Recording Business Transactions

This chapter explains the rules regarding debits and credits. Debits and credit increase and decrease certain accounts. Spend some time learning the rules of debits and credits, since they are the foundation of accounting principles. Posting a debit where a credit should be, or vice versa, will cause you to be out of balance. You will then have to re-trace all of your postings to uncover your error, which would be very frustrating and time-consuming. Since accounting is the "language of business", it is very important that you understand the building blocks of the language.  Even if you hire a CPA to do your books, you need an understanding of what drives your results so that you can manage accordingly, and avoid becoming a victim of fraud.

The ledger

A ledger (general ledger) is the complete collection of all the accounts of a company. The ledger may be in loose-leaf form, in a bound volume, or in computer memory.

Accounts fall into two general groups: (1) balance sheet accounts (assets, liabilities, and stockholders' equity) and (2) income statement accounts (revenues and expenses). The terms real accounts and permanent accounts also refer to balance sheet accounts. Balance sheet accounts are real accounts because they are not subclassifications or subdivisions of any other account. They are permanent accounts because their balances are not transferred (or closed) to any other account at the end of the accounting period. Income statement accounts and the Dividends account are nominal accounts because they are merely subclassifications of the stockholders' equity accounts. Nominal literally means "in name only". Nominal accounts are also called temporary accounts because they temporarily contain revenue, expense, and dividend information that is transferred (or closed) to the Retained Earnings account at the end of the accounting period.

The chart of accounts is a complete listing of the titles and numbers of all the accounts in the ledger. The chart of accounts can be compared to a table of contents. The groups of accounts usually appear in this order: assets, liabilities, stockholders' equity, dividends, revenues, and expenses.

Individual accounts are in sequence in the ledger. Each account typically has an identification number and a title to help locate accounts when recording data. For example, a company might number asset accounts, 100-199; liability accounts, 200-299; stockholders' equity accounts and Dividends account, 300-399; revenue accounts, 400-499; and expense accounts, 500-599. We use this numbering system in this text. The uniform chart of accounts used in the first 11 chapters appears in a separate file at the end of the text. You should print that file and keep it handy for working certain problems and exercises. Companies may use other numbering systems. For instance, sometimes a company numbers its accounts in sequence starting with 1, 2, and so on. The important idea is that companies use some numbering system.

Now that you understand how to record debits and credits in an account and how all accounts together form a ledger, you are ready to study the accounting process in operation.