable to reflect an increase in a liability. When the company pays its supplier the amount owed, it debits accounts payable to reflect a reduction in the liability.

Equity accounts, such as common stock and retained earnings, also increase with credits and decrease with debits. Revenues and gains are increases in equity, so these accounts will increase with credits. However, expenses and losses decrease equity, so they will increase with a debit. Similarly, dividends decrease equity so dividends also increase with debits. 

The normal balance refers to the expected balance in an account, and it is the side that increases the value of the account. If an account increases with a debit, then its normal balance is a debit. Conversely, if an account increases by a credit, then its normal balance is a credit.

Journal Entries

Journalizing a transaction is the process of entering a transaction in the general journal. To journalize a transaction, companies prepare a journal entry, which contains the following elements in the common format:

1. The date the transaction occurred is in the first column.

2. Accounts debited are listed first and positioned at the left side. The dollar amount debited is placed in the debit column.

3. Accounts credited are recorded next and indented to the right a few spaces. The dollar amount credited is placed in the credit column.

4. A brief explanation is frequently included below the entry. 

For example, Plush Service Corporation issued 10,000 shares of its common stock for $80,000 on January 2, 2018, as indicated by the following journal entry for this transaction.

Companies initially record transactions in the general journal. The general journal presents transactions in chronological order with a column for the date, the account titles and explanations, reference number, debits, and credits. The column for the reference number is left blank until the entries are posted to the general ledger accounts, at which time the account number is included in the reference column. Because events are recorded in the general journal first, it is known as the book of original entry.

Using the general journal as the first record of the economic event has several advantages. The general journal maintains a complete record of the transaction and provides an explanation of the event when the transaction involves complex events. In addition, all economic events are listed in chronological order, facilitating the location and correction of errors.

In Example 4.2, we journalize the transactions from Example 4.1 from part 25.

EXAMPLE 4.2 Journal Entries

PROBLEM: Consider the transactions for Plush Service Corporation from Example 4.1. Provide the journal entry for each transaction.

SOLUTION: We analyzed each transaction earlier. In the following journal entries, we indicate the increases and decreases in assets, liabilities, and stockholders' equity, the specific account affected, and whether the account is debited or credited.

   

*GORDON, RAEDY, SANNELLA, 2019, INTERMEDIATE ACCOUNTING, 2ND ED., PP. 97-101*

                                                      

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