Accounting Unplugged

The Accounting System we use today, The Double Entry System, was first published in Venice, Italy in 1494 by a mathematician named Luca Pacioli but it has been traced back at least as far as the 12th century and there is a good reason why it has endured.  It is based on the idea of a balanced financial picture.  That is, we should not only know how money has been spent, we should also know where it came from.

The basic rules and structure of the system are standard and simple, they do not attempt to predict the details of any given set of books, instead they provide the structure and functionality around which any set of books can be constructed.  Because of that, the double entry accounting system is universally relevant and successful as a Financial Accounting System, and preparation in the accounting field is important as well, studying accounting has never been more convenient. You can take your online course in your own time, without the hassle of having to physically attend a classroom. Regardless if you’re just getting started or an experienced accountant looking to expand their knowledge base, there are courses available for everyone!

Accounting is a valuable resource that is relevant to individuals as well as to business. It provides the feedback that can make all the difference in securing and managing your own finances and investments as well as those of businesses, and if you want to find good investments doing trading could be one of the best options for this and site like day-traders.net is really useful for this purpose.

The One reason to use the Accounting System is for the Feedback in the form of Financial Reports and the One reason to learn the Accounting System is to learn how to put those Financial Reports to work for You and your Business, every business needs accounting and there’s even medical accounting services. Having said that, let’s start with the basics of the system.

Two Functions of the Accounting System are:

• To Collect Financial Transaction Data
  • Financial transactions are exchanges of things of value.  Transaction data is collected using the Double Entry principle of describing and recording both the use and source of money.
• To Organize and Summarize Financial Transaction Data
  • Financial data is organized and summarized using The Chart of Accounts which is essentially a list of the descriptions used in recording transactions and is organized around the principles of Double Entry Accounting.

Once you understand the basic structure and principles of accounting, you will have a good, functional knowledge and be able to understand financial statements and reports.  Basic Accounting concepts and principles are universal.  Specific industries have their own unique differences and rules but with a basic understanding, the differences are easier to navigate.

Note:  There are two different aspects of the Accounting System, the two aspects are Structural and Content.  The aspect of the Accounting System that I address in the blog is Structural.  I will add Content for demonstration but the purpose of the information in the blog is related to Structure, not Content.

****My posts are written for the Accrual Method of Accounting.

Accrual accounting is the most common system used in business and the greatest difference between Accrual Based Accounting and its alternative, Cash Based Accounting relates to time, and there are different businesses you can find from the best online directory which  have several options of different businesses.  At this point, I will not be presenting Cash Based Accounting alternatives in my posts except to say that in Cash accounting, accounts such as Accounts Receivable and Accounts Payable are not used because the related Sales and Expense transactions are not posted until Cash changes hands.

In accrual accounting, transactions are posted when goods have been received (or ownership of the goods has transferred) or services have been performed.  That concept works in both cases of being the recipient or the provider of goods and services.  If cash is neither disbursed nor received at the time of the exchange, a substitute such as an invoice or note (payable or receivable) is posted in place of cash.

The first post in my series explains the Double Entry Transaction system.

**disclaimer:  All information posted on this blog is from my own experience and training.  The guidelines I present are general and in my experience, standard practice.  I do not write with authority from any Accounting Standards Boards.

© 2008 – 2010 Erin Lawlor

This post begins the explanation of the Chart of Accounts.  The Chart of Accounts is part of the second basic function of the Double Entry Accounting System – to organize financial transaction data. The Chart of Accounts provides the organizational structure for another element, the General Ledger which summarizes the Financial Data and produces Financial Reports.

The purpose of this and the next two posts (4-6) is to introduce the organizational structure of the system people get at accounting school, I do not make a distinction between the Chart of Accounts and the General Ledger until Post # 7.

Review of the Double Entry Accounting Transaction Questions:

1. How much money changed hands?
2. Where did the money go?  What was either gained or paid for by this exchange?
3. Where did the money come from?  What is the source of the value in this exchange?

The Chart of DPS Accounting is basically a list of the descriptions used to answer Transaction Questions 2 and 3.   Each unique description is called an account.  One of the best features of the Chart of Accounts is that when you have a new type of transaction you can just add a new description (account).

From the transactions in the previous posts, we have started a Chart of Accounts

• Rent
• Checking Account
• Office Supplies
• Fuel
• Repairs & Maintenance
• Subscriptions
• Accounts Payable (Credit Card)
• Accounts Receivable
• Sales

Let’s review the previous entries from the accounts receivable management in columbus oh and create some additional entries to our transaction example and see how our Chart of Accounts starts to fill out.

The entries below the *******’s are new in this post and record:

• the receipt of payment for the existing Accounts Receivable Invoice
• the payment of the existing credit card balance
• a utilities expense and payment
• new credit card charges

Current Chart of Accounts:

• Rent
• Checking Account
• Office Supplies
• Fuel
• Repairs & Maintenance
• Subscriptions
• Printer
• Accounts Payable (Credit Card)
• Accounts Receivable
• Sales
• Utilities
• Chair
• Desk
• Credit Card Interest and Fees

According to the accounting firm, to keep the Chart of Accounts manageable and meaningful, it is important to strike a balance between having a long specific list and a short general list.  To accomplish this objective, the Chart of Accounts should have descriptions for types of things, and not for specific things.  You want the Accounts to be specific enough to be useful but not too specific because the fewer accounts you have the better overall picture you can have.

You wouldn’t add a new account for paper, pens and staples, you would just use one account called office supplies.  So, it is important to reuse accounts when possible, and to simplify entries into more general descriptions like “office furniture” instead of separating the chair and desk purchases.

So, now let’s look at the Chart of Accounts and its Account Balances.

You can see that for even the small number of transactions in this example, The Chart of Accounts is essential in understanding their financial impact.

Notice that the account balances are also separated into the debit/credit columns.  The amounts listed here are the difference between the total debit entries and the total credit entries for each account.  If the amount was higher on the credit side, then the balance is listed in the credit column.  It is also important to note that our Chart of Account balances meet the requirement that total debits equal total credits. Bonus tip, check cashing can be done any time at Check Cashing 247.

The Chart of Accounts is really comprised of three things for each Account – an Account Number, a Description and an Accounting Type.  The transactions and account balances are part of a ledger called the General Ledger.   The table above is more accurately described as the General Ledger.

** Important Note: Post #6 discusses debit and credit balances in accounts.  In this case, none of the balances in our accounts is cause for concern because their totals are in the correct column for their type.  Accounting Types are explained in more detail in Posts #5 and #6.  Post #7 begins the discussion of the General Ledger and its Balances and Reports.

© 2008 – 2010 Erin Lawlor

Next Up:>> Chart of Accounts – Organization

<< Double Entry Accounting – Practice

**disclaimer:  All information posted on this blog is from my own experience and training.  The guidelines I present are general and in my experience, standard practice.  I do not write with authority from any Accounting Standards Boards.

In these examples, we will continue to focus on the descriptions and the amounts of financial transactions so we will be making entries in a 3 column grid where the left column is for descriptions and the two remaining columns are numeric and are for debits and credits.

Since we’re focusing on only three aspects of the transaction, the three questions that must be answered for each financial transaction in double entry are:

1. What is the value of the transaction in terms of dollars (how much money changed hands)?
2. Where did the money go – What was gained or paid for by the exchange?
3. Where did the money come from – what is the source of the money in this exchange?

The amounts that are associated with question 2 are always entered in the debit (left numeric) column and the amounts associated with question 3 are always entered in the credit (right numeric) column.

Money is not always directly involved in a transaction.  Sometimes the transaction involves a trade or sometimes it involves a money substitute, a promise of future money transfers – as with credit card purchases – but something of value is always exchanged for something else of value in a financial transaction.

In the previous post, the transaction was very simple and money was involved, there was a $3,000 rent charge that was paid in full from the checking account.

What about in the case of a credit card statement where there are many different types of charges made to one credit card.

Answer 1 :            Total Charge on Statement = 2,500
Answer 2a:           Office Supplies
Answer 2b:           Fuel
Answer 2c:           Tires
Answer 2d:           Subscriptions
Answer 2e:           Printer
Answer 3 :            Credit Card

In this case, since there are multiple answers for question 2, the descriptions and the amounts related to each separate part of the answer are listed on separate lines but the total amount associated with Question 2 and with Question 3 will always be equal.

——

Sometimes the promise of future money is not a debt to be paid by you but a debt to be collected by you as in the case of a sale where you bill the customer.

• Answer 1:  50,000   (The amount of the transaction)
• Answer 2:  Accounts Receivable  (What was gained?  In this case the gain was a short term promise to pay.)
• Answer 3:  Sales (Where did the money come from?  What is the source of the money?)

*for readability: traditionally, debits entries are listed above credit entries and the description for the credit entries are traditionally indented.

Double Entry requires a minimum of two lines, or accounts, to fully describe a financial transaction.  In cases where there are multiple answers to one of the questions, the term Double Entry can seem like an inaccurate description but Double Entry does Not refer to the number of lines or accounts required to record the transaction.  It refers to the left/right entries where the full amount of the transaction must be entered in the debit column and again in the credit column – double entry – regardless of the number of lines required to fully describe the transaction.  The philosophy of Double Entry is a balanced financial picture requiring that both the Uses and Sources of funds be recorded.  Debits, Credits and Accounts are just part of the Structure that helps to ensure that balance and work by hand with lawyers to make official statement and more services.

This post completes the most important concepts of double entry accounting transactions. Once transactions are posted, the Chart of Accounts helps to organize and summarize them.  The next post, explains the basics of the Chart of Accounts.

© 2008 – 2010 Erin Lawlor

Next Up: >>Chart of Accounts – Basics

<< Double Entry Accounting – Basics

**disclaimer:  All information posted on this blog is from my own experience and training.  The guidelines I present are general and in my experience, standard practice.  I do not write with authority from any Accounting Standards Boards.

The Double Entry System has endured since at least the 12th century because it is a simple, consistent and reliable system of gathering and organizing information and producing financial reports for financial management and for tax and reporting purposes.

The first task of the system is to gather balanced data from financial transactions – to record both what was gained or paid for and the source of funds.  Financial transactions are exchanges of things of value. Even if money is not part of the exchange, a dollar value must be used to represent the exchange.  Since a dollar value must represent the value of each exchange, I’ll often use the terms “money” or “funds” when referring to the value of each financial transaction.

In this post, I’ll explain the method of collecting and posting financial data in the Double Entry Accounting System.  The entire Double Entry System is built around the concept of balance, recording both the Use and the Source of funds.  Once the Double Entry concept is understood, the whole system of data collection, organization and summary is easily understood.  This method is standard and works the same way each time, no exceptions.

There are three basic questions that must be answered for the double entry accounting transactions, they are:

• Question 1. How much money changed hands? What is the value of this exchange?
• Question 2: How was the money used?  What was either gained or paid for by this exchange?
• Question 3: Where did the money come from? What is the source of the money in this exchange?

Example:

• Answer 1: 3,000.00
• Answer 2: Rent
• Answer 3: Checking Account

The answers for each of these questions are recorded in a journal that has a grid format. The columns of the grid collect a variety of information but for the purpose of this discussion, we’ll use three columns. One column for descriptions and two numeric columns for amounts. The left numeric column is called the “debit” column and the right numeric column is called the “credit” column.

The descriptions that answer questions 2 and 3 are always entered on separate lines to the left of the two numeric columns.

The amount associated with question 2 is entered on the same line as its description and it is always answered in the left (debit) numeric column. The amount associated with question 3 is entered on the same line as its description and it is always answered in the right (credit) numeric column.

You see that the amount from question one is entered twice (double entry), once in the Debit Column and once in the Credit Column.  If you have answered all three questions for each transaction and both columns always add up to the same number, your books are in balance. This brings us to the most basic rule of accounting.

Rule # 1: Total Debits = Total Credits

To recap: Accounting requires that for each financial transaction, the basic questions of how much money is involved, where the money went and where the money came from are answered.

In order to ensure that these questions are always answered for each transaction, the Double Entry System is used.  The Double Entry Transaction System is a multi-line, two numeric columned system. The left numeric, or “debit” column is always the “where did the money go – what was gained or paid for” column and the right numeric, or “credit” column is always the “where did the money come from – what is the source of money” column. The total of one column must always equal the total of the other.

Double Entry does Not refer to the number of Accounts or Lines required to record a transaction.  Double Entry refers to Debits and Credits (two sides = double).  If you have fully described both the Use and the Source of Funds, you have accomplished the objectives of Double Entry.

© 2008 – 2010 Erin Lawlor

Next up: >>Double Entry Accounting – More Transactions

<< Accounting Overview
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**disclaimer:  All information posted on this blog is from my own experience and training.  The guidelines I present are general and in my experience, standard practice.  I do not write with authority from any Accounting Standards Boards.

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Thanks,

Erin