• Accounting Equation: Assets = Liability + Equity

• Types of Accounts

1. Assets

2. Expenses

3. Liabilities

4. Equity

5. Revenue (or income)

how do debits and credits affect asset, expense, liability, equity, and revenue
accounts? Do debits decrease or increase these accounts in your books? How about
credits?

Assets and expenses increase when you debit the accounts and decrease when you
credit them. Liabilities, equity, and revenue increase when you credit the accounts
and decrease when you debit them.

Here’s a quick-reference chart you can use to get started:

ACCOUNT TYPE INCREASES DECREASES

BALANCE BALANCE
Assets: Assets are things you own such as Debit Credit
cash, accounts receivable, bank accounts,
furniture, and computers

Liabilities: Liabilities include things you owe Credit Debit

such as accounts payable, notes payable,
and bank loans

Revenue: Revenue is the money your Credit Debit

business is paid for the sale of products and
services

Expenses: Expenses are considered the Debit Credit

cost of doing business and include things
such as office supplies, insurance, rent,
payroll expenses, and postage
 Capital/Owner Equity: The Capital/Owner Credit Debit
Equity account represents your financial
interest in the business

A detailed look at the types of accounts

—and their sub-accounts 
By this point, you might be wondering about all the other accounts you’ve seen and
heard of. Where’s the Checking account? The Petty Cash account? The Accounts
Payable account? 

Rather than listing each transaction under the above five accounts, businesses can
break accounts down even further using sub-accounts.

Sub-accounts (e.g., Checking account) show you exactly where funds are coming in
and out of. And, you can better track how much money you have in each individual
account. 

Let’s say you make a sale on credit. This increases the money owed to your business,
not money you actually have on hand. Instead of debiting a general asset account,
debit your Accounts Receivable account to show how much your business expects to
receive.

Here are some sub-accounts you can use within asset, expense, liability, equity, and
income accounts.

Asset accounts
Assets are the physical or non-physical types of property that add value to your
business. For example, your computer, business car, and trademarks are considered
assets.

Some examples of asset sub-accounts include:

 Checking
 Petty Cash
 Inventory
 Accounts Receivable

Although your Accounts Receivable account is money you don’t physically have, it is
considered an asset account because it is money owed to you.

Again, debits increase assets and credits decrease them. Debit the corresponding sub-
asset account when you add money to it. And, credit a sub-asset account when you
remove money from it.

Example
Let’s look at an example. You sell some inventory and receive $500. You put the $500
in your Checking account. Increase (debit) your Checking account and decrease
(credit) your Inventory account.

Date Account Debit Credit

XX/XX/XXXX Checking 500

Inventory 500

Expense accounts
Expenses are costs your business incurs during operations. For example, office
supplies are considered expenses.

Examples of sub-accounts that fall under the expense account category include:

 Payroll
 Insurance
 Rent
 Equipment
 Cost of Goods Sold (COGS)

Remember that debits increase your expenses, and credits decrease expense
accounts. When you spend money, you increase your expense accounts.
 Example
Let’s say you spend $1,000 on rent. You pay for the expense with your Checking
account. Increase your Rent Expense account with a debit and credit your Checking
account.

Date Account Debit Credit

XX/XX/XXXX Rent Expense 1,000

Checking 1,000

Liability accounts
Liabilities represent what your business owes. These are expenses you have incurred
but have not yet paid.

Types of business accounts that fall under the liability branch include:

 Payroll Tax Liabilities

 Sales Tax Collected
 Credit Memo Liability
 Accounts Payable

Accounts payable (AP) are considered liabilities and not expenses. Why? Because
accounts payables are expenses you have incurred but not yet paid for. As a result,
you add a liability, or debt.

Credit liability accounts to increase them. Decrease liability accounts by debiting

them.

Example
You buy $500 of inventory on credit. This increases your Accounts Payable account
(credit). And, it increases the amount of inventory you have (debit). Your journal
entry might look something like this:
 Date Account Debit Credit

XX/XX/XXXX Inventory 500

Accounts Payable 500

Equity accounts
Equity is the difference between your assets and liabilities. It shows you how much
your business is worth.

Here are a few examples of equity sub-accounts:

 Owner’s Equity
 Common Stock
 Retained Earnings

Again, equity accounts increase through credits and decrease through debits. When
your assets increase, your equity increases. When your liabilities increase, your equity
decreases.

Example
You invested in stocks and received a dividend of $500. To reflect this transaction,
credit your Investment account and debit your Cash account. 

Date Account Debit Credit

XX/XX/XXXX Cash 500

Investment 500
 Revenue accounts
Last but not least, we’ve arrived at the revenue accounts. Revenue, or income, is
money your business earns. Your income accounts track incoming money, both from
operations and non-operations.

Examples of income sub-accounts include:

 Product Sales
 Earned Interest
 Miscellaneous Income

To increase revenue accounts, credit the corresponding sub-account. Decrease

revenue accounts with a debit.

Example
Say you make a $200 sale to a customer who pays with credit. Through the sale, you
increase your Revenue account through a credit. And, increase your Accounts
Receivable account through a debit.

Date Account Debit Credit

XX/XX/XXXX Accounts Receivable 200

Revenue 200

Quick-reference list of accounts in

accounting
Keeping track of your different types of accounts in accounting can be a challenge.
Remember, you can create a chart of accounts to stay organized.

Use the list below to help you determine which types of accounts you need in
business.
• Debits and Credits

Debits: A debit is an accounting transaction that increases either an asset account like
cash or an expense account like utility expense. Debits are always entered on the left
side of a journal entry.

Credits: A credit is an accounting transaction that increases a liability account such as

loans payable, or an equity account such as capital. A credit is always entered on the
right side of a journal entry.

If you’re unsure when to debit and when to credit an account, check out our t-chart
below.

Debit and credit accounts

ACCOUNT WHEN TO DEBIT WHEN TO CREDIT

When depositing funds or a

Cash and bank accounts When bills are paid
customer makes a payment

When the customer

Accounts receivable When a sale is made on credit
pays
 ACCOUNT WHEN TO DEBIT WHEN TO CREDIT

Various expense accounts such as rent, When a purchase is made or a When a refund is
utilities, payroll, and office supplies bill paid received

When entering a bill

Accounts payable When a bill is paid
for future payment

When a product is returned, or

Revenue When a sale is made
a discount is given

Examples of debits and credits in double-entry accounting

Here are a few examples of common journal entries made during the course of
business.

Recording a sales transaction

Recording a sales transaction is more detailed than many other journal entries because
you need to track cost of goods sold as well as any sales tax charged to your customer.

For example, on February 1, your company sells five leather journals at a cost of $20
each. After 7% sales tax, the customer is invoiced for $107.00. Here is how you would
record these debits and credits in a journal entry:

DATE ACCOUNT DEBIT CREDIT

2-1-2020 Accounts Receivable $107

2-1-2020 Cost of Goods Sold $ 55

2-1-2020 Revenue $100

2-1-2020 Inventory $  55

2-1-2020 Sales Tax Payable $    7

You will increase (debit) your accounts receivable balance by the invoice total of $107,
with the revenue recognized when the transaction takes place. Cost of goods sold is an
expense account, which should also be increased (debited) by the amount the leather
journals cost you.

Revenue will be increased (credited) by $100.

The inventory account, which is an asset account, is reduced (credited) by $55, since
five journals were sold.
Finally, you will record any sales tax due as a credit, increasing the balance of that
liability account.

Recording a business loan

On January 1, 2020, your business receives a loan in the amount of $25,000, with a 5%
interest rate, paid annually. The note is due December 31, 2022. Here is how you
record it:

DATE ACCOUNT DEBIT CREDIT

1-1-2020 Cash $25,000

1-1-2020 Notes Payable $25,000

1-1-2020 Interest Expense $625

1-1-2020 Interest Payable $625

Make a debit entry (increase) to cash, while crediting the loan as notes or loans
payable. You will also need to record the interest expense for the year.

When you pay the interest in December, you would debit the interest payable account
and credit the cash account.

Recording a bill in accounts payable

When you receive a bill from a supplier or a utility company, you'll enter it into accounts
payable, since the bill will be paid in the near future. The entry would look like this:

DATE ACCOUNT DEBIT CREDIT

2-1-2020 Utility Expense $203

2-1-2020 Accounts Payable $203

You would debit (increase) your utility expense account, while also crediting (increasing)
your accounts payable account.

Recording payment of a bill

When you pay the utility bill the following month, the entry would look like this:

DATE ACCOUNT DEBIT CREDIT

2-28-2020 Accounts Payable $203

2-28-2020 Cash $203

You would debit (reduce) accounts payable, since you’re paying the bill. You would also
credit (reduce) cash.

Examples of debits and credits

To get a better understanding of the basics of recordkeeping, let’s look at a few
debits and credits examples.

Say your company sells a product to a customer for $500 in cash. This would result in
$500 of revenue and cash of $500. You would record this as an increase of cash (asset
account) with a debit, and increase the revenue account with a credit.

Looking at another example, let’s say you decide to purchase new equipment for your
company for $15,000. The equipment is a fixed asset, so you would add the cost of
the equipment as a debit of $15,000 to your fixed asset account. Purchasing the
equipment also means you will increase your liabilities. You will increase your
accounts payable account by crediting it $15,000.

You would record the new equipment purchase of $15,000 in your accounts like this:

Here are some additional examples of accounting basics for debits and credits:
 Repay a business loan: Debit loans payable account and credit cash account.
 Sell to a customer on credit: Debit accounts receivable and credit the revenue
account.
 Purchase inventory from your vendor and pay cash: Debit inventory account and credit
the cash account.

For example:

 One bucket might represent all of the cash you have in your business

bank account (the “cash” bucket)

 Another bucket might represent the total value of all the furniture your

business has in its office (the “furniture” bucket)

 Another bucket might represent a bank loan you recently took out (the
“bank loan” bucket)
When your business does anything—buy furniture, take out a loan, spend
money on research and development—the amount of money in the buckets
changes.

Recording what happens to each of these buckets using full English

sentences would be tedious, so we need a shorthand. That’s where debits
and credits come in.
When money flows into a bucket, we record that as a debit (sometimes
accountants will abbreviate this to just “dr.”)

For example, if you deposited $300 in cash into your business bank account:

An accountant would say we are “debiting” the cash bucket by $300, and
would enter the following line into your accounting system:
Account Debit Credit

Cash $300

When money flows out of a bucket, we record that as a credit (sometimes

accountants will abbreviate this to just “cr.”)

For example, if you withdrew $600 in cash from your business bank account:
An accountant would say you are “crediting” the cash bucket by $600 and
write down the following:

Account Debit Credit

Cash $600

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Debits and credits in action

There’s one thing missing from the examples above. Money doesn’t just
disappear or appear out of nowhere. It has to come from somewhere, and go
somewhere.

That’s what credits and debits let you see: where your money is going, and
where it’s coming from.

Let’s say that one day, you visit your friend’s startup. After taking a tour of the
office, your friend shows you a beautiful ergonomic standing desk. You’ve
been looking for this model for months, but all the furniture stores are sold out.
Your friend ordered an extra one, and she can sell it to you for cheap. You
agree to buy it from her for $600.
Here’s what that would look like using our bucket system. First, we move $600
out of your cash bucket.

Just like in the above section, we credit your cash account, because money is
flowing out of it.

But this isn’t the only bucket that changes. Your “furniture” bucket, which
represents the total value of all the furniture your company owns, also
changes.
In this case, it increases by $600 (the value of the chair).

You debit your furniture account, because value is flowing into it (a desk).

In double-entry accounting, every debit (inflow) always has a corresponding

credit (outflow). So we record them together in one entry.

In this case, the entry would be:

Account Debit Credit

Furniture $600

Cash $600

An accountant would say that we are crediting the bank account $600

and debiting the furniture account $600.

How debits and credits affect liability accounts

The two buckets we used in the above example—cash and furniture—are
both asset buckets. (That is, they keep track of something you own.)

But not all buckets are asset buckets. Some buckets keep track of what you
owe (liabilities), and other buckets keep track of the total value of your
business (equity).

Let’s imagine that after buying that expensive desk, you want to get some
extra cash for your business. So you take out a $1,000 bank loan, and you
increase (debit) your cash account by $1,000.
Now here’s the tricky part.

In addition to adding $1,000 to your cash bucket, we would also have to

increase your “bank loan” bucket by $1,000.
Why? Because your “bank loan bucket” measures not how much you have,
but how much you owe. The more you owe, the larger the value in the bank
loan bucket is going to be.

In this case, we’re crediting a bucket, but the value of the bucket is increasing.
That’s because the bucket keeps track of a debt, and the debt is going up in
this case.

An accountant would record that the following way:

Account Debit Credit

Cash $1,000

Bank Loan $1,000

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How debits and credits affect equity accounts

Let’s do one more example, this time involving an equity account.

Let’s say your mom invests $1,000 of her own cash into your company. Using
our bucket system, your transaction would look like the following.

First, your cash account would go up by $1,000, because you now have
$1,000 more from mom.
But that’s not the only bucket that changes. You mom now has a $1,000
equity stake in your business—so the bucket labelled “equity (Mom)” also
increases by $1,000:
An accountant would record that the following way:

Account Debit Credit

Cash $1,000

Equity (Mom) $1,000

Why is it that crediting an equity account makes it go up, rather than down?
That’s because equity accounts don’t measure how much your business has.
Rather, they measure all of the claims that investors have against your
business.

The Equity (Mom) bucket keeps track of your Mom’s claims against your
business. That’s her equity, not your business’s. In this case, those claims
have increased, which means the number inside the bucket increases.

• Types of Assets

Assets refer to resources owned and controlled by an entity. Technically, an asset is

defined as a "resource controlled by an entity as a result of past event and from which
future economic benefits are expected to flow to the entity".
IN A NUTSHELL

Assets refer to properties owned and controlled by a business entity, either for short-term or
long-term use.
Current assets are short-term in nature and include: cash & cash equivalents, trade receivables,
short-term investment, inventory, and prepaid expenses.
Non-current assets pertain to long-term resources. Examples are: land, building, machinery,
equipment, long-term investments, intangibles, and other assets usually expected to be realized
in more than a year.
Assets
By studying the definition above, we can draw important points that would help us
understand assets better.
1. A resource – tangible or intangible property that is used by the entity in its activities
2. Controlled by the entity – the entity should have ownership and control over the
property for it to be recognized as an asset of that entity
3. A result of past transaction – an asset can be acquired through purchase, exchange,
rendering of service, sale of goods, donations, and other transactions or events.
4. Provides future economic benefits – the resource is used to contribute directly or
indirectly to the objective of the company of generating profits. A building is used to
house a company's operations; supplies such as paper and ink are used to document
business activities; cash is used to purchase materials and pay for expenses, etc.

Assets are classified into two: current assets and non-current

assets. Current assets are those that are expected to be realized or used
within the company's normal operating cycle or 1 year, whichever is longer.
They include properties that are held primarily for the purpose of selling
them in the near future. In essence, current assets are short-term in
nature. Non-current assets, on the other hand, are properties held for a long
period of time (i.e. more than 1 year).
Here's a list of asset accounts under each line item, and classified into
current and non-current:
Current Assets
1. 1. Cash and Cash Equivalents
 Cash on Hand - consists of un-deposited collections
 Cash in Bank - made up of bank accounts that are unrestricted as
to withdrawal
 Short-term cash funds such as Petty Cash Fund, Payroll
Fund, Tax Fund, etc.
 Cash Equivalents are short-term investments with very near
maturity dates making them assets that are "as good as cash".
2. 2. Trading Securities or "Financial Assets at Fair Value"
 Trading Securities are investments in stocks that are held with the
purpose of trading (speculative investments)
3. 3. Trade and Other Receivables
 Accounts Receivable - receivables from customers arising from
rendering of services or sale of goods
 Notes Receivable - receivables from customers which are backed
up by promissory notes
 Other receivables representing claims from other parties such
as: Rent Receivable, Interest Receivable, Dividend Receivable, etc.
 Allowance for Bad Debts - a contra-asset account deducted from
Accounts Receivable. It represents the estimated uncollectible amount
of the receivable.
4. 4. Inventories
 Inventories are assets that are held for sale in the normal
operations of the business. A service business normally has no
inventory account.
 Merchandising businesses normally maintain one inventory
account – Merchandise Inventory.
 Manufacturing businesses have several inventories: Raw
Materials Inventory, Work in Process Inventory, Finished Goods
Inventory, and Factory Supplies Inventory.
5. 5. Prepaid Expenses or Prepayments
 Prepayments consists of costs already paid but are yet to be used
or incurred. Common prepaid expense accounts include: Office
Supplies, Service Supplies, Prepaid Rent, and Prepaid Insurance.
Non-Current Assets
1. 1. Property, Plant, and Equipment (PPE) also known as Fixed
Assets
  PPE includes tangible assets that are expected to be used for
more than one year. PPE accounts
include: Land, Building, Machinery, Service Equipment, Computer
Equipment, Delivery Equipment, Furniture and Fixtures, Leasehold
Improvements, etc.
 Take note that land that is not used by the business in its
operations but is rather held for appreciation is not part of PPE but of
investments.
 Accumulated Depreciation - a contra-asset
account deducted from the related PPE account. It represents the
decrease in value of the asset due to continuous use, passage of time,
wear & tear, and obsolescence.
2. 2. Long-Term Investments
 Investment in Long-Term Bonds, Investment in
Associate, Investment in Subsidiary, Investment Property, Long-Term
Funds; these are investments that are intended to be held for more
than one year.
3. 3. Intangibles
 An intangible has no physical form but from which benefits can be
derived and its cost can be measured reliably.
 Intangibles include Patent for inventions, Copyright for authorship,
compositions and other literary works,Trademark, Franchise, Lease
Rights, and Goodwill.
4. 4. Other Non-Current Assets
 Assets which cannot be classified under the usual non-current
asset categories
 Includes: Advances to Officers, Directors, and Employees not
collectible within one year, Cash in Closed Banks, and Abandoned or
Idle Property
There you have a comprehensive list of asset accounts. Take note that
different companies may use different (although similar) sets of account
titles. It will depend upon the company's business and industry, and what
specific accounts were adopted in its chart of accounts.

Examples of assets include:

 Cash and cash equivalents

 Accounts Receivable
 Inventory
 Investments
  PPE (Property, Plant, and Equipment)
 Vehicles
 Furniture
 Patents (intangible asset)

Properties of an Asset

There are three key properties of an asset:

 Ownership: Assets represent ownership that can be eventually turned

into cash and cash equivalents
 Economic Value: Assets have economic value and can be exchanged or
sold
 Resource: Assets are resources that can be used to generate future
economic benefits

Classification of Assets

Assets are generally classified in three ways:

1. Convertibility: Classifying assets based on how easy it is to convert

them into cash.
2. Physical Existence: Classifying assets based on their physical existence
(in other words, tangible vs. intangible assets).
3. Usage: Classifying assets based on their business operation
usage/purpose.

 
 

Classification of Assets: Convertibility

If assets are classified based on their convertibility into cash, assets are
classified as either current assets or fixed assets. An alternative expression of
this concept is short-term vs. long-term assets.

1. Current Assets

Current assets are assets that can be easily converted into cash and cash
equivalents (typically within a year). Current assets are also termed liquid
assets and examples of such are:

 Cash
 Cash equivalents
 Short-term deposits
 Accounts receivables
 Inventory
  Marketable securities
 Office supplies

2. Fixed or Non-Current Assets

Non-current assets are assets that cannot be easily and readily converted into
cash and cash equivalents. Non-current assets are also termed fixed assets,
long-term assets, or hard assets. Examples of non-current or fixed assets
include:

 Land
 Building
 Machinery
 Equipment
 Patents
 Trademarks

Classification of Assets: Physical Existence

If assets are classified based on their physical existence, assets are classified as
either tangible assets or intangible assets.

1. Tangible Assets

Tangible assets are assets with physical existence (we can touch, feel, and see
them). Examples of tangible assets include:

 Land
 Building
 Machinery
 Equipment
 Cash
  Office supplies
 Inventory
 Marketable securities

2. Intangible Assets

Intangible assets are assets that lack physical existence. Examples of intangible
assets include:

 Goodwill
 Patents
 Brand
 Copyrights
 Trademarks
 Trade secrets
 Licenses and permits
 Corporate intellectual property

Classification of Assets: Usage

If assets are classified based on their usage or purpose, assets are classified as
either operating assets or non-operating assets.

1. Operating Assets

Operating assets are assets that are required in the daily operation of a
business. In other words, operating assets are used to generate revenue from
a company’s core business activities.  Examples of operating assets include:

 Cash
 Accounts receivable
 Inventory
  Building
 Machinery
 Equipment
 Patents
 Copyrights
 Goodwill

2. Non-Operating Assets

Non-operating assets are assets that are not required for daily business
operations but can still generate revenue. Examples of non-operating assets
include:

 Short-term investments
 Marketable securities
 Vacant land
 Interest income from a fixed deposit

• Types of Expenses

Expenses refer to costs incurred by a company in conducting business. Examples are:

Cost of sales
Advertising Expense
Bank Service Charges
Delivery Expense
Depreciation Expense
Insurance Expense
Interest Expense
Rent Expense
Repairs and Maintenance
Representation Expense
Salaries and Wages
Supplies Expense
License Fees and Taxes
Telecommunications
Utilities Expense, etc.

Expenses
From the technical definition of expense, we can draw the following points:
1. Decrease in benefits during the accounting period - Expenses are measured from
period to period, and results in a decrease in economic benefits.
2. Decrease in assets or increase in liabilities - The decrease in economic benefits
mentioned above could be in the form of a decrease in assets or an increase in liabilities.
When a company incurs an expense, it pays cash; thereby decreasing assets. Besides
cash, the company may also use other assets in paying expenses. It may also incur in a
liability in cases of accrued expenses (unpaid expenses).
3. Decrease in equity, other than distributions to equity participants - There are only two
elements that decrease equity: distributions to owners (i.e., withdrawals or dividends)
and expenses.

List of Expense Accounts

1. 1. Cost of Sales - also known as Cost of Goods Sold, it represents the value of the items sold to
customers before any mark-up. In merchandising companies, cost of sales is normally the
purchase price of the goods sold, including incidental costs. In manufacturing businesses, it is the
total production cost of the units sold. Service companies do not have cost of sales.
 Purchases - cost of merchandise acquired that are to be sold in the normal course of
business. At the end of the period, this account is closed to Cost of Sales.
 Freight in - If the business shoulders the cost of transporting the goods it purchased,
such cost is recorded as Freight-in. This account is also closed to Cost of Sales at the end
of the period.
2. 2. Advertising Expense - costs of promoting the business such as those incurred in newspaper
publications, television and radio broadcasts, billboards, flyers, etc.
3. 3. Bank Service Charge - costs charged by banks for the use of their services
4. 4. Delivery Expense - represents cost of gas, oil, courier fees, and other costs incurred by the
business in transporting the goods sold to the customers. Delivery expense is also known
as Freight-out.
5. 5. Depreciation Expense - refers to the portion of the cost of fixed assets (property, plant, and
equipment) used for the operations of the period reported
6. 6. Insurance Expense - insurance premiums paid or payable to an insurance company who
accepts to guarantee the business against losses from a specified event
7. 7. Interest Expense - cost of borrowing money
8. 8. Rent Expense - cost paid or to be paid to a lessor for the right to use a commercial property
such as an office space, a storeroom, a building, etc.
9. 9. Repairs and Maintenance - cost of repairing and servicing certain assets such as building
facilities, machinery, and equipment
10. 10. Representation Expense - entertainment costs for customers, employees and owners. It is
often coupled with traveling, hence the account title Travel and Representation Expense.
11. 11. Salaries Expense - compensation to employees for their services to the company
12. 12. Supplies Expense - cost of supplies (ball pens, ink, paper, spare parts, etc.) used by the
business. Specific accounts may be in place such as Office Supplies Expense, Store Supplies
Expense, and Service Supplies Expense.
 13. 13. License Fees and Taxes - business taxes, registration, and licensing fees paid to the
government
14. 14. Telecommunications Expense - cost of using communication and telephony technologies
such as mobile phones, land lines, and internet
15. 15. Training and Development - costs for the enhancement of employee skills
16. 16. Utilities Expense - water and electricity costs paid or payable to utility companies
And others, such as Accounting or Bookkeeping Fees, Legal and Attorney Fees, etc. Expenses are
deducted from revenues to arrive at the company's net income.

An expense is defined in the following ways:

 Office supplies use up the cash (asset)

 Depreciation expense, which is a charge to reduce the book value
of capital equipment (e.g., a machine or a building) to reflect its usage
over a period.
 A prepaid expense, such as prepaid rent, is an asset that turns into a
cash expense as the rent is used up each month

A summary of all expenses is included in the income statement as deductions

from the total revenue. Revenue minus expenses equals the total net profit of
a company for a given period.

In the double-entry bookkeeping system, expenses are one of the five main
groups where financial transactions are categorized. Other categories include
the owner’s equity, assets, liabilities, and revenue. Expenses in double-entry
bookkeeping are recorded as a debit to a specific expense account. A
corresponding credit entry is made that will reduce an asset or increase a
liability.

The purchase of an asset such as land or equipment is not considered a simple

expense but rather a capital expenditure. Assets are expensed throughout
their useful life through depreciation and amortization.

 
Expenses in Cash Accounting and Accrual Accounting

Expenses are recorded in the books on the basis of the accounting system
chosen by the business, either through an accrual basis or a cash basis. Under
the accrual method, the expense for the good or service is recorded when the
legal obligation is complete; that is when the goods have been received or the
service has been performed.

Under cash accounting, the expense is only recorded when the actual cash has
been paid. For example, a utility expense incurred in April but paid in May will
be recorded as an expense in April under the accrual method but recorded as
an expense in May under the cash method – as this is when the cash is actually
paid.

Accrual accounting is based on the matching principle that ensures that

accurate profits are reflected for every accounting period. The revenue for
each period is matched to the expenses incurred in earning that revenue
during the same accounting period. For example, sale commission expenses
will be recorded in the period that the related sales are reported, regardless of
when the commission was actually paid.

Types of Expenses

Expenses affect all financial accounting statements but exert the most impact
on the income statement. They appear on the income statement under five
major headings, as listed below:

1. Cost of Goods Sold (COGS)

Cost of Goods Sold (COGS) is the cost of acquiring raw materials and turning
them into finished products. It does not include selling and administrative
costs incurred by the whole company, nor interest expense or losses on
extraordinary items.
  For manufacturing firms, COGS includes direct labor, direct materials,
and manufacturing overhead.
 For a service company, it is called a cost of services rather than COGS.
 For a company that sells both goods and services, it is called cost of
sales.

Examples of COGS include direct material, direct costs, and production

overhead.

2. Operating Expenses – Selling/General and Admin

Operating expenses are related to selling goods and services and include sales
salaries, advertising, and shop rent.

General and administrative expenses include expenses incurred while running

the core line of the business and include executive salaries, R&D, travel and
training, and IT expenses.

3. Financial Expenses

They are costs incurred from borrowing from lenders or creditors. They are
expenses outside the company’s core business. Examples include loan
origination fees and interest on money borrowed.

4. Extraordinary Expenses

Extraordinary expenses are costs incurred for large one-time events or

transactions outside the firm’s regular business activity. They include laying off
employees, selling land, or disposal of a significant asset.

5. Non-Operating Expenses
These are costs that cannot be linked back to operating revenues. Interest
expense is the most common non-operating expense. Interest is the cost of
borrowing money. Loans from banks usually require interest payments, but
such payments don’t generate any operating income. Hence, they are
classified as non-operating expenses.

Non-Cash Expenses

Under the accrual method of accounting, non-cash expenses are those

expenses that are recorded in the income statement but do not involve an
actual cash transaction. Depreciation is the most common type of non-cash
expense, as it reduces net profit, but is not a result of a cash outflow.   The
accounting transaction and its impact on the financial statements are outlined
below.:

 A debit to a depreciation expense account and a credit to a contra asset

account called accumulated depreciation
 On the balance sheet, the book value of the asset is decreased by the
accumulated depreciation.

Expenses are income statement accounts that are debited to an account, and
the corresponding credit is booked to a contra asset or liability account.

• Types of Liabilities

A liability is a financial obligation of a company that results in the company’s

future sacrifices of economic benefits to other entities or businesses. A liability
can be an alternative to equity as a source of a company’s financing.
Moreover, some liabilities, such as accounts payable or income taxes payable,
are essential parts of day-to-day business operations.

 
 

Liabilities can help companies organize successful business operations and

accelerate value creation. However, poor management of liabilities may result
in significant negative consequences, such as a decline in financial
performance or, worse, bankruptcy.

In addition, liabilities determine the company’s liquidity and capital structure.

 

Accounting Reporting of Liabilities

A company reports its liabilities on its balance sheet. According to the

accounting equation, the total amount of the liabilities must be equal to the
difference between the total amount of the assets and the total amount of the
equity.

Assets = Liabilities + Equity

Liabilities = Assets – Equity

Liabilities must be reported according to the accepted accounting principles.

The most common accounting standards are the International Financial
Reporting Standards (IFRS). The standards are adopted by many countries
around the world. However, many countries also follow their own reporting
standards such as the GAAP in the U.S. or the RAP in Russia. Although the
recognition and reporting of the liabilities comply with different accounting
standards, the main principles are close to the IFRS.

On a balance sheet, liabilities are listed according to the time when the
obligation is due.

Current Liabilities vs. Long-term Liabilities

The primary classification of liabilities is according to their due date. The

classification is critical to the company’s management of its financial
obligations.

Current liabilities are those that are due within a year. These primarily occur as
part of regular business operations. Due to the short-term nature of these
financial obligations, they should be managed with consideration of the
company’s liquidity. Liquidity is frequently determined as a ratio between
current assets and current liabilities. The most common current liabilities are:

 Accounts payable: These are the unpaid bills to the company’s vendors.

Generally, accounts payable are the largest current liability for most
businesses.
 Interest payable: Interest expenses that have already occurred but have
not been paid. Interest payable should not be confused with the interest
expenses. Unlike interest payable, interest expenses are expenses that
have already been incurred and paid. Therefore, interest expenses are
reported on the income statement, while interest payable is recorded on
the balance sheet.
 Income taxes payable: The income tax amount owed by a company to
the government. The tax amount owed must be payable within one year.
Otherwise, the tax owed must be classified as a long-term liability.
 Bank account overdrafts: A type of short-term loan provided by a bank
when the payment is processed with insufficient funds available in the
bank account.
 Accrued expenses: Expenses that have incurred but no supporting
documentation (e.g., invoice) has been received or issued.
 Short-term loans: Loans with a maturity of one year or less.

Long-term Liabilities

Long-term (non-current) liabilities are those that are due after more than one
year. It is important that the long-term liabilities exclude the amounts that are
due in the short-term, such as interest payable.

Long-term liabilities can be a source of financing, as well as refer to amounts

that arise from business operations. For example, bonds or mortgages can be
used to finance the company’s projects that require a large amount of
financing. Liabilities are critical to understanding the overall liquidity and
capital structure of a company.

Long-term liabilities include:

  Bonds payable: The amount of outstanding bonds with a maturity of
over one year issued by a company. On a balance sheet, the bonds
payable account indicates the face value of the company’s outstanding
bonds.
 Notes payable: The amount of promissory notes with a maturity of over
one year issued by a company. Similar to bonds payable, the notes
payable account on a balance sheet indicates the face value of the
promissory notes.
 Deferred tax liabilities: They arise from the difference between the
recognized tax amount and the actual tax amount paid to the
authorities. Essentially, it means that the company “underpays” the taxes
in the current period and will “overpay” the taxes at some point in the
future.
 Mortgage payable/long-term debt: If a company takes out a
mortgage or a long-term debt, it records the face value of the borrowed
principal amount as a non-current liability on the balance sheet.
 Capital lease: Capital leases are recognized as a liability when a
company enters into a long-term rental agreement for equipment. The
capital lease amount is a present value of the rental’s obligation.

Contingent Liabilities

Contingent liabilities are a special category of liabilities. They are probable

liabilities that may or may not arise, depending on the outcome of an
uncertain future event.

A contingent liability is recognized only if both of the following conditions are

met:

 The outcome is probable.

 The liability amount can be reasonably estimated.

If one of the conditions is not satisfied, a company does not report a

contingent liability on the balance sheet. However, it should disclose this item
in a footnote on the financial statements.
One of the most common examples of contingent liabilities is legal
liabilities. Suppose that a company is involved in litigation. Due to the stronger
evidence provided by the opposite party, the company expects to lose the
case in court, which will result in legal expenses. The legal expenses may be
recognized as contingent liabilities because:

 The expenses are probable.

 The legal expenses can be reasonably estimated (based on the remedies
asked by the opposite party).

• Types of Equity

In finance and accounting, equity is the value attributable to the owners of

a business. The book value of equity is calculated as the difference
between assets and liabilities on the company’s balance sheet, while the market
value of equity is based on the current share price (if public) or a value that is
determined by investors or valuation professionals. The account may also be
called shareholders/owners/stockholders equity or net worth.

There are generally two types of equity value:

1. Book value
2. Market value
 

#1 Book value of equity

In accounting, equity is always listed at its book value. This is the value that
accountants determine by preparing financial statements and the balance sheet
equation that states: assets = liabilities + equity. The equation can be
rearranged to: equity = assets – liabilities.

The value of a company’s assets is the sum of each current and non-current
asset on the balance sheet. The main asset accounts include cash, accounts
receivable, inventory, prepaid expenses, fixed assets, property plant and
equipment (PP&E), goodwill, intellectual property, and intangible assets.

The value of liabilities is the sum of each current and non-current liability on
the balance sheet. Common liability accounts include lines of credit, accounts
payable, short-term debt, deferred revenue, long-term debt, capital leases,
and any fixed financial commitment.

In reality, the value of equity is calculated in a much more detailed way and is
a function of the following accounts:

 Share capital
 Contributed surplus
 Retained earnings
 Net income (loss)
 Dividends

To fully calculate the value, accountants must track all capital the company has
raised and repurchased (its share capital), as well as its retained earnings,
which consist of cumulative net income minus cumulative dividends. The sum
of share capital and retained earnings is equal to equity.

#2 Market value of equity

In finance, equity is typically expressed as a market value, which may be

materially higher or lower than the book value. The reason for this difference
is that accounting statements are backward-looking (all results are from the
past) while financial analysts look forward, to the future, to forecast what they
believe financial performance will be.

If a company is publicly traded, the market value of its equity is easy to

calculate. It’s simply the latest share price multiplied by the total number of
shares outstanding.
If a company is private, then it’s much harder to determine its market value. If
the company needs to be formally valued, it will often hire professionals such
as investment bankers, accounting firms (valuations group), or boutique
valuation firms to perform a thorough analysis.

Estimating the market value of equity

If a company is private, the market value must be estimated. This is a very

subjective process, and two different professionals can arrive at dramatically
different values for the same business.

The most common methods used to estimate equity value are:

 Discounted cash flow (DCF) analysis

 Comparable company analysis
 Precedent transactions

In the discounted cash flow approach, an analyst will forecast all future free
cash flow for a business and discount it back to the present value using a
discount rate (such as the weighted average cost of capital). DCF valuation is a
very detailed form of valuation and requires access to significant amounts of
company information. It is also the most heavily relied on approach, as it
incorporates all aspects of a business and is, therefore, considered the most
accurate and complete measure.

To learn more, read CFI’s guide to business valuation resources.

Personal equity (Net worth)

The concept of equity applies to individual people as much as it does to

businesses. We all have our own personal net worth, and a variety of assets
and liabilities we can use to calculate our net worth.
Common examples of personal assets include:

 Cash
 Real estate
 Investments
 Furniture and household items
 Cars and other vehicles

Common examples of personal liabilities include:

 Credit card debt

 Lines of credit
 Outstanding bills (phone, electric, water, etc.)
 Student loans
 Mortgages

The difference between all your assets and all your liabilities is your personal
net worth.

There are several types of equity accounts that combine to make up

total shareholders’ equity. These accounts include common stock, preferred
stock, contributed surplus, additional paid-in capital, retained earnings, other
comprehensive earnings, and treasury stock.

Equity is the amount funded by the owners or shareholders of a company for

the initial start-up and continuous operation of a business. Total equity also
represents the residual value left in assets after all liabilities have been paid
off, and is recorded on the company’s balance sheet. To calculate total equity,
simply deduct total liabilities from total assets.
Learn more in CFI’s Free Accounting Fundamentals Course!

Types of Equity Accounts

The seven main equity accounts are:

#1 Common Stock

Common stock represents the owners’ or shareholder’s investment in the

business as a capital contribution. This account represents the shares that
entitle the shareowners to vote and their residual claim on the company’s
assets. The value of common stock is equal to the par value of the shares
times the number of shares outstanding. For example, 1 million shares with $1
of par value would result in $1 million of common share capital on the balance
sheet.

#2 Preferred Stock

Preferred stock is quite similar to common stock. The preferred stock is a type
of share that often has no voting rights, but is guaranteed a cumulative
dividend. If the dividend is not paid in one year, then it will accumulate until
paid off.

Example: A preferred share of a company is entitled to $5 in cumulative

dividends in a year. The company has declared a dividend this year but has
not paid dividends for the past two years. The shareholder will receive $15
($5/year x 3 years) in dividends this year.

#3 Contributed Surplus

Contributed Surplus represents any amount paid over the par value paid by
investors for stocks purchases that have a par value. This account also holds
different types of gains and losses resulting in the sale of shares or other
complex financial instruments.
Example: The company issues 100,000 $1 par value shares for $10 per share.
$100,000 (100,000 shares x $1/share) goes to common stock, and the excess
$900,000 (100,000 shares x ($10-$1)) goes to Contributed Surplus.

#4 Additional Paid-In Capital

Additional Paid-In Capital is another term for contributed surplus, the same as
described above.

#5 Retained Earnings

Retained Earnings is the portion of net income that is not paid out as
dividends to shareholders. It is instead retained for reinvesting in the business
or to pay off future obligations.

#6 Other Comprehensive Income

Other comprehensive income is excluded from net income on the income

statement because it consists of income that has not been realized yet. For
example, unrealized gains or losses on securities that have not yet been sold
are reflected in other comprehensive income. Once the securities are sold,
then the realized gain/loss is moved into net income on the income
statement.

#7 Treasury Stock (Contra-Equity Account)

Treasury stock is a contra-equity account. It represents the amount of

common stock that the company has purchased back from investors. This is
reflected in the books as a deduction from total equity.

 
• Types of Revenue or income

Revenue is the sales amount a company earns from providing services or

selling products (the “top line”). Income can sometimes be used to mean
revenue, or it can also be used to refer to net income, which is revenue less
operating expenses (the “bottom line”).

Learn more in CFI’s Free Accounting Courses.

Types of Revenue

Let’s take a closer look at what revenue can mean by looking at examples of
the different types that frequently appear in finance and accounting.

Types of revenue include:

  The sale of goods, products, or merchandise
 The sale of services, such as consulting
 Rental income from a commercial property (notice the use of “income”)
 The sale of tickets to a concert
 Interest income from lending

Types of Income

As we explained above, the term “income” can sometimes be confusing, as

accountants often use it to refer to a revenue. The term net income clearly
means after all expenses have been deducted.

Types of income include:

 Gross income (before any expenses are deducted)

 Net income (after all expenses are deducted)

Learn more about “Gross vs Net.”

Examples of Revenue vs Income

Let’s look at some examples to further illustrate the point. Read through each
case below and see if you can determine what you would categorize it as.

Example #1

Tom’s Pizza Inc sells pizzas, soft drinks, snacks, and dips directly to customers.
The customers either pay for the products with a credit card or with cash. At
the end of the year, Tom gives his accountant all the receipts from sales, as
well as invoices and receipts for all employee wages, supplies, energy, and
food/drink costs. His accountant takes all the receipts and tells Tom his
________ is $125,869. The answer is “net income.”

Example #2
Sara’s Photography Ltd provides a wide range of services, including portrait
photos, wedding shots, family photos, and special occasions. She charges
clients for these services upfront and at the end of the year, enters all the
invoices into a spreadsheet and determines that her _______ is $248,120. The
answer is “revenue.”

Revenues refer to gross income generated in conducting business. Some typical

revenue accounts are:
Sales
Service revenue
Professional fees
Rent income
Investment income
Commission income
Royalties
Franchise fee
Interest income

Revenues
The following points can be drawn from the definition of revenue:
1. Result in benefits during the accounting period. Income is
measured from period to period, and provides economic benefits to
the company.
2. Increase in assets or decrease in liabilities. The economic
benefits mentioned above could be in the form of an increase in
assets or a decrease in liabilities. When a company renders services
or sells goods, it receives cash as payment; thereby increasing
assets. It can also acquire a receivable if the sale was made on
credit, or receive any other asset in place of cash. Also, an existing
liability may be forgiven or cancelled in exchange for the company's
services.
3. Increase in equity, other than contributions from equity
participants. There are only two elements that provide increases in
equity: contributions from owners and revenues.
List of Revenue Accounts
1. 1. Service Revenue - revenue earned from rendering services. Other
account titles may be used depending on the industry of the business, such
as Professional Fees for professional practice and Tuition Fees for schools.
 2. 2. Sales - revenue from selling goods to customers. It is the principal
revenue account of merchandising and manufacturing companies.
 Sales Discounts - a contra-revenue account that represents
reduction in the amount paid by customers for early payment. It is
shown in the income statement as a deduction to Sales.
 Sales Returns and Allowances - also a contra-revenue account
and therefore shown as a deduction to Sales. Sales return occurs when
there is actual return of a defective item. Sales allowance happens
when the customer is willing to keep the item with a reduction in its
selling price.
3. 3. Rent Income - earned from leasing out commercial spaces such as
office space, stalls, booths, apartments, condominiums, etc.
4. 4. Interest Income - revenue earned from lending money
5. 5. Commission Income - earned by brokers and sales agents
6. 6. Royalty Income - earned by the owner of a property, patent, or
copyrighted work for allowing others to use such in generating revenue
7. 7. Franchise Fee - earned by a franchisor in a franchise agreement
On the income statement, net income is computed by deducting all expenses from all revenues.
Revenues are presented at the top part of the income statement, followed by the expenses.

•Journalizing

Journal Entry Examples

 
 

Example 1 – Borrowing money journal entry

ABC Company borrowed $300,000 from the bank

 The accounts affected are cash (asset) and bank loan payable (liability)
 Cash is increasing because the company is gaining cash from the bank,
and bank loan payable is increasing because the company is increasing
its liability to pay back the bank at a later date.
 The amount in question is $300,000
  A = L + SE, A is increased by 300,000, and L is also increased by 300,000,
keeping the accounting equation intact.

Therefore, the journal entry would look like this:

DR Cash                      300,000

CR Bank Loan Payable          300,000

Example 2 – Purchasing equipment journal entry

Purchased equipment for $650,000 in cash.

DR Equipment            650,000

CR Cash                      650,000

To learn more, launch our free accounting courses.

Example 3 – Purchasing inventory journal entry

Purchased inventory costing $90,000 for $10,000 in cash and the

remaining $80,000 on the account.

DR Inventory              90,000

CR Cash                                  10,000

CR Accounts Payable             80,000

 
Example 4 – Acquiring land journal entry

Purchased land costing $50,000 and buildings costing $400,000. Paid

$100,000 in cash and signed a note payable for the balance.

DR Land                     50,000

DR Buildings              400,000

CR Cash                      100,000

CR Note payable         350,000

What Is Included in a Journal Entry?

To make a complete journal entry you need the following elements:

 A reference number or also known as the journal entry number, which is unique for every
transaction.
 The date of the journal entry.
 The account column, where you put the names of the accounts that have changed.
 Two separate columns for debit and credit. Here you will put the amounts that will be credited
and debited. Again, it’s important to remember that they must be equal in the end. If you’re
using accounting software, it won’t let you post the journal entry unless the amounts match.
However, if you’re using manual apps like Sheets or Excel, always triple check the balance.
 Lastly, the journal entry explanation. This needs to be a brief but accurate description of the
journal entry. You may need to refer back to it in the future, so be as clear as possible.

This is what the previous transaction would look like in a Journal:

Ref DATE Account Titles and Explanation Debit Credit

.

101 September Cash $10,00

3rd 0

Capital (Owners investment in the $10,000

Ref DATE Account Titles and Explanation Debit Credit
.

business)

What are the Most Common Types of Journals?

Businesses are diverse - in size, service, ownership. That’s why there are different types of
journals, based on the company you run. Mainly, however, we divide them into two
categories: general and special.

We briefly mentioned the general journal in the beginning. To recap, the general journal is the
company book in which accountants post (or summarize) all journal entries.

While small businesses and startups might not have difficulty fitting all of their entries in the
general journal, that’s not always the case.

For big industries like trading or manufacturing, other journals, called special journals are
necessary. Their purpose is to group and record transactions of a specific type. These types
depend on the nature of the business. Usually, though, special journals record the most recurring
transactions within a company.

Here’s a list of the most frequent types of special journals utilized by companies:

 Sales - income you earn from sales.

 Sales Return - loss of income from sales you’ve refunded
 Accounts Receivable - cash owed to the company
 Accounts Payable - cash the company owes
 Cash Receipts - cash you’ve gained
 Purchases - payments you’ve done
 Equity - owner’s investment
 Payroll - payroll transactions such as gross wages, or withheld taxes

Most Common Journal Entries for a Small Business

Some of the most common types of journal entries that a small business will make are the
following:

All examples assume tax is applied on sales and purchase. If no tax, then it can be removed as
the value will be zero.

Journal Entry for Sales of Services

Ref DATE Account Titles and Explanation Debit Credit
.

101 September Cash $10,00

3rd 0

Capital (Owners investment in the $10,000

business)

Journal Entry for Sales Invoice - Goods/Inventory

Ref. DATE Account Titles and Explanation Debit Credit

100 September Accounts Receivable $1,100

3rd

Sales $1,000

Tax $100

Inventory $500

Cost of Goods Sold $500

Journal Entry for Cash Sales

Ref. DATE Account Titles and Explanation Debit Credit

100 September Cash $1,100

3rd

Sales $1,000

Tax $100

Journal Entry for Receiving Payment for Invoice

Ref. DATE Account Titles and Explanation Debit Credit

100 September Bank (or Cash) $1,100

3rd

Accounts Receivable $1,100

Journal Entry for Purchase of Goods

Ref DATE Account Titles and Explanation Debi Credit

. t

100 September Inventory $500

3rd

Tax $50

Accounts Payable $550

Journal Entry for Purchase of Services

Ref DATE Account Titles and Explanation Debi Credit

. t

100 September Purchases $500

3rd

Tax $50

Accounts Payable $550

Journal Entry for Making Payments for Purchases

Ref DATE Account Titles and Explanation Debi Credit
. t

100 September Accounts Payable $550

3rd

Bank (or Cash) $550

Journal Entry for Only Fulfilling Orders (transfer of goods/inventory out of the system)

Ref DATE Account Titles and Explanation Debi Credit

. t

100 September Cost of Goods Sold $500

3rd

Inventory $500

Journal Entry for Only Receiving Goods (transfer of goods/inventory into the system)

Ref DATE Account Titles and Explanation Debi Credit

. t

100 September Inventory $500

3rd

Accrued Purchases $500

As you might’ve guessed, a journal entry for sales of goods, is created whenever your business
sells some manufactured goods. Since these are self-descriptive enough, let’s move on to some
more complex accounting journal entries.

What Are the Different Types of Journal Entries?

There are three other main types of journal entries in accounting:

Compound Entries
When transactions affect more than two accounts, we make compound entries. These are
common when the recordings are related in nature or happen during the same day.

Remember: debits and credits must always be equal. The principle stays the same, there are just
more accounts that change.

Let’s check out an example.

XYZ company decides to buy new computer software for $1,000. They pay $500 in cash right
away and agree to pay the remaining $500 later.

The steps are the same as in the double-entry bookkeeping.

First, we figure out which accounts have changed and by how much. In this scenario, those are
three:

 Asset account, which increases by $1,000 when buying the new computer software.
 Cash account, which decreases $500 in Cash from paying.
 Accounts payable account, which increases $500 from the remaining unpaid amount.

The next step is to translate them into debit and credit.

Assets increase when debited, so Equipment will be debited for $1,000. Expenses decrease when
credited, so Cash will be credited for $500. Liabilities increase when credited, so Accounts
Payable will also be credited for $500.

This is what the transaction would like in a Journal:

Ref DATE Account Titles and Explanation Debit Credit

.

101 September Equipment $1,000

3rd

Cash $500

Accounts payable $500

(purchased computer software with a balance on the

account)

Adjusting Entries
Adjusting entries are used to update previously recorded journal entries. They ensure that
those recordings line up to the correct accounting periods. This does not mean that those
transactions are deleted or erased, though.  Adjusting entries are new transactions that keep the
business’ finances up to date.

They are usually made at the end of an accounting period. The accounting period usually
coincides with the business fiscal year.

There are four main types of adjusting entries:

1. Prepaid expenses are payments in cash for assets that haven’t been used yet. Think of
insurance. It protects a company from possible losses, like fire or theft, which haven’t happened
yet.
2. Unearned revenue is cash received before the product or service is provided. Take your yearly
gym membership or Spotify subscription - you’re paying in advance for future service.
3. Accrued revenue is money earned, but not collected. If you take a loan, the interest rate income
from the loan will be recorded as an accrued revenue.
4. Accrued expenses are expenses made, but not paid. An example would be not paying your
workers their salary until the end of the month.

Let’s put all of this information into a concrete exercise.

On October 2nd, you sell to a client, a service worth $3,000. You receive the payment for the
provided service, however, you forget to make a journal entry.

Then at the end of October, you compare the actual cash reserve with the cash reserve shown on
the balance sheet.

Since the two sums will not match, it means that there is a missing transaction somewhere. At
this point, you need to make a journal entry adjustment.

The journal entry on October 31st would look like this:

DATE Account Titles and Explanation Ref Debit Credit

.

October Cash 101 $3,000

31st

Unearned Revenue $3,000

(adjusting entry due to excess cash)

Reversing Entries
Reverse entries are the opposite of adjusting entries. When we say the opposite, we don’t mean
that the adjusting entries get deleted. No amount previously recorded changes. Reverse entries
only simplify financial reports, by canceling out the effect of the adjusting entries.

Since their goal is just to simplify, reverse entries are optional. Some accountants choose to
make them, others don’t.

They’re usually done at the start of a new accounting period.

Why?

Because adjusting entries are made at the end of the period. So, for instance, if the period ends
on December 31st, you would do the reverse the next day, on January 1st.

Now, you can’t reverse all types of adjusting entries: only accrued revenues and accrued
expenses.

Let’s see how the previous accrued revenues example would look like reversed.

The adjusting entry in the last section was:

 Accounts receivable debited for $3000

 Service revenue credited for $3000

What reversing entries do is switch the places of the two. So now:

 Service revenue will be debited for $3000

 Accounts receivable will be credited for $3000

This is what the complete journal entry would look like:

DATE Account Titles and Explanation Ref. Debit Credit

December Service Revenue 101 $3,000

2nd

Accounts receivable $3,000

(to reverse November 2nd adjusting

entry)
Step 1 – Recording Accounting Journal Entries With Debits And Credits:

 In a double entry accounting system (used by most businesses) every business

transaction is recorded in at least two accounts. (Learn more about double-entry
accounting in our bookkeeping section)
 One account from your small business chart of accounts will be debited which simply
means the amount will be recorded on the left side and one account will
be credited…amount recorded on right side.
 Debits and credits must balance equal.
 See more about debits and credits in our basic accounting concepts section.
Step 2 – Journalizing

Note: Today most accounting is done on computers and the journalizing (recording

accounting journal entries) is done in the background; however, it is still important to know
the basics of double entry accounting.
 In manual accounting, each financial transaction is first recorded in a book called
a journal.
 In that accounting journal entry, the title of the account to be debited is listed first,
followed by the amount to be debited. The title of the account to be credited is listed
below and to the right of the debit, followed by the amount to be credited.
 To determine which account is debited and which is credited you have to first
determine what kind of account is being affected and if it was increased or
decreased.
Step 3 – Recording Accounting Journal Entries Using The Accounting
Equation:

 To determine which account is debited and which is credited memorize this basic
accounting equation (the foundation of all basic accounting concepts):
Assets = Liabilities + Owner’s Equity
 Assets are on the left side or debit side and asset accounts such as Cash have their
normal balances on the left side.
 Liabilities and Owner’s equity are on the right side or credit side and their accounts
in the general accounting ledger have their normal balance on the right side.
Okay…here’s where it gets a little complicated…but keeping the above equation in mind
makes it a lot easier to understand:)

Step 4 – Recording Accounting Journal Entries: Increase Or Decrease?

 To record a business transaction in an accounting journal entry, we need to look

closely at the transaction and see which accounts it involves and if it increased or
decreased those accounts.
 If it involved an asset account such as Cash, you would picture that basic accounting
equation above and know that its normal balance is on the left side (debit side), so if
we received (increase) cash we would record the amount on the left side.
  However, if it decreased our asset account such as paying our small business bills,
we would record it on the second line and on the right side to show a decrease in
that account.
 If the business transaction increased our liabilities or owner’s equity we would record
it on the right side ( credit side) because those balance sheet accounts have a
normal credit (right) balance. (Remember that equation?)
 If the transaction decreased our liabilities or owner’s equity we would record it on the
left side ( debit side).
 To sum it up—remembering the basic accounting equation: increase a balance
sheet account by recording the amount on the same side as its on in the equation;
decrease it by recording amount on the opposite side.
 For income statement accounts such as revenue (income) and expenses, you just
need to remember revenue accounts have a normal right credit balance. (Easy for
me to remember—Revenue increases owner’s equity and has the same normal
“credit” balance). There are single-step income statements and multi-step income
statement templates available online that can be accessed via download that will
reflect operating expenses, gross profit, operating income, net sales, non-operating
revenues, gross margin, net operating income, non-operating expenses and non-
operating income, all over a specific period of time.
 So following the rules above—when you increase your revenue account, you would
record the amount on its normal credit (right) side and to decrease it you would
record the amount on the debit (left )side.
 Expenses have a normal debit (left) balance. To increase your expense account, you
would record the amount on its normal debit (left) side and to decrease it you would
record the amount on its opposite (credit) side. Tip: Expenses are almost always
debited! Expenses include such line items as licenses, bank charges, interest
expense, postage, permits, professional fees, delivery expenses, vehicle
expenses, credit card fees, freight, subscriptions and repairs.
Step 5 – Practice Recording Accounting Journal Entries:

The best way to learn something is to do it…so let’s study some examples of general
journal entries using double-entry bookkeeping:  Bob open their brand new store selling
thingamajigs. Here are some examples of their basic accounting journal entries for the first
accounting period:
Transaction #1 – Jane an Bob invest $15,000 into their new business; rent a building, and
start selling their merchandise. How should the general journal entry be made?
Date  Account Names & Explanation  Debit  Credit 

3/1 Cash 15000

 

Capital 15000
   

  Jane and Bob deposit $15,000 in their new business bank    

account.
 Debit: increase in asset (cash)
     

Credit: increase in owner’s equity

     

Transaction #2 – On March 5th, the company paid their first month’s rent of $1,700. The
expense is recorded by debiting it and deceasing cash by crediting it.

3/5 Rent Expense 1700

 

Cash 1700
   

     
Paid first month’s rent of $1700.

Debit: increase in expenses (rent)

     

Credit: decrease in asset (cash)

     

Transaction #3 – On March 10th, the company purchased direct material for inventory that

was worth $4,000 on credit. This will result in an increase in an asset account which is a
debit and a credit to Accounts Payable in the amount of $4,000.

3/10 Thingamajig Material – Inventory 4000

 

Accounts Payable 4000

   

  To make their thingamajigs Jane purchased $4000 in    

thingamajig materials on credit for cost of goods.

Debit: increase in assets (inventory)

     

Credit: increase in liabilities (AP)

     

Transaction #4 – On March 15, the company made sales of $2,200 and received $1,200 in
cash and the remaining $1,000 as Accounts Receivable. This results in a compound
journal entry. We will record an increase in cash and Accounts Receivable and debit those
accounts. In addition, the Revenue account is credited by $2,200 even though full payment
hasn’t been received.

3/15 Cash 1200

 

Account Receivable 1000

   

Revenue 2200
   

Sales of $2200. Cash sales of $1200 and sold $1000 on

  customer credit. (Compound entry: Some transactions will    
affect more than one account)

Debit: increase in assets (cash)

     

Debit: increase in assets (AR)

     

Credit: increase in Revenue

     

Transaction #5 – Also on March 15, an expense was made to purchase materials that will
be used to create inventory for $600.  As such there will be a debit in expenses and credit
in inventory.

3/15 Thingamajig Material Expense 600

 

Thingamajig Material – Inventory 600

   

  $600 in Thingamajig material was used to make more    

Thingamajigs.

Debit: increase in expenses (Thingamajig Material)

     
 Credit: decrease in asset (inventory)
     

Transaction #6 – For this accounting entry, on March 28, the company paid some of its
liability from Transaction #3 by issuing a check.  To record this transaction, we will debit
Accounts Payable for $1,800 to decrease it, then we will credit cash to decrease it as a
result of the payment. 

3/28 Accounts Payable 1800

 

Cash 1800
   

     
Paid $1800 on credit account.

Debit: decrease in liabilities (AP)

     

Credit: decrease in assets (cash)

     

Transaction #7 – On March 30 the company collected a portion of the amount due from the
customer in Transaction #4.  This transaction is recorded as an increase in cash by
debiting it by $500.  Then, we credit Accounts Receivable to decrease it, which will reduce
the receivable since some of the money has been collected.

3/30 Cash 500

 

Accounts Receivable 500

   

 
Collected $500 in cash from credit customers.

Debit: increase in assets (cash)

     
 Credit: decrease in asset (AR)
     

Notice how each transaction is balanced. Everything entered on the left hand (debit) side
equals the (credit side) right hand side. That’s what double entry bookkeeping is all about—
transactions must balance. It’s kind of like what you learned in basic algebra classes–if you
can remember back that far – what you did to one side of the equation you had to do to the
other side.

A couple of more tips on journal entry accounting:

 The above accounting journal entries did not include account numbers. Usually in
real life, you would use the account numbers from your chart of accounts to identify
each account.
 You do not use dollar signs in recording the amounts. If the journal is prepared in the
United States the amounts are understood to be in the US Dollar.

Having a detailed understanding of how the journal entry works, we can now move on to
practical examples to view the practical application of journal entries illustrated by the
following comprehensive example:
George intends to develop a mobile app that creates and tracks personal budgets. He has
registered a startup business by the name of G. Tech to fulfill his aim. The entity was
registered on 1st Jan, 2017 and at the end of the month, the following transactions were
identified, George wants journal entries for to be passed for these transactions and have
contacted you for help. Review the transactions and journal entry examples accordingly.
Events:
1st Jan George deposited $50,000.00 from his personal savings and borrowings into the
business bank account.
1st Jan Company registration charges of $750.00 were paid to registration consultant from
business bank account.
3rd Jan  Purchase of computer equipment worth $500.00.
3rd Jan Office premises is acquired for a monthly rent of $900.00 payable at the start of
each month. Real Estate agent’s commission of $1,000.00 is paid at the spot.
4th Jan George withdrew $230.00 from the business bank account for groceries. On the
same day, another expense of $100.00 for fuel was paid by George from his own pocket,
George believes this fuel expense should be charged to business since most of the
traveling would be for business development.
8th Jan George hires a developer and a business analyst on monthly salaries of $5,000.00
and $2,800.00 respectively.
15th Jan The newly hired developer collaborates with a freelance IT service provider to get
a module of the app configured, the freelancer worked for 4 hours at $40.00 per hour. The
payment would only be made after a test run and approval from George.
20th Jan George made a payment of $1,250.00 is the monthly installment for his auto loan
from his business account.
28th Jan As the application goes into the testing phase, George wants to let a word out
about his product and spends $300.00 on marketing from the business account.
31st Jan Salaries for the month of Jan and Rent for Feb is paid.
Solution:
Date Description  Debit (USD)  Credit (USD)  

1st Jan Bank 50,000.00    

1st Jan Capital   50,000.00  

Narration: Increase in asset and equity accounts.  

         

1st Jan Company Registration Expense 750.00    

1st Jan Bank   750.00  

Narration: Increase in Expense and Decrease in asset Account.  

         

3rd Jan Computer Equipment asset 500.00    

3rd Jan Bank   500.00  

Narration: Increase in one asset account and a decrease in another.  

         

3rd Jan Prepaid Rent 841.93    

3rd Jan Bank                       841.93  

Narration: Rent for 29 days starting from 3rd Jan to 31st Jan (900 x 29/31 = 841.95)
resulting in the creation of an asset i.e. prepayment and decrease in asset bank
account.  

         

3rd Jan Estate Agent Commission             1,000.00    

3rd Jan Bank                     1,000.00  

Narration: Increase in expense and decrease in the asset account.  

         

4th Jan Capital                230.00    

4th Jan Bank                         230.00  

Narration: Decrease in both the capital and asset accounts.  

         

4th Jan Fuel Expense                100.00    

4th Jan Payable to George                         100.00  

Narration: Increase in both expense and liability accounts.  

         

15th
Jan Professional services expense                160.00    

15th
Jan Payable to Freelancer                         160.00  

Narration: Increase in both expense and liability accounts.  

         

20th
Jan Capital             1,250.00    

20th
Jan Bank                     1,250.00  

Narration: Decrease in both equity and asset accounts.  

         

28th
Jan Marketing Expense                300.00    

28th
Jan Bank                         300.00  

Narration: Increase in expense and decrease in the asset account.  

         

31st
Jan Salaries Expense             6,038.71    

31st
Jan Bank                     6,038.71  
 Narration: Salaries for 24 days = 7800 x 24/31 = 6038.71 as an increase in the
expense and decrease in asset account.  

         

31st
Jan Prepaid Rent for Feb                900.00    

31st
Jan Bank                         900.00  

Narration: Increase in two asset accounts i.e. prepayment and bank.  

         

31st
Jan Rent expense for the first month                841.93    

31st
Jan Prepaid rent paid on 3rd Jan                         841.93  

Narration: This entry records the rent expense when it is due i.e.at the end of the  
accounting period, at the time of payment on 3rd Jan, the prepayment was created as
an asset. This is an example of adjusting journal entry usually made at the time of
period end or closing of accounts.  
These are just a few examples of accounting journal entries for a small business.  Entering
entries is critical in order to prepare accurate financial statements that help keep a company
operating efficiently.  We have more examples of journal entries on our site to help with
understanding the concept. Going back to accounting basics with the accounting equation:
Assets = Liabilities + Owner’s Equity in mind will also help clarify the process of journal
entries.

• Normal Balance of Accounts

Normal Balance and the

Accounting Equation
 Accountants generally utilize the double-entry method of bookkeeping which
means that every business transaction should have at least two
corresponding journal entries: a debit and a credit.

The Accounting Equation is considered to be the foundation of double-entry

bookkeeping. It’s a basic principle whereby Assets = Liabilities + Owner’s
Equity (A=L+OE). The Accounting Equation determines whether an account
increases with a debit or a credit entry. The normal balance is part of the
double-entry bookkeeping method and refers to the expected debit or credit
balance in a specified account. For example, accounts on the left-hand side
of the accounting equation will increase with a debit entry and will have a
debit (DR) normal balance. Accounts on the right-hand side of the
accounting equation will have a normal credit (CR) balance.

Below is a list of the standard accounts and their expected normal balance:

 Asset: Debit
 Expense: Debit
 Dividends: Debit
 Liability: Credit
 Owner’s Equity: Credit
 Revenue: Credit
 Retained Earnings: Credit

Normal Balance Examples

We can explain normal balance using an example. Let’s say you own a café
and you purchase $450 of coffee beans from your local supplier. You’re
sitting down in the evening to update your books, and you’re presently
recording all of your accounting transactions by hand. Using the double-
entry method of bookkeeping, you will record the transaction twice: one
entry under the Cash account to decrease it, and one entry under the
Supplies account to show an increase in supply. Both accounts belong to
Assets, so they have a normal debit balance and will increase with a debit
entry and decrease with a credit entry.

Let’s look at another example. Let’s assume that you deposit $10,000 into
your business account. When recording this transaction, you’ll make one
entry under “Bank” (because money is being received) and one entry under
“Capital” (because cash put into the business by the owner is allocated to
the Capital account). The Bank account is an Asset account which means it
has a normal debit balance. The capital account is an Owner’s Equity
account which means it has a normal credit balance.
 Contra Accounts

Contra accounts are individual accounts that are established to decrease

the balance in another account indirectly by netting the two accounts
together in the General Ledger. They are “backwards” accounts which
means that their normal balances are opposite of the normal balances of
their corresponding account(s). 

Below are some examples of Primary Accounts with a normal debit balance
and their corresponding Contra Accounts which, in turn, have a normal
credit balance:

 Accounts Receivable – Allowance for Doubtful Accounts

 Fixed Assets – Accumulated Depreciation
 Intangible Assets – Accumulated Amortization
 Sales Revenue – Sales Returns and Allowance / Sales Discounts
 Loans Receivable – Allowance for Doubtful Loans

An example of a contra asset account is ‘Accumulated Depreciation’. A

company invests in a truck. The truck cost the company $35,000 which
depreciated by $6,000. Therefore, the carrying amount (or book value) of
the truck is $29,000.

Using the Normal Balance

Double-entry bookkeeping enables businesses to maintain accurate and
reliable financial records. This method of recording financial transactions
would not exist without the normal balance. 

It’s important to note that an account that has a normal credit balance can
have a debit balance or not. This may occur due to an error when recording
entries. Knowing what the normal balance for a particular account should be
is important in order to easily identify data entry mistakes.    

There are other reasons for an account with a normal credit balance to
show a debit balance or vice versa. This result may be attributed to an entry
reversing a transaction that was in a prior year and already zeroed out of
the account. Or, a bookkeeper may have made an offsetting entry prior to
the entry it was intended to offset. If you notice an account doesn’t display
the normal balance as expected, it’s a red flag. If the reason why is not
immediately obvious, it’s a good idea to consult with your bookkeeper or
accountant ASAP.
Normal Balances of
Accounts Chart
We now know that each account has either a credit normal balance or a
debit normal balance. When looking at the expanded accounting equation:
Assets + Expenses + Dividends + Losses = Liabilities + Capital + Revenue
+ Gains, it is much easier to determine which account has a credit or a debit
normal balance. In the table below, you can check the normal balances of
different types of accounts and see how debit and credit entries affect them.