Accounting Basics

Terms you need to know

1. 2. 3. 4. 5. 6. 7. 8. 9.

Ledger: A group of accounts. General Accounting Equation: Assets = Liabilities + Owners Equity Assets: Items owned by the business that have a future worth Liabilities: Debts of the business (or what the business owes) Owners Equity: Net worth of the business (after deducting liabilities from assets) Expenses: costs that are incurred running the business (e.g. rent, hydro) Credit: recorded on the right side of a T-Account Debit: recorded on the left side of a T-Account T-Account: a simple account form used to demonstrate relationships between accounts and to show recording of Credits and Debits

Types of Accounts
Category Types of Accounts Cash Accounts Receivable Supplies Equipment Automobiles Land Buildings Prepaid Insurance Prepaid Rent Long Term Notes Payable Rent Payable Salaries Payable Unearned Fees Owners Withdrawals Rent Expense Telephone Expense Utilities Expense Insurance Category Types of Accounts Accounts Payable Notes Payable Category Types of Accounts Owners Capital Fees Earned (Revenue)

Assets

Liabilities

Owners Equity

Expense Salaries Expense NOW, in order to proceed successfully with accounting, you need to do the following: 1. forget about the banking system; and 2. remember that accounting is a "building block" type of course. Let me explain these two points. Most of us have bank accounts and are familiar with the system of withdrawing and depositing money. When we withdraw money from our accounts, the bank debits our accounts. In fact, most of us now own and frequently use Debit cards, cards which directly debit our accounts upon making a transaction. On the other hand, when we add money to our accounts (unfortunately, with less regularity than we withdraw), the bank credits our accounts to show the increase. Now, back to the accounting system. Accountants have developed a system for crediting and debiting that is quite different from that of their banking cousins. Credits and debits are used not only to indicate increases, but also to indicate decreases to certain groups of related accounts. Let me demonstrate.

Asset accounts (such as Cash, Accounts Receivable) are increased with a DEBIT and

decreased with a CREDIT! The exact opposite to what happens with our bank accounts. Ex. If we were to increase the Cash account of our business by $1000.00, we would record it as follows: Cash T-Account Debit side increases $1000.00 Credit side - decreases

Liability accounts (i.e. Accounts Payable), on the other hand, handle debits and credits
differently. When a Liability account is decreased by a specified amount, the account is Debited. Alternatively, the account is Credited when the balance is increased. Ex.

Accounts Payable T-Account Debit side - decreases Credit side - increases

Owner Equity accounts such as Capital and Revenue increase with Credits and decrease
with Debits. However, Owner Equity accounts such as Expenses and Owner Withdrawals, normally are only debited because expenses and withdrawals, for the most part, decrease equity. Ex. Rent Expense T-Account Debit side increases Credit side - decreases

Dont start to fret yet. Mastering the art of debits and credits takes a little bit of patience and a lot of practice. The more accounting problems that you attempt and successfully complete, the better. Thus, a word of advice, do all of - advice which conveniently leads me to my next point.

your homework all of the time

As previously mentioned, accounting is a building block type of course. By this I mean accounting is progressive. What is learned in the first few chapters lays the foundation for the next few chapters and so on and so on. Therefore, it is important that you spend the time necessary to conquer and master the basics of accounting in the first few chapters of your text. It will not go away. In fact, it will only become more difficult if you do not carry a fundamental understanding of accounting terminology, practices, and principles with you. One last thing, accounting is a very structured discipline governed by set rules and principles. These rules have been formulated to standardize and regulate accounting practices, not to make your introduction to accounting difficult. If you take the time to understand and learn the basics of accounting, accounting may not become entirely enjoyable to some of you, but it may become "do-able".

Good luck.

The Adjustment Process

The monthly procedure of adjusting accounts is often one of the most confusing to students in the throes of grasping the basics of accounting. Although it may seem to be a frustrating process to learn, the process of adjusting accounts is an integral part of the normal accounting cycle, and; therefore, learning how to master the following steps is vital to your continued success in accounting. 1. The first step to conquering this phase of the accounting cycle is to understand the general flow of the adjustment process.

Adjustment Process Flow

Month: January month end Normal monthly journalizing and posting completed

Unadjusted Trial Balance completed

Month: February Adjustment journal entries made for January

Adjustments posted for January Accounts now have adjusted balances

Adjusted Trial Balance for January completed

January Statements completed*

*Normal accounting process for February simultaneously done. 2. The next step is to determine the types of adjustments that normally occur during the accounting process.

Types of Adjustments: Assets:

1. Consumable Assets Assets that get used up over time E.g. Supplies, Pre-Paid Rent, Pre-Paid Insurance To adjust: DEBIT the expense account associated with the asset Balance of the asset account should always be for what is left CREDIT the asset account for the amount that has been used Balance of the expense account should always be for what has been used 2. Assets that Depreciate Over Time E.g. Automobiles, Land, Buildings, Equipment adjusted using two associated accounts- Accumulated Amortization and Amortization Expense for the asset Accumulated Amortization account is used to keep a running total, over time, of the amount by which the asset is losing value To adjust: DEBIT Amortization Expense Account for the asset CREDIT Accumulated Amortization Account for the asset

Revenues:
1. Unearned Revenues unearned revenues occur when a company is paid up front for work that has not yet been completed at this time, the full amount would have been posted into the UNEARNED REVENUE account (Credit) and CASH (Debit) as work is completed, the revenue must be recognized during the accounting period in which it was done and amount entered to Fees Earned account therefore, amount earned must come out of Unearned account and into Earned account To adjust: DEBIT the Unearned Revenue account for the portion that has now been

completed or earned Balance of the Unearned account should always be what has yet to be earned CREDIT the Fees Earned account Balance of the Fees Earned should always be what has been earned

Accrued Revenues and Expenses:

1. Accrued Revenues occurs when work has been completed for a client, but, as of the end of the month (or accounting period), the client has not yet paid To adjust: DEBIT Accounts Receivable CREDIT Revenue account 2. Accrued Expenses occurs when a bill for an expense comes after the end of the month in which it occurred E.G. Telephone bill for January arrives February 10 expense must be posted to January in this case To adjust: DEBIT Expense Account CREDIT Accounts Payable Accounts Payable is credited because, as of the end of January, the telephone bill for January had not yet been paid 3. It is necessary at this stage to carefully read the problems that are assigned. Dates are important to note (particularly when dealing with pre-paid assets), as are terms such as accrued, expired, on hand, unearned, and unrecorded. Each of these terms dictates a different type of adjustment. Term Accrued Expired Meaning amount has accumulated and has not yet been received or paid indicates that stated figure is the amount of the asset that has been used to this date

indicates that stated figure is the amount of the asset that is left at the end of the accounting period Unearned services have been supplied, but no payment has been received yet information regarding actual cost of expense was not available at the Unrecorded end of the accounting period; therefore, amount was not recorded or entered for that particular account On hand 4. The final step is a relatively simple one- practice, practice, and then practice some more! As you practice be aware of patterns of wording, and patterns of adjustments. A recognition of these will assist you in mastering the adjustment process.