Rules of Debits and Credits

Read the rules of debits and credits, and copy and keep handy as a quick reference. Then, read the section on the ledger and the chart of accounts again. Learning about financial accounting for the first time is all about building upon and refining your knowledge of accounting processes and methods step-by-step. Be sure to note which accounts are permanent and which accounts are temporary.

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.

The accounting process in operation

MicroTrain Company is a small corporation that provides on-site personal computer software training using the clients' equipment. The company offers beginning through advanced training with convenient scheduling. A small fleet of trucks transports personnel and teaching supplies to the clients' sites. The company rents a building and is responsible for paying the utilities.

We illustrate the capital stock transaction that occurred to form the company (in November) and the first month of operations (December). The accounting process used by this company is similar to that of any small company. The ledger accounts used by MicroTrain Company are:

Acct. Account 
Title No. Description
Assets 100 Cash Bank deposits and cash on hand.
103 Accounts Receivable
Amounts owed to the company by customers.
107 Supplies on Hand
Items such as paper, envelopes, writing materials, and other materials used in performing training services for customers or in doing administrative Assets and clerical office work.
108 Prepaid Insurance
Insurance policy premiums paid in advance of the periods for which the insurance coverage applies.
112 Prepaid Rent
Rent paid in advance of the periods for which the rent payment applies.
150 Trucks
Trucks used to transport personnel and training supplies to clients' locations.
200 Accounts Payable Amounts owed to creditors for items purchased from them.
Liabilities 216 Unearned Service Fees 
Amounts received from customers before the training services have been performed for them.
300 Capital Stock Retained 
The stockholders' investment in the business.

310 Earnings The earnings retained in the business.
Dividends 320 Dividends The amount of dividends declared to stockholders.
Revenues 400

Service Revenue Amounts earned by performing training services for customers.
505  Advertising Expense The cost of advertising incurred in the current period.
506  Gas and Oil Expense The cost of gas and oil used in trucks in the Expenses current period.

507 Salaries Expense The amount of salaries incurred in the current period.
511 Utilities Expense The cost of utilities incurred in the current period.

Notice the gaps left between account numbers (100, 103, 107, etc.). These gaps allow the firm to later add new accounts between the existing accounts.

To begin, a transaction must be journalized. Journalizing is the process of entering the effects of a transaction in a journal. Then, the information is transferred, or posted, to the proper accounts in the ledger. Posting is the process of recording in the ledger accounts the information contained in the journal.