Financial and Managerial Accounting
Chapter 2
The Recording Process
Account
Account is an individual accounting record of increases and decreases in a specific asset,
liability, or owner’s equity item. For example, Softbyte would have separate accounts for Cash,
Accounts Receivable, Accounts Payable, Service Revenue, Salaries and Wages Expense, and so
on. 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.
Debits and Credits
The term debit indicates the left side of an account, and credit indicates the right side. They are
commonly abbreviated as Dr. for debit and Cr. for credit. When comparing the totals of the two
sides, an account shows a debit balance if the total of the debit amounts exceeds the credits. An
account shows a credit balance if the credit amounts exceed the debits.
The procedure of recording debits and credits in an account is shown in the transactions affecting
the Cash account of Softbyte.
Tabular Summary
Account Form
Cash Cash
15,000
(Debits) (Credits)
–7,000 15,000 7,000
1,200
1,500 1,200 1,700
–1,700 1,500 250
–250
600 600 1,300
Balance 8,050
–1,300 (Debit)
TK. 8,050
In the account form, we record the increases in cash as debits and the decreases in cash as
credits. For example, the TK.15,000 receipt of cash is debited to Cash, and the TK.7,000
payment of cash is credited to Cash. Having increases on one side and decreases on the other
reduces recording errors and helps in determining the totals of each side of the account as well as
the account balance. The balance is determined by netting the two sides (subtract in one amount
from the other). The account balance, a debit of TK. 8,050, indicates that Softbyte had TK. 8,050
more increases than decreases in cash. In other words, Softbyte started with a balance of zero and
now has TK. 8,050 in its Cash account.
Balances
1
1. Debit Balance of Asset Account, Expense Account and Drawings Account.
2. Credit Balance of Liabilities Account, Revenue Account and Capital Account.
The rules of debit and credit
1. Assets, Expense and Drawings accounts are increased by Debit and decreased by
Credit.
2. Liabilities, Revenues and Capital accounts are decreased by Debit and increased by
Credit.
Steps in the Recording Process
Practically every business uses three basic steps in the recording process:
1. Analyze each transaction for its effects on the accounts.
2. Enter the transaction information in a journal.
3. Transfer the journal information to the appropriate accounts in the ledger.
The Journal
Companies initially record transactions in chronological order (the order in which they occur).
For each transaction, the journal shows the debit and credit effects on specific accounts. Every
company has the most basic form of journal, a general journal.
The journal makes several signifi cant contributions to the recording process:
1. It discloses in one place the complete effects of a transaction.
2. It provides a chronological record of transactions.
3. It helps to prevent or locate errors because the debit and credit amounts for each entry can be
easily compared.
Entering transaction data in the journal is known as journalizing. Companies make separate
journal entries for each transaction. A complete entry consists of (1) the date of the transaction,
(2) the accounts and amounts to be debited and credited, and (3) a brief explanation of the
transaction.
SIMPLE AND COMPOUND ENTRIES
Some entries involve only two accounts, one debit and one credit. This type of entry is called a
simple entry. Some transactions, however, require more than two accounts in journalizing. An
entry that requires three or more accounts is a compound entry.
The Ledger
The entire group of accounts maintained by a company is the ledger. The ledger provides the
balance in each of the accounts as well as keeps track of changes in these balances. A general
ledger contains all the asset, liability, and owner’s equity accounts. Transferring journal entries
to the ledger accounts is called posting. Posting should be performed in chronological order. That
is, the company should post all the debits and credits of one journal entry before proceeding to
the next journal entry.
2
CHART OF ACCOUNTS
Most companies have a chart of accounts. The number and type of accounts differ for each
company. This chart lists the accounts and the account numbers that identify their location in the
ledger. The numbering system that identifi es the accounts usually starts with the balance sheet
accounts and follows with the income statement accounts. For example, a small company like
Softbyte will have fewer accounts than a corporate giant like Dell. Softbyte may be able to
manage and report its activities in 20 to 30 accounts, while Dell may require thousands of
accounts to keep track of its worldwide activities.
Trial Balance
A trial balance is a list of accounts and their balances at a given time. Customarily, companies
prepare a trial balance at the end of an accounting period. They list accounts in the order in
which they appear in the ledger. Debit balances appear in the left column and credit balances in
the right column. The trial balance proves the mathematical equality of debits and credits after
posting. Under the double-entry system, this equality occurs when the sum of the debit account
balances equals the sum of the credit account balances.
The steps for preparing a trial balance are:
1. List the account titles and their balances in the appropriate debit or credit column.
2. Total the debit and credit columns.
3. Prove the equality of the two columns.
Limitations of a Trial Balance
A trial balance does not guarantee freedom from recording errors, however. Numerous errors
may exist even though the totals of the trial balance columns agree. For example, the trial
balance may balance even when:
1. A transaction is not journalized.
2. A correct journal entry is not posted.
3. A journal entry is posted twice.
4. Incorrect accounts are used in journalizing or posting.
5. Offsetting errors are made in recording the amount of a transaction.
As long as equal debits and credits are posted, even to the wrong account or in the wrong
amount, the total debits will equal the total credits. The trial balance does not prove that the
company has recorded all transactions or that the ledger is correct.