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Steps When Recording Transactions

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Accounts and rules
An account is a tool for transaction recording. An account shows all changes in a particular asset, liability, owners’ equity element, expense or revenue caused by transactions. Every account has a left side called Debit, and a right side called Credit.
To make correct records on accounts, we have to follow and apply some rules.
When an asset or expense increases, this increase has to be placed on the left side of the account.
When an asset or expense decreases, this decrease has to be placed on the right side of the account.
When a liability, owner’s equity or revenue increases, this increase has to be placed on the right side of the account.
When a liability, owner’s equity or revenue decreases, this decrease has to be placed on the left side of the account.
Let’s see a simple example.
A business buys computers for a price of $4200. Computers are assets, and the purchase of these assets has to be recorded on the left side of the account “Computers”. This means that you will record the sum of $ 4200 on the debit side of the account.
The business pays the sum of $4200 from its bank account. This payment causes a decrease in the money of the business, which is an asset. That’s why you will record the sum of $4200 on the right side of the account that can have the name “Bank”.
Accrual accounting system
There are two accounting systems: cash accounting system and accrual accounting system.
The cash accounting system recognizes expenses and revenues only when a payment is made or received.
Most businesses apply the accrual accounting system. It allows a business to recognize revenues and expenses incurred, not when a payment is received or made.
A business that applies the accrual accounting system can sell on credit and purchase on credit.
If a business sells goods for $21000 in November 2021 and the client will pay in January 2022, the business must recognize the cost of goods sold as revenue in 2021, no matter whether the business will receive the money next year.
The sum of $21000 will affect the financial result in 2021, when the revenue is recognized. However, this revenue will not affect the financial result in 2022, although the business will receive the payment this year.
In this case, the business makes a sale on credit. Therefore, the sum of $21000 will appear on the Sales revenue account and on Accounts receivable account.
When a business sells on credit, you should debit accounts Receivable. This debit record shows that a business expects a cash inflow. When a business receives a payment from its customers, You should credit accounts Receivable. This credit record shows that the expected cash inflow is already received.
Suppose a business buys materials for $3600 in October 2021 and directly puts all of them into the production process. In that case, the business has to recognize the cost of the materials as an expense, no matter when it will pay the bill.
In this case, the business makes a material purchase on credit. Therefore, the sum of $3600 will affect the Material expenses account and Accounts payable account.
Accounts payable is a liability account. When a business purchases inventory on credit, Accounts Payable should be credited. This credit record expresses an obligation. When a business makes a payment to its creditor, Accounts Payable should be debited. This debit record expresses a decrease in business’ obligations.
Main steps when recording transactions
The first step of the process of recording transactions is receiving or creating an appropriate document. This document is evidence of what happened. Such evidence are invoices, bills, receipts, cheques, credit notes, debit notes, vouchers, orders, etc. All these documents verify the accuracy of recorded transactions during the period.
The second step is recording all transactions in chronological order. Such chronological records happen in a book called Journal. A Journal is a chronological list of all transactions and the affected accounts. When a business looks at the Journal it sees what transaction happened on a particular date, which accounts are affected and how they are affected.
The third step in the recording process is posting of amounts from the Journal to the appropriate accounts in the General Ledger. Nowadays, accounting software does it automatically. Therefore, the General Ledger can be explained as a list of all business accounts and all changes that happened on them as a result of business transactions.
The fourth step is preparing a trial balance. This report is a list of all business accounts and shows their balances at the end of a current period. The trial balance is the basis of the preparation of all financial statements: balance sheet, income statement, cash flow statement.
And the preparation of the financial statements is the last step of the process of recording transactions.
Double-entry accounting system
A double-entry accounting system means that every transaction affects at least two accounts. Therefore, you should debit one or more accounts, and one or more should be credited.
When a transaction affects only two accounts, one account must be debited, and one must be credited. When a transaction affects more than two accounts, one or more accounts must be debited and one or more credited.
Let’s see how these two types of entry look like following three steps:
First, we will analyze which accounts change and what type these accounts are.
Then, we will see how these accounts change – if they increase or decrease.
Third, using the rules of “debit-credit language”, we will make records on the particular accounts.
Here is the first example:
A business buys machines of $ 14 000 on credit.
This transaction affects two accounts: Machinery and Accounts Payable. Therefore, the accountant has to make one debit record and one credit record.
A machinery account is an asset account that increases, Accounts payable is a liability account that increases, too. Therefore, following the double-entry accounting system rules, we have to make a debit record on the Machinery account and credit record on the Accounts Payable account.
Journal
Account Title
Debit
Credit
Machinery
14 000


Accounts Payable


14 000


The accounting software transfers these amounts to the particular accounts in the General Ledger.
General Ledger
Machinery
5000











Accounts Payable


5 000









The second example is the following:
A business buys materials for $ 8 000. It should pay 50% immediately and the rest 50% later. The cash balance at this point in time is $ 18 000.
This transaction affects three accounts: Inventory account, Cash account and Accounts Payable account. In this case, one account has to be debited, and two have to be credited.
An inventory account is an asset account that increases, a Cash account is an asset account that decreases and Accounts payable is a liability account that increases. Therefore, following the double-entry accounting system rules, we have to make a debit record on the Inventory account and credit record on the Cash account and Accounts Payable account.
Journal
Account Title
Debit
Credit
Inventory
8 000


Accounts Cash


4 000
Accounts Payable


4 000


The accounting software transfers these amounts to the particular accounts in the General Ledger.
General Ledger
Inventory
8 000











Accounts Payable


4 000








Cash
18 000
4 000