1ACCOUNTING STEP BY STEPTHE LANGUAGE OF DEBIT AND CREDITDr. R.G.A. Boland FCA, CPA, DBABRIEF LECTURES TO REINFORCE THE KEY PROGRAM LEARNING ACTIVITY- LEARNING BY DOING!
2 CHAPTER I - INTRODUCTION TO BOOKKEEPING In 2006 all the hard work of bookkeeping is now done by computer. But ... We must understand the language of "debit and credit", so that we can use the computer data to produce RELIABLE accounting reports in accordance with IAS (International Accounting Standards).
3No matter what the form of the record, the basic rule of bookkeeping remains the same: the concept of debit and credit.The five key steps are ...
Book-keeping and AccountingThe process of book-keeping and accounting may be summarized into the following five steps: A. BOOK-KEEPING 4A. BOOKKEEPING: I. Translate transactions into debits and credits in a journal. 2. Post the debits and credits to ledger accounts.3. Balance the ledger accounts to summarize the net effect of the entries.4. Extract a trial balance to check the arithmetical accuracy of the postings.
5B. ACCOUNTING5. From the trial balance prepare the accounting reports, balance sheet and income statement (profit and loss account) with IAS!
Accounting LanguageAccounting has been called the language of business. Like any language, it can never express our thoughts with absolute precision and clarity. 6Our task of learning this language is complicated by the fact that many of the words used in accounting mean almost, but not quite, the same as they mean in every-day life. We must learn to think of words in their accounting rather than their popular meaning. In this program, we have used a standard set of English and American accounting terms, although certain other terms are also of accounting terms reinforces your basic grasp of the language.
7 Accounting PeriodThe basis of all profit is the period (accounting period) during which the profit is realized. Thus $10 a week is not the same as $10 for a whole year. Again, the financial position of a business must relate to a particular date. Thus the picture at January 1st may not be the same as the picture at June 3oth. Therefore, the accounting period and the date, is vital information which affect the significance of the accounting reports.
8A glossary of common bookkeeping words is provided at the end of the program.The following list indicates some of the major differences between English and American terminology:
9English Term American TermDebtors Accounts receivable Creditors Accounts payable Stock of goods InventoryShare capital Capital stockProfit IncomeAccumulated profits Retained earnings Profit and loss account Income statement
Debit & Credit 10 Some textbooks teach the application of debit and credit as:(a) Credit the giver(b) Debit the receiver
11 However this has certain logical limitations. So, in this program we use a different approach. We first define:(a) Debit, as the left-hand side(b) Credit, as the right-hand side(c) Basic debits as, assets, costs and expenses(d) Basic credits, as liabilities, owners' equity and sales This facilitates very rapid assimilation of the bookkeeping technique, while the computer does all the hard work!
12 CHAP TER II - ACCOUNTING REPORTSSET I - INCOME STATEMENT (PROFIT AND LOSS ACCOUNT)SUMMARYThe income statement (profit and loss account) of a business relates to a specific accounting period. It matches sales against cost of ales and expenses, to compute a figure of profit for the accounting period.Profit realized is NOT the same as cash received.Cash is more important than profit!
13Sales, less cost of sales and less expenses, equals profit.Sales equals cost of sales, plus expenses, plus profit.
14IMPORTANT NOTEIn the front of each set is a summary (as above) of technical terms and ideas to be learned from the set. Read it quickly.If you already understand all of the summary do not complete the set, pass on to the next one.If you do not completely understand every technical term and idea in the summary, do the whole set. Do not attempt to do only parts of a particular set.
15CHAPTER II SET 2 - BALANCE SHEET SUMMARYThe balance sheet presents a financial picture of a business and lists the assets, liabilities and owner's equity of the business at a specific date. It is not the same as an income statement.Valuable things owned by a business such as cash, debtors, inventory (stock), prepaid expenses and car are assets. Creditors are liabilities.
16The owner's equity is the original investment of the owners (share capital) in the business plus the profits earned and left to accumulate in the business.
17Assets are generally recorded at cost or lower and NOT at higher resaleprices - very conservative!.
18Assets less liabilities equals owner's equity or net worth.Assets equals liabilities plus owner's equity.
19Note.(a) In our balance sheets we shall (for bookkeeping) always record assets on he left side, and liabilities and owner's equity on the right side.Note: In some countries they may present the balance sheet in many different ways ... but in bookkeeping ... debit (left) and credit (right) are always the same... hooray!
20(b) Remember: Debtors are receivables Creditors are payables Stock is inventoryAccumulated profit is retained earnings Profit is income
21CHAPTER II - SET 3 - BUSINESS TRANSACTIONSTransactions may be for cash or for credit. In a credit transaction liability is incurred but cash is transferred later as a separate transaction.All transactions have a "dual aspect" (debit & credit) and thereby affect two items on the balance sheet.
22Accounting conventions recognize transactions at particular times. For example:Sales transactions are generally recognized when the goods leave the seller's premises, whereas Purchase transactions arc normally recognized when the goods are received by the buyer.
1. An instantaneous financial picture of a business as of a particular date is a. income statementb. statement of accumulated profitc. balance sheetd. profit and loss account C
2. An accounting report of the flows of sales, costs, expenses and net profit over an accounting period is called a: a. sales reportb. balance sheetc. income statementd. owner's equity C
3. In a balance sheet the assets are exactly equal to the:a. liability to creditorsb. owner's equityc. current assetsd. claims against the assets D
4. Owner's claims against the assets of a business are called: a. liabilities b. capital stock c. owner's equity d. income C
5. Valuable things owned by a business are called:a. capitalb. assetsc. fixed assetsd. liabilities B
6. Assets less liabilities equals:a. share capitalb. accumulated profitsc. owner's equityd. sales C
7. People who owe debts to a business are listed on a balance sheet of that business as:a. trade creditorsb. incomec. claims against the assetsd. debtors D
8. Land, building, etc., owned by a manufacturing business is a:a. current assetb. "other" assetc. fixed assetd. capital C
9. Stock is a:a. fixed assetb. part of owner's equityc. assetd. claim which the business agrees to pay C
10. The owner's equity of a limited company consists of:a. share capital and accumulated profitsb. share capitalc. assetsd. dividends A
11. Assets less owner's equity equals:a. claims of the shareholdersb. current liabilitiesc. capitald. liabilities A
.12. If a business has cash of £2,000, trade creditors of £100, a mortgage payable of £5,000 and land of 10,000 the owner's equity is:a. impossible to computeb. £10,000c. £5,100d. £6,900 D
13. A balance sheet is prepared for a business entity. For a limited company this entity is:a. the company and its managementb. the company and its shareholdersc. the shareholders aloned. the company alone B
22. Which of the following are basic debits?a. liabilitiesb. fixed assetsc. owner's equityd. share capital B
23CHAPTER III - BOOK-KEEPING TECHNIQUESET 4 - DEBIT AND CREDIT SUMMARYDebit means "left-hand side". Credit means "right-hand side". In bookkeeping debit and credit have NO significance as being "good" or "bad" as is implied by the popular use of the same words.
24Each item in the balance sheet and income statement is, by convention, either a basic debit or a basic credit: 1. The items on the left-hand side: assets, costs and expenses are basic debits. 2. The items on the right-hand side: liabilities and owner's equity and sales are basic credits.
25A basic debit is increased by debits and decreased by credits. Conversely a basic credit is increased by credits and decreased by debits.Each business transaction has a debit aspect and a credit aspect of the same amount. Thus in a set of books the total debits always equal the total credits."Dr" means debit. "Cr" means credit.
26IMPORTANT NOTEAt this point we must unlearn something about the words debit and credit, which is current in every-day life but does NOT apply to bookkeeping!!Repeat aloud the following sentences:"Credit means right side, It does not mean good or bad.""Debit means left side. It does not mean good or bad."
28 CHAPTER III SET 5 ACCOUNTS AND BALANCESUMMARYFor each basic debit item and each basic credit item in the accounting reports there is an "account" in the books of the business. An account is simply a page in the books. In a series of accounts in the books we analyze and summarize each aspect (Dr and Cr) of a large number of business transactions.
29The balance brought down summarizes the net amount of the transactions recorded in the account to date. Each account may have a debit or credit balance according to the net total of debit and credit postings.
30CHAPTER III SET 6 - CASH AND CREDIT SUMMARYIn bookkeeping the word "credit" has two meanings: Credit means NOT for cash Credit means right side of the account, the opposite of debit.
31Transactions may be either for cash or credit Cash transactions are either cash receipts or cash payments, which increase or decrease the cash balance.Credit transactions increase either receivables or payables, but NOT cash ... until they are paid with a cash transaction!.
32Cash is an asset and therefore a basic debit.
33In terms of debit and credit, cash sales and purchases are recorded thus:Cash receipts: Cash account Dr. Sales account Cr.Cash payments:. Purchases account Dr. Cash account Cr
34Credit transactions do not affect the balance of cash but they do increase debtors (basic debits) or creditors (basic credits). Remember - debtors - receivables - basic assetCreditors - payables - basic credit
35Credit transactions for sales and purchases are recorded thus:Credit sales: Debtor (receivable) account Dr. Sales account CrCredit purchases: Purchases account Dr Creditor account Cr.
36CHAPTER III SET 7 - JOURNALIZING TRANSACTIONS SUMMARYThis is a revision set to give you practice in journalizing transactions by translating them into debits and credits.The journal of a business is the book in which any transaction may be recorded in the following form of entry.
37FORM OF GENERAL JOURNAL ENTRY:DateAccount name Dr 1000 Account name Cr 1000Plus an explanation of the transaction for future reference.