Chapter 2: The Accounting Process

The Account: In accounting, an account is essentially a record used to categorize, track, and
store financial transactions. Think of it like a filing cabinet for your business's money. These
accounts are typically found in a general ledger, which is like the master record book for all your
financial activity.

Here are some common types of accounts:

1. Asset Accounts: These are resources owned by the business, such as cash, inventory,
equipment, and accounts receivable.

2. Liability Accounts: These represent obligations or debts owed by the business to external
parties, such as loans, accounts payable, and accrued expenses.

3. Owner’s Equity Accounts: This represents the owner's claim to the assets of the
business and is calculated as the difference between assets and liabilities. It includes items such
as owner's capital and retained earnings.

i. Capital Account: The capital account is a record of the investment of the owner(s) in a
business. It reflects the net assets or worth of a business at a particular point in time. The capital
account increases when the owner(s) invest additional money in the business and decreases when
the owner(s) withdraw funds for personal use. It represents the residual claim of the owner(s) on
the business's assets after all liabilities are settled.

ii. Revenue: These track the income your business generates from sales of goods or services.
These accounts track income earned by the business from its primary operations, such as sales
revenue and service revenue.

iii. Expenses: These accounts record the costs incurred by the business in generating revenue,
such as salaries, utilities, and advertising expenses.

iii. Drawings: A drawings account is a specific type of account used in accounting for
businesses with sole proprietors or partnerships. It's essentially a record that tracks money and
other assets withdrawn from the business by the owner(s) for their personal use.
Each account has a unique name and a designated place in the accounting records. Transactions
are recorded in these accounts using a system of debits and credits, with each transaction
affecting at least two accounts. This double-entry accounting system helps ensure accuracy and
consistency in financial reporting.

 Record of increases and decreases in a specific asset, liability, equity, revenue, or

expense item.
 Debit = “Left”
 Credit = “Right”

Double Entry System

The double-entry system is a fundamental concept in accounting that ensures accuracy and
integrity in financial records. It is based on the principle that every financial transaction has two
equal and opposite effects, which are recorded in at least two different accounts.

Here's how the double-entry system works:

1. Dual Aspect: Every transaction affects at least two accounts, with one account debited and
another credited. The total debits must always equal the total credits, ensuring that the
accounting equation (Assets = Liabilities + Equity) remains balanced.

2. Debits and Credits: Debits and credits are used to record increases and decreases in
accounts. The rules for debits and credits depend on the type of account:

- Assets: Debits increase asset accounts and credits decrease them.

- Liabilities and Equity: Credits increase liabilities and equity accounts, while debits decrease
them.

- Revenue: Credits increase revenue accounts and debits decrease them.

- Expenses: Debits increase expense accounts and credits decrease them.

3. Accounting Equation: The double-entry system ensures that the accounting equation
(Assets = Liabilities + Equity) remains balanced after every transaction. For every debit entry,
there must be an equal credit entry, maintaining the equality of the equation.

4. Recording Transactions: When a transaction occurs, accountants make journal entries to

record the transaction's effects on the relevant accounts. Each journal entry includes the date,
accounts debited and credited, and the amount for each entry.

5. Posting to Ledger: After recording journal entries, the amounts are transferred to the
appropriate accounts in the general ledger, maintaining a running balance for each account.

6. Trial Balance: Periodically, accountants prepare a trial balance to verify that total debits
equal total credits. Any discrepancies indicate errors that need to be corrected.

Debit Credit Summary

 Steps in the Recording Process
Business documents, such as a sales slip, a check, a bill, or a cash register tape, provide evidence
of the transaction.

The Journal

The term "journal" in accounting has a specific meaning. It refers to a chronological record of all
financial transactions a business makes. Think of it as a business diary for money matters. Every
time a sale is made, a bill is paid, or any other financial event occurs, it gets documented in the
journal.

Here are some key characteristics of a journal in accounting:

 Chronological Order: Transactions are recorded in the journal in the order they happen,
providing a clear timeline of the business's financial activity.
 Original Entry: The journal is the first place where transactions are formally recorded. It serves
as the initial record-keeping step before the information is transferred to other accounting records
like the general ledger.
 Detailed Information: Each journal entry typically includes the date, a brief description of the
transaction, the accounts involved (debited and credited), and the amount.
 A general journal has

1 spaces for dates

2 account titles and explanations
3 references
4 two amount columns
 The Ledger

In accounting, the ledger is the central record book for all a business's financial transactions. It's
like a filing cabinet that organizes the information from the journal into separate accounts.

Here's how the ledger works:

 Organized by Accounts: Unlike the journal, which is chronological, the ledger groups
transactions by specific accounts. These accounts represent different categories of financial
elements, such as assets, liabilities, equity, revenue, and expenses.
 Individual Accounts: Each account in the ledger has its own page or record. This page shows
all the debits and credits for that particular account throughout the accounting period.
 Posting from the Journal: After transactions are recorded in the journal, they are then "posted"
to the appropriate accounts in the ledger. This involves transferring the date, description,
debit/credit information, and amount to the relevant account.
 Account Balances: Each account in the ledger has a balance. This balance represents the net
effect of all the debits and credits recorded for that account. For example, the cash account
balance would show the total amount of cash on hand.
The Trial Balance

A trial balance is a bookkeeping worksheet in which the balances of all ledgers are compiled
into debit and credit account column totals that are equal. A company prepares a trial balance
periodically, usually at the end of every reporting period. The general purpose of producing a
trial balance is to ensure that the entries in a company’s bookkeeping system are mathematically
correct.