Chapter Three

Recording Accounting Transactions

As a matter of honor, one man owes it to another to manifest the truth.”

Thomas Aquinas

BACKGROUND

At this point, we have presented the accounting process and the basic accounting formulas but not how information is actually entered into the accounting system.

This chapter will explain the conventions used to record the transactions. This will introduce double entry bookkeeping, “T” accounts and revenue and expense accounts.

DOUBLE ENTRY BOOKKEEPTING

Double entry bookkeeping has been used for a very long time.  Benedetto Cotrugli is credited with inventing double entry bookkeeping in the fourteen hundreds.  A Franciscan monk by the name of Frater Luca Bartolomes Pacioli expanded that concept and invented a system labeled Pacioli’s system of memorandum, journal, and ledger.  Frater Pacioli is considered, by many, as the father of accounting and wrote many books on that topic.  In 1494 it is believed that Pacioli wrote Summa de Arithmetics, Geometria, Proportioni ET Proportionalita which contained explanations of record keeping including double entry bookkeeping.  So do not blame the Jesuits.  That work is the reference text and teaching tool for accounting for the next several hundred years.

DEBITS AND CREDITS

A significant factor in his bookkeeping system is the use of debits and credits.  Accountants to describe entries into the financial records to reflect increases or decreases in account balances terms use these.  This convention facilitates the double entry bookkeeping concept where debits must equal credits.  It is best to forget what you think a debit or credit is since these terms have a different meaning in accounting.  The terms are derived from the Latin: debere (debit) credere (credit).  Very simply, think of debits as always being on the left side of the ledger and credit being on the right side of the ledger.

T ACCOUNTS

There are five fundamental accounting elements and accountants will define them as Assets, Liabilities, OWNERS EQUITY, EXPENSES, and REVENUE.  The Balance Sheet reflects the accounting equation (Assets equal Liabilities plus OWNERS EQUITY).  Assets are located on one side of the equation and liabilities and net assets on the other.  An equal sign separates the debits located on the left half side of the balance sheet from the credits on the right.  Debits on the left side of the balance sheet increase balances and debits decrease balances.  On the liability side of the balance sheet (right), Debit decrease balances and credits increase the account balance.  See figure 1.

In order to visualize this assertion refer to Figure 1 and notice a blue line separates the two sides after assets and before liabilities.  This is consistent with the accounting formula and the balance sheet where assets equal liabilities plus net assets.  This chapter is addressing only balance sheet accounts and not the temporary accounts (revenue & expense) that are not described yet.  Temporary accounts and the debit/credit effect on them is the subject of a future chapter.  This distinction among assets, liabilities and net assets and their relationship with the equal sign is important to understand. The T account assists in understanding this relationship. 

Figure 1

Let us consider the T account.  It is a graphical representation of an account in the accounting system represented in the form of a T.  The T accounts have a space at the top to identify the account (Cash/Liability).  Under the accounts name and on the left of the T is a Debit and on the right is a credit.  Regardless of the account, debits are always on the left and credits are always on the right.  Debits/credits either increase or decrease the acounting equation (Assets=Liabilities +Fund Balance or equity).

Again, debits increase assets and decrease liabilities and the equity account.  Credits decrease assets and increase liabilities and the net assets.