1.

1 INTRODUCING ACCOUNTS AND BALANCES

Accounting may be defined as the process of analyzing, classifying, recording, summarizing, and
interpreting business transactions. One of the key aspects of the process is keeping “running totals” of “things.”
Examples of items a business might keep track of include the amount of cash the business currently has, what a
company has paid for utilities for the month, the amount of money it owes, its income for the entire year, and the
total cost of all the equipment it has purchased. You want to always have these running totals up to date so they
are readily available to you when you need the information. It is similar to checking what your cash balance in the
bank is when deciding if you have enough money to make a purchase with your debit card.

We will now refer to these “running totals” as balances and these “things” as accounts. Any item that a
business is interested in keeping track of in terms of a running dollar balance so it can determine “how much right
now?” or “how much so far?” is set up as an account. There are five types, or categories, of accounts.

There are many items that businesses keep records of. Each of these accounts fall into one of five categories.
1. Assets: Anything of value that a business owns
2. Liabilities: Debts that a business owes; claims on assets by outsiders
3. Stockholders’ equity: Worth of the owners of a business; claims on assets by the owners
4. Revenue: Income that results when a business operates and generates sales
5. Expenses: Costs associated with earning revenue

Different accounts fall into different categories:

Cash is an account that falls in the asset category. The Cash account keeps track of the amount of money
a business has. Checks, money orders, and debit and credit cards are considered to be cash. Other than Cash, we
will begin by covering accounts that fall into the revenue and expense categories.
Revenue is income that results from a business engaging in the activities that it is set up to do. For
example, a computer technician earns revenue when they repairs a computer for a customer. If the same
computer technician sells a van that they no longer needs for his business, it is not considered revenue.

Fees Earned is an account name commonly used to record income generated from providing a service. In
a service business, customers buy expertise, advice, action, or an experience but do not purchase a physical
product. Consultants, dry cleaners, airlines, attorneys, and repair shops are service-oriented businesses. The Fees
Earned account falls into the revenue category.

Expenses are bills and other costs a business must pay in order for it to operate and earn revenue. As the
adage goes, “It takes money to make money.”

Expense accounts differ from business to business, depending on individual company needs.

1.3.1 THE JOURNAL

Financial statements are key goals of the accounting process. In order to prepare them at the end of an
accounting period, individual financial transactions must be analyzed, classified, and recorded all throughout the
period. This initially takes place in a record book called the journal, where financial events called transactions are
recorded as they happen, in chronological order.

When a transaction occurs, two or more accounts are affected. There is also a dollar amount associated
with each of the accounts. Determining which accounts are impacted, and by how much, is the first step in making
a journal entry. This is a sample of a few rows in a journal. It has five columns: Date, Account, Post, Ref., Debit, and
Credit.
 In the journal, the column heading Debit means “left” and Credit means “right.” There are other familiar
interpretations of these words, so don’t be confused: the terms here only have to do with whether a dollar amount
is entered in the left or the right number column. These words may also be used as verbs: To “debit an account”
means to enter its amount in the left column. To “credit an account” means to enter its amount in the right
column.

JOURNALIZING TRANSACTIONS
We now will come to one of the most important procedures in the recordkeeping process: journal
entries. It involves analyzing and writing down financial transactions in a record book called a journal. Financial
events are evaluated and translated into the language of accounting using the process of journalizing.
Select two accounts and, according to the rules of debit and credit for cash, revenue, and expense
accounts, decide which account to debit (left column) and which to credit (right column). The debit entry is always
listed first. No dollar signs are required in the journal.

Journalizing involves the following steps:

1. Select two (or more) accounts impacted by a transaction.
2. Determine how much, in dollars, each account is affected. Often times the amounts are given; other times the
amounts must be calculated based on the information provided.
3. Based on the rules of debit and credit, decide which account(s) is debited and which is credited.
4. Enter the date on the first line of the transaction only.
5. Enter the account that will be debited on the first line of the transaction. Enter its amount in the Debit column
on the same line.
6. Enter the account that will be credited on the second line of the transaction. Enter its amount in the Credit
column on the same line. NOTE: Indent the credit account name three spaces.

1.3.5 POSTING
The process of copying from the journal to the ledger is called posting. It is done one line at a time from the
journal. Here are step-by-step instructions for doing so.

1. Take note of the account name in the first line of the journal. Find that ledger account.
2. Copy the date from the journal to the first blank row in that ledger.
3. Leave the Item column blank in the ledger at this point.
4. Take note of the amount on the first line of the journal and the column it is in.
5. Copy that amount to the same column in the ledger on the same line where you entered the date.
6. Update the account’s running balance. Take note of the previous balance in the last two columns of the ledger,
if there is one. Do one of the following, based on the situation.
 If there is no previous balance and the entry is a Debit, enter the same amount in the Debit balance
column.
 If there is no previous balance and the entry is a Credit, enter the same amount in the Credit balance
column.
 If the previous balance is in the Debit column and the entry is a Debit, add the two amounts and
enter the total in the Debit balance column.
 If the previous balance is in the Debit column and the entry is a Credit, subtract the credit amount
from the balance and enter the difference in the Debit balance column.
 If the previous balance is in the Credit column and the entry is a Credit, add the two amounts and
enter the total in the Credit balance column.
 If the previous balance is in the Credit column and the entry is a Debit, subtract the debit amount
from the balance and enter the difference in the Credit balance column.
* * Note: The only exception to the above is the rare occasion when one of the calculations above results in a
negative number. No negative amounts should appear in the ledgers. Instead, the balance will appear in the
opposite balance column.

7. Go back to the journal and enter an “x” or checkmark in the PR column to indicate that you have posted that line
item.
8. Repeat the process for the next line in the journal.

Every time an account appears on a line in the journal, its amount is copied to the proper column in that account’s
ledger. A running total is maintained for each account and is updated every time an amount is posted.

1.3.2 RULES OF DEBIT AND CREDIT

Whether a particular account should be debited or credited is based on (1) the type of account it is and (2)
whether the account is increasing or decreasing.

JOURNALIZING TRANSACTIONS:
WHAT IS THE CHART OF ACCOUNTS?
A chart of accounts is a list of accounts used for recording transactions in a company’s general ledger.
Think of it as the filing cabinet for your small business’s accounting system. It organizes transactions into groups,
which helps track money coming in and out of the company.

The chart of accounts is a listing of all accounts used in the general ledger of an organization. The chart is
used by the accounting software to aggregate information into an entity's financial statements. The chart is usually
sorted in order by account number, to ease the task of locating specific accounts. The accounts are usually
numeric, but can also be alphabetic or alphanumeric.

` Accounts are usually listed in order of their appearance in the financial statements, starting with the
balance sheet and continuing with the income statement. Thus, the chart of accounts begins with cash, proceeds
through liabilities and shareholders' equity, and then continues with accounts for revenues and then expenses.
Many organizations structure their chart of accounts so that expense information is separately compiled by
department; thus, the sales department, engineering department, and accounting department all have the same
set of expense accounts. The exact configuration of the chart of accounts will be based on the needs of the
individual.

A numbering system is used in a chart of accounts to make organization and recordkeeping easier.

The following numbering system would be similar to that of a midsized business:

101-199 Asset Accounts

201-299 Liability Accounts
301-399 Equity Accounts
401-499 Revenue Accounts
501-599 Expense Accounts

The following are examples of Asset accounts:

101 Cash
102 Petty cash
103 Cash equivalents
104 Short-term investments
106 Accounts receivable
107 Allowance for doubtful accounts
109 Interest receivable
110 Rent receivable
111 Notes receivable
119 Merchandise inventory
124 Office supplies
128 Prepaid insurance
129 Prepaid interest
131 Prepaid rent
141 Long-term Investments
151 Automobiles
 152 Accumulated depreciation- Automobiles
153 Trucks
154 Accumulated depreciation-Trucks
159 Library
160 Accumulated depreciation-Library
161 Furniture
162 Accumulated depreciation-Furniture
163 Office Equipment
164 Accumulated depreciation-Office equipment
169 Machinery
170 Accumulated depreciation-Machinery
175 Building
176 Accumulated depreciation-Building
179 Land improvements
180 Accumulated depreciation-Land improvements
183 Land
185 Mineral deposit
186 Accumulated depreciation-Mineral deposit
191 Patents
192 Leasehold
193 Franchise
194 Copyrights
195 Leaseholds improvements
196 Licenses
197 Accumulated amortization

The following are examples of Liability accounts:

201 Accounts payable

202 Insurance payable
203 Interest payable
204 Legal fees payable
207 Office salaries payable
208 Rent payable
209 Salaries payable
210 Wages payable
211 Accrued payroll payable
214 Estimated warranty liability
215 Income taxes payable
216 Common dividend payable
217 Preferred dividend payable
218 State unemployment taxes payable
219 Employee federal income taxes payable
221 Employee medical insurance payable
222 Employee retirement program payable
223 Employee union dues payable
224 Federal unemployment taxes payable
225 FICA taxes payable
226 Estimated vacation pay liability
 230 Unearned consulting fees
231 Unearned legal fees
232 Unearned property management fees
235 Unearned janitorial revenue
238 Unearned rent
240 Short-term notes payable
245 Notes payable
251 Long-term notes payable
253 Long-term lease liability
255 Bonds payable
258 Deferred income tax liability

The following are examples of Equity accounts:

301 Owner’s Capital

302 Owner’s Withdrawals
307 Common stock, par value
308 Common stock, no par value
309 Common stock, stated value
310 Common stock dividend distributable
311 Paid-in capital in excess of par value, Common stock
312 Paid-in capital in excess of stated value, No-par common stock
313 Paid-in capital from retirement of common stock
314 Paid in capital, Treasury stock
315 Preferred stock
316 Paid-in capital in excess of par value, Preferred stock
318 Retained earnings
319 Cash dividends
320 Stock dividends
321 Treasury stock, Common
322 Unrealized gain-Equity
323 Unrealized loss-Equity

The following are examples of Revenue accounts:

401 Fees earned from product one*

402 Fees earned from product two*
403 Service revenue one*
404 Service revenue two*
405 Commissions earned
406 Rent revenue
407 Dividends revenue
408 Earnings from investments in “blank”
409 Interest revenue
410 Sinking fund earnings
 413 Sales
414 Sales returns and allowances
415 Sales discounts

*A firm will have a varying number of these accounts depending on the number of products or services
the firm manufactures or offers.

The following are examples of Expense accounts:

501 Amortization expense

502 Depletion expense
503 Depreciation expense-Automobiles
504 Depreciation expense-Building
505 Depreciation expense-Furniture
506 Depreciation expense-Land improvements
507 Depreciation expense-Library
508 Depreciation expense-Machinery
509 Depreciation expense-Mineral deposit
510 Depreciation expense-Office equipment
511 Depreciation expense-Trucks
520 Office salaries expense
521 Sales salaries expense
522 Salaries expense
523 “Blank” wages expense
524 Employees’ benefits expense
525 Payroll taxes expense
530 Cash over and Short
531 Discounts lost
532 Factoring fee expense
533 Interest expense
535 Insurance expense-Delivery equipment
536 Insurance expense-Office equipment
540 Rent expense
541 Rent expense-Office space
542 Rent expense-Selling space
543 Press rental expense
544 Truck rental expense
545 “Blank” rental expense
550 Office supplies expense
551 Store supplies expense
552 “Blank” supplies expense
555 Advertising expense
556 Bad debts expense
557 Blueprinting expense
558 Boat expense
559 Collection expense
561 Concessions expense
562 Credit card expense
563 Delivery expense
564 Dumping expense
 566 Equipment expense
567 Food and drinks expense
568 Gas and oil expense
571 General and administrative expense
572 Janitorial expense
573 Legal fees expense
574 Mileage expense
576 Miscellaneous expense
577 Mower and tool expense
578 Operating expense
579 Organization expense
580 Permits expense
581 Postage expense
582 Property taxes expense
583 Repairs expense
584 Selling expense
585 Telephone expense
587 Travel and entertainment expense
590 Utilities expense
591 Warranty expense
595 Income taxes expense

The journal entry rules for the accounts are as follows:

 For Asset accounts you debit increases and credit decreases.
 For Liability accounts you credit increases and debit decreases
 For Revenue accounts you credit increases and debit decreases
 For Expense accounts you debit increases and credit decreases