Accounting Elements
An Account is an abstraction which represents something and it is used to record its changes. As an example, the Cash account will be used to record additions and subtractions to the amount of cash an entity has. This is an exceptionally easy example because the unit of an account is monetary, and is this case one dollar equals one dollar. If we had an account for toasters, which cost 5 dollars each, a balance of 20 dollars in the toasters account would represent 4 toasters.
Debit (Dr.) and Credit (Cr.) simply mean left and right. In double entry bookkeeping the sum of Debits and Credits must add up to the same amount, or as we say Balance. Accounts have a normal balance of either Debit or Credit, to increase the amount of an account, add to the normal balance. As an example Cash which has a Debit balance would be debited in order to record an increase in cash.
If each and every transaction has equal debits and credits, then the sum of all accounts will also balance.
Generally speaking the source account is the credit and the destination account is the debit, though I understand there are some exceptions to this rule. The origin of Debit comes from the Latin
debere “to owe”, and credit comes from the Latin credere “to entrust”.
In addition to having a normal balance, every account has a name and belongs to one of five categories: Assets, Liabilities, Equity, Revenues (or Gains) and Expenses (or Losses)
The Accounting Equation: Assets = Liabilities + Equity
Equity can be expanded to: Equity = Investment by Owners + Retained Earnings – Distributions to Owners + Revenues - Expenses
| Normal Balance |
|---|
| (Dr.) | (Cr.) |
| Assets | Liablities |
| Expenses | Revenues |
| Losses | Gains |
| Distributions to owners | Investments from owners |
| Retained Earnings |
Assets: The resources with economic value controlled by the entity with the expectation that it will provide future benefits.
Liabilities: The rights of creditors that represent debts of the entity.
Equity: The amount of funds contributed by the owners plus the retained earnings.
Investments by Owners: Increases in assets of an entity by owners, resulting in greater ownership.
Distributions to Owners: Decrease in assets of an entity by owners, resulting in lesser ownership.
Comprehensive Income: The change in a company's net assets (equity) from non-owner sources over a specified period of time.
Revenues: The money that is brought into a company by its business activities.
Gains: The money that is brought into a company by other than its business activities.
Expenses: The costs that a business incurs through its operations to earn revenue.
Losses: The costs that a business incurs through other than its operations to earn revenue.
Event: A change recognized on the financial statements of an accounting entity.
Account: An abstraction that records the effect of transactions and other events on a specific item: cash, machine, loan, etc.
Real Accounts: Permanent accounts that appear on the balance sheet: asset, liability, and equity.
Nominal Accounts: Temporary accounts: revenue, expense, and distributions. Revenue and expense appear are income statement accounts.
Double-entry Accounting: is a process used to record transactions in which two or more accounts are affected and the sum of debits must match the sum of credits.
Transactions: Transactions are external events involving a transfer or exchange between entities.
Journal: The Journal or (Book of original entry) is an accounting record where all business transactions are originally entered. A journal details which transactions occurred and what accounts were affected. Journal entries are usually recorded in chronological order, and using the double-entry method of bookkeeping. Entering transaction data in the journal is known as journaling.
Ledger: The Ledger is a book of accounts in which data from transactions recorded in journals are posted and thereby classified and summarized. A general ledger is a collection of all accounts. A subsidiary ledger contains the details related to a single general ledger account.
Posting: The process of transferring the journal entries to the ledger accounts.
Trial Balance: A list and summation of all open accounts to ensure that credits equal debits.
Adjusting Entry: A bookkeeping entry made at the end of an accounting period in order to correctly reflect the timings of income and expenditure. Some adjusting entries include accounts receivable, accounts payable, depreciation and amortization.
Closing Entries: The process where all nominal accounts are reduced to zero, and the net income (loss) is transferred to owners’ equity.
Financial Statements: Reports that outline the financial activities of an entity, as clearly and concisely as possible. Financial statements usually include: Income Statement, Balance Sheet, Statements of Comprehensive Income and Statement of Cash Flows.
Accounting Cycle