Sequence N°: 1
Title: THE ACCOUNT
A. ACCOUNT
An account is an accounting record of increases and decreases in a
specific asset, liability, or owner’s equity item. Would have separate accounts
for Cash, Accounts Receivable, Accounts Payable, Service Revenue, and
Salaries Expense. In its simplest form, an account consists of three parts: (1) a
title, (2) a left or debit side, and (3) a right or credit side. Because the format of
an account resembles the letter T, we refer to it as a T account. Illustration 1-1
shows the basic form of an account.
Illustration 1-1 Basic form of account
The T account is a standard shorthand in accounting, which helps make
clear the effects of transactions on individual accounts.We will use it often
throughout this lecture to explain basic accounting relationships.
B. DEBITS AND CREDITS
The terms debit and credit are directional signals: Debit indicates left, and
credit indicates right.They indicate which side of a T account a number will be
recorded on. Entering an amount on the left side of an account is called debiting
the account. Making an entry on the right side is crediting the account.We
commonly abbreviate debit as Dr. and credit as Cr.
Having debits on the left and credits on the right is an accounting custom,
or rule, like the custom of driving on the right-hand side of the road . This rule
applies to all accounts.
Illustration 1-2 shows the recording of debits and credits in an account for the
1
cash transactions.The data are taken from the cash column of the tabular
summary in Illustration 1-2 which is reproduced here.
Illustration 1-2 Tabular summary compared to account form
In the tabular summary, every positive item represents for any company
receipt of cash; every negative amount represents a payment of cash. In the
account form we record the increases in cash as debits, and the decreases in cash
as credits. Having increases on one side and decreases on the other helps
determine the total of each side as well as the overall account balance.The
balance, a debit of $8,050, indicates that had $8,050 more increases than
decreases in cash. When the totals of the two sides of an account are compared,
an account will have a debit balance if the total of the debit amounts exceeds
the credits. An account will have a credit balance if the credit amounts exceed
the debits.The account in Illustration 1-2 has a debit balance.
C. DEBIT AND CREDIT PROCEDURE
In this lecture you learned the effect of a transaction on the basic
accounting equation. Remember that each transaction must affect two or more
accounts to keep the basic accounting equation in balance. In other words, for
each transaction, debits must equal credits in the accounts.The equality of debits
and credits provides the basis for the double-entry system of recording
transactions.
In the double-entry system the dual (two-sided) effect of each
transaction is recorded in appropriate accounts. This system provides a logical
method for recording transactions. It also helps ensure the accuracy of the
recorded amounts. The sum of all the debits to the accounts must equal the sum
of all the credits.
The double-entry system for determining the equality of the accounting
equation is much more efficient than the plus/minus procedure used in this
lecture. We will illustrate debit and credit procedures in the double-entry
system.
2
D.ASSETS AND LIABILITIES
Assets and Liabilities. Both sides of the accounting equation (Assets
_Liabilities _ Owner’s equity) must be equal. It follows, then, that we must
record increases and decreases in assets opposite from each other. In Illustration
1-2, entered increases in cash—an asset—on the left side, and decreases in cash
on the right side. Therefore, we must enter increases in liabilities on the right or
credit side, and decreases in liabilities on the left or debit side. Illustration 1-3
summarizes the effects that debits and credits have on assets and liabilities.
Illustration 1-3 Debit and credit effects— assets and liabilities
Debits to a specific asset account should exceed the credits to that
account. Credits to a liability account should exceed debits to that account. The
normal balance of an account is on the side where an increase in the
account is recorded.Thus, asset accounts normally show debit balances, and
liability accounts normally show credit balances. Illustration 1-4 shows the
normal balances for assets and liabilities.
Illustration 1-4 Normal balances—assets and liabilities
Knowing the normal balance in an account may help you trace errors.
For example, a credit balance in an asset account such as Land would indicate a
recording error. Similarly, a debit balance in a liability account such as Wages
Payable would indicate an error. Occasionally, though, an abnormal balance
may be correct.
The Cash account, for example, will have a credit balance when a
company has overdrawn its bank balance (i.e., written a “bad” check). (Notice
that when we are referring to a specific account, we capitalize its name.)
3
E. OWNERS EQUITY
Owner’s Equity. It owner’s investments and revenues increase owner’s
equity. Owner’s drawings and expenses decrease owner’s equity. Companies
keep accounts for each of these types of transactions.
Owner’s Capital. Investments by owners are credited to the Owner’s
Capital account. Credits increase this account, and debits decrease it. When an
owner invests cash in the business, the company debits (increases) Cash and
credits (increases) Owner’s Capital.When the owner’s investment in the
business is reduced, Owner’s Capital is debited (decreased).
Illustration 1-5 shows the rules of debit and credit for the Owner’s Capital
account.
Illustration 1-5 Debit and credit effects— Owner’s Capital
We can diagram the normal balance in Owner’s Capital as follows.
Illustration 1-6 Normal balance—Owner’s Capital
Owner’s Drawing. An owner may withdraw cash or other assets for
personal use. Withdrawals could be debited directly to Owner’s Capital to
indicate a decrease in owner’s equity. However, it is preferable to use a separate
account, called Owner’s Drawing. This separate account makes it easier to
determine total withdrawals for each accounting period. Owner’s Drawing is
increased by debits and decreased by credits. Normally, the drawing account
will have a debit balance.
Illustration 1-7 shows the rules of debit and credit for the drawing account.
Illustration 1-7 Debit and credit effects— Owner’s Drawing
4
We can diagram the normal balance as follows.
Illustration 1-8 Normal balance—Owner’s Drawing
The Drawing account decreases owner’s equity. It is not an income
statement account like revenues and expenses.
Revenues and Expenses. The purpose of earning revenues is to benefit
the owner(s) of the business. When a company earns revenues, owner’s equity
increases. Therefore, the effect of debits and credits on revenue accounts is
the same as their effect on Owner’s Capital. That is, revenue accounts are
increased by credits and decreased by debits.
Expenses have the opposite effect: Expenses decrease owner’s equity.
Since expenses decrease net income, and revenues increase it, it is logical that
the increase and decrease sides of expense accounts should be the reverse of
revenue accounts.
Thus, expense accounts are increased by debits and decreased by credits.
Illustration 1-9 Debit and credit effects— revenues and expenses
Credits to revenue accounts should exceed debits. Debits to expense
accounts should exceed credits. Thus, revenue accounts normally show credit
balances, and expense accounts normally show debit balances.We can diagram
the normal balances as follows.
Illustration 1-10 Normal balances—revenues and expenses
Summary of Debit/Credit Rules
5
Illustration 1-11 shows a summary of the debit/credit rules and effects on
each type of account. Study this diagram carefully. It will help you understand
the fundamentals of the double-entry system.
Illustration 1-11 Summary of debit/credit rules
Summary
Explain what an account is and how it helps in the recording process.
An account is a record of increases and decreases in specific asset, liability,
and owner’s equity items.
Define debits and credits and explain their use in recording business
transactions.
The terms debit and credit are synonymous with left and right. Assets,
drawings, and expenses are increased by debits and decreased by credits.
Liabilities, owner’s capital, and revenues are increased by credits and
decreased by debits.
