Understanding accounting terms is an important first step in learning how accounting really works.
So let's look at some key terms and their meanings.
The Journal, sometimes call the Book of Original Entry or more commonly the General Journal, is how transactions are recorded or entered into accounting records. It is a chronological list of a company's transactions.
An account is a basic summary device used in accounting. All of the related transactions to a particular account are recorded in that account. For example, all of the transactions affecting cash would be recorded in the cash account.
Accounts are grouped or organized into 5 broad categories which include:
We will now learn how financial data moves from the journal into the accounts. In an academic setting the account is often expressed as a T account.
Two additional terms that are very important are debit and credit. Debit, which is sometimes abbreviated DR, means left side. Credit, sometimes abbreviated CR, means right side. And that's it. Debits and credits are how different accounts are increased or decreased; but, they don't mean increase or decrease because it depends on what type of account they effect.
Each transaction must effect two or more accounts to keep the accounting equation balance. This is known as double-entry accounting. So every transaction must include at least two accounts. One account that is debited and one account that is credited. There can be more than two accounts but there can never be less. Debits must always equal credits or the accounting equation would be out of balance
Account balances are either debit balances or credit balances. There are no negative balances in accounting. Balances are calculated by totaling the debit side of an account and totaling the credit side of the account. Then subtract the smaller side from the larger side. This is the balance that goes on the larger side. An account can have only one type of balance.
The ledger, sometimes known as the general ledger, is a collection of all the company's accounts. So all of the assets, liability, equity, revenue, and expense accounts are located in the ledger.
Before we end, I would like to revisit a few terms we've learned earlier and define the accounts a little bit better.
Assets are economic resources, that means something of value, that are owned or controlled by a business and they will provide benefits into the future. The key when trying to determine if something is an asset is that assets provide future benefit. Supplies is an assets because we haven't used them up yet. When we do they will become an expense, supplies expense to be exact, and they will be a past benefit not a future benefit anymore. Accounts receivable is money that is owed to us from our customers. If we perform services on account, we would use accounts receivable in recording that transaction. Prepaid expenses are like supplies. They will become a past benefit but until they do they are assets.
Liabilities are claims on our assets from external parties like creditors. Accounts payable is for money that we owe to our vendors or suppliers. Accrued liabilities, sometimes called accrued expenses, are amounts that we owe for our bills related to operations. Utility bills received but not yet paid is a type of accrued liability.
Equity is the claim on assets from owners. It is sometimes called net worth or net assets because it's the value of the assets that remain after the liabilities are paid and settled. Owner's capital comes from both owner investments in a company and increases resulting from net income.
Owner's withdrawal are the amounts distributed to the owners of a businesses.
Revenues are inflows from operations and result in an increase to equity. They are the benefit companies receive from their business operations.
Service revenue is earned by performing service.Sales revenue is earned by selling goods.
Expenses are outflows from operations and result in a decrease to equity. They are the costs companies incur operating their business.