Accounting Basics

Accounting is managing debits and credits. That’s all. Debit equals Credit. If in any transaction you have your debit balance equals to 1000 then the corresponding credit balance should equals to 1000. This is also called double-entry bookkeeping where every transaction has direct effect on more than one ledger accounts.

There are only two categories of debits : Assets and Expenses and there are only three categories of credits: Income, Liabilities and equity. Now a critic would say what about the contra entries and the treasury stock. Contra –Assets are also credits and the treasury stocks are also debits.( I won’t be covering these two sections over here).

Basically, Assets are things you own and liabilities are things you owe to others. Equity is your investment in the company. Revenues are income you earn where as expenses are mostly bills you pay. An account is a catalogue number with a description. For example: 0100 Petty Cash. Every account will fall into one of the five categories mentioned above i.e. Assets, Liabilities, Income, Expenses and Equity.

Now when you have all your accounts listed in this way, you will end up with this big book which is called “General Ledger”. General Ledger can either take an electronic form i.e. maintained in the computer software or the manual form that’s basically the manual paper book. Now let’s say you want to look at this big general ledger in summary, the summary of all the ledger balances are grabbed in a statement called Trial Balance For example, “You could have many transaction in relation to the cash which are all accumulated and preserved in the Cash Ledger, similarly there could be many ledgers covering different transactions like sales ledger, purchase ledger etc. The end result of all ledger balances are summarized to a single amount in the trial balance (which will show the end balance of all the ledgers). Trial balance will present the Debits in the left column and Credits in the right column. The thing is this that the total of the debit column and credit column should have the same total, WHY????? Because Debits Equals Credits. Below listed figure is a sample of trial balance prepared in a excel sheet.

Now you should have question, how I post entries to the general ledger.  Let’s make it simple there is a term called “journal “. Entries you will put in the journal are called the” journal entries”.  When you enter the journal entries the computer systems record Journal Entries in the Ledger and Journal at the same time. Debit entries increases the debit balances, and credit entries decrease them. It’s just like a mathematics .For example,

Let’s assume you have a retail shop where you sell your goods to the customer and purchaser form the supplier to resell. You have cash ledger and you should know that cash is an asset and by default assets is a debit, say, your cash balance now is 10000

Scenario 1,

 1 hour later you made cash sales of 5000 then your journal entry will be:

Dr(debit).Cash a/c:  5000

 Cr(credit). Sales a/c: 5000

Now in the Cash ledger the end balance will be: 10000(which was previous) + 5000(from the new sale) =15000. Similarly the Sales ledger will be updated for its credit entry.

Scenario 2,

 Again after 1 hour, you made cash purchase of goods from the supplier for 8000, Then, the journal entry will be:

Dr. Purchase a/c: 8000

Cr. Cash a/c: 8000

Now, what will be the balance on you ledger, can you please calculate. Let’s do it.

We have our updated cash account after the recent sale with 15000 and we should know cash is a asset and it is always debit. Now from scenario 2(journal entry), Cash a/c was credited. That means the updated Cash Ledger account will be: Dr. 15000(after the sale)-8000(purchase of goods where Cash a/c is credited). Then the end Cash A/c Ledger balance will be 7000. Similarly, there will be effect on the Purchase A/c  Ledger.

This is how each ledger accounts get updated as in course of the business and it is an ongoing process. The balance of the ledger account will go to the trial balance and from the trial balance we will prepare other financial statements like Balance Sheet & Income Statement.

Hope, this article has helped students and small business owners to understand how the accounting system works and how can you maintain your accounting system or simply can understand what your accountant is doing.

To know more about accounting, you can follow along the link to:

Sales Revenue

Cost Of Goods Sold (COGS)

Overheads Expenditure

If you have any questions then please be free to ask by commenting on the comment box please do share if  you like this article. Thank you.