Everyone has their ups and downs - know your left from your right.

Assets = Liabilities + Owner's Equity

Debits = Credits

These two equations are absolute in accounting. But what are debits and credits you may ask?

They are something to memorize.

Accounts are used to indicate and summarize the increases or decreases to and balances of each asset, liability and owner's equity-type items, such as, capital, withdrawals, revenues and expenses.

Businesses establish an account for anything they wish to keep track of separately.

Think of an account like a bucket. If you put water in, you are increasing the water in the bucket; if you pour water out, you are decreasing the water in the bucket. An account works the same way.

Let us assume that Luca Pacioli, the Franciscan monk who described the double-entry bookkeeping system over 500 years ago, said to himself:

I want everything in my system to look the same. Even though my basic equation that will rule everything that is done in the system is: Assets = Liabilities + Owner's Equity, I cannot be spending all my time worrying about that. I need to record the different transactions in one place and I need to keep the effects to the different assets, liabilities, capital, withdrawals, revenues and expenses separate. I need to show the increases and decreases to each account, but I want the accounts to look the same. How can I do that?
He decided that if he labelled the same columns in all accounts Increase and Decrease or if he labelled different columns in different kinds of accounts Increase and Decrease, he could not be sure that Assets = Liabilities + Owner's Equity without looking to make sure after each transaction was recorded nor could he list the transactions neatly in one place. It just was not possible to do both those things at the same time unless the accounts looked the same.

So, eventually along came the solution - use at least two columns in each account. Use one column for increases and one column for decreases. But, instead of using the same column for increases/decreases in every account, use one column for increases and the other column for decreases in asset accounts and use the opposite columns for increases and decreases in liability and owner's equity accounts. This allows you to list what you are going to do to each account (no matter what account) for each transaction in one place and the equation Assets = Liabilities + Owner's Equity takes care of itself without your having to worry about it.

The rules are arbitrary, but it was decided that increases to asset accounts would be shown in the left column and decreases to asset accounts would be shown in the right column. That means that increases to liability and owner's equity accounts are shown in the right column and decreases to liability and owner's equity accounts are shown in the left column. This accomplishes all of the goals. It works!

Wait a minute! What if there is an account like (Owner's Name), Withdrawals or an Expense? They decrease Capital. No Problemo! Use the left column to increase these kind of accounts because they decrease owner's equity. This just leaves one other thing to deal with.

Rather than say: put in the left column, say: Debit.

Rather than say: put in the right column, say: Credit.

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WOW!! There are no questions in this module, but there are several modules to follow that will hopefully help you to memorize debit and credit rules. Read this module again, give yourself a few minutes to relax, then try some of the following modules on debits and credits. You can also access these modules from the Table of Contents or from each successive module.

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Owner's Equity is not just another pretty phrase

Accounts are used to indicate and summarize the increases or decreases to and balances of each asset, liability and owner's equity-type items, such as, capital, withdrawals, revenues and expenses.

The names of accounts sometimes seem strange at first. This section is intended to help you learn or memorize owner's equity-type account names.

OWNER'S EQUITY, as a whole, is what the business owes the owner. It consists of different categories of accounts, each of which serve a special purpose. The business owes the owner for any monies they invest in the business. The business also owes the owner for any profit it makes. The owner must absorb any loss the business suffers. In order to know if and how the business makes profit or suffers losses, it is necessary to keep the different revenues and different expenses separate for a period of time. This helps the management of the business analyze the results of its operations. If the owner takes any assets out of the business, the business owes the owner that much less. It is good for the owner to know how much they have taken out over a period of time so this amount is kept separate for a period of time also.

(Owner's Name), Capital is the main owner's equity account. The amounts in all the other owner's equity accounts are eventually recorded in the Capital account. Any monies the owner invests in the business are entered directly into this account.

(Owner's Name), Withdrawals or Drawing account sums the assets (cash, inventory, etc.) that the owner takes out of the business for personal use. The amount in this account is eventually recorded in the Capital account and decreases the Capital account.

Revenue is what a business earns for what it is in business to do. For example, what a dry cleaning business charges for cleaning a suit is revenue. Revenue accounts can have many different names, but normally fall into one or two categories: service revenue or sales revenue. The amounts in revenue accounts are eventually put in the Capital account and these amounts increase the Capital account.

Expenses are the cost of generating revenues. In other words, expenses are the cost of doing business. There are many different kinds of expenses with many different names, but they normally fall into two or three different categories: cost of goods sold, selling expenses, general and administrative expenses. Almost all expense account names, with the exception of Cost of Goods Sold, end with "expense", such as, Wage Expense, Rent Expense, etc. The amounts in expense accounts are eventually put in the Capital account and these amounts decrease the Capital account

You owe me -- Big Time!

Accounts are used to indicate and summarize the increases or decreases to and balances of each asset, liability and owner's equity-type items, such as, capital, withdrawals, revenues and expenses.

The names of accounts sometimes seem strange at first. This section is intended to help you learn or memorize liability account names.

LIABILITIES are what the business owes outsiders. Following are some common liability accounts:

Accounts Payable is what the business owes to people or companies that it has purchased goods or services from on open account. This type of credit is normally referred to as trade credit.

Notes Payable are liabilities for which the business has issued (signed) a promissory note to pay the lender what they borrowed, plus interest. Normally, just the principal (what the business borrowed) is in the account. The interest is reported in a separate account (Interest Payable) that will be discussed later.

Accrued Expenses Payable is a category of accounts that summarize things the business has used but has not yet paid for. They are broken down into different accounts such as: Salaries and Wages Payable (for salaries and wages that have been earned by the employees but not yet paid); Interest Payable (for interest on notes payable, etc., that has accumulated on the note but has not been paid).

Unearned Revenue is used to record advance payments for goods or services that have not yet been delivered.

Customer Deposits is used to record deposits (such as rent deposits) that are made to secure payment or cover damages to

Assets are not small donkeys

Accounts are used to indicate and summarize the increases or decreases to and balances of each asset, liability and owner's equity-type items, such as, capital, withdrawals, revenues and expenses.

The names of accounts sometimes seem strange at first. This section is intended to help you learn or memorize asset account names.

ASSETS are what the business has or owns. Following are some common asset accounts:

Cash is money the business has on hand and in the bank.

Accounts Receivable is the amount of money customers owe the business for goods or services.

Inventory is the cost of goods a business buys to resell.

Prepaid Expenses is a category of accounts that summarize things that the business pays for in advance, to use in the near future. They are broken down into individual accounts such as: Supplies Inventory (for office supplies, etc.); Prepaid Insurance (businesses pay for insurance sometimes two or three years in advance); Prepaid Rent, Prepaid Interest, etc.

Land (Property), Buildings (Plant) and Equipment (all are sometimes called fixed assets) are purchased to operate the business. They are expected to last a long time. As the fixed assets are used, their cost is written off systematically - this is called depreciation. It is assumed that land cannot be used up; therefore, the cost of land is never written off in this manner. As the cost of the other fixed assets is written off, the amount is accumulated in an account that serves as an off-set against the cost of the asset.

Accumulated Depreciation is the account that is used to report the total amount that a fixed asset has been depreciated from the time it was acquired. The accounts are specific to each asset account (for example, Accumulated Depreciation - Buildings or Accumulated Depreciation - Equipment) and the balance in the accumulated depreciation account is deducted from the balance in the respective asset account to arrive at a net (undepreciated) cost for the asset. This amount is called the Book Value of the asset

What is the meaning of it all?

Accounting is built around the equation: Assets = Liabilities + Owner's Equity. For the equation, and thus the accounting system to function properly, it is assumed that a business owes someone for everything it has. It is also assumed that the business is self-contained. What the business has (or owns) are called Assets and it either owes outsiders, called Liabilities, or owes the owner, called Owner's Equity, for them. The business owes the owner for any monies or other assets that the owner brings into the business (called investing). It also owes the owner for any profit it makes. The owner has to accept any loss the business suffers. In other words, profit increases what the business owes the owner and a loss decreases what the business owes the owner. Profit or Loss is a calculation of: Revenues - Expenses. If Revenues are more than Expenses, there is Profit. If Expenses are more than Revenues, there is Loss. Carried one step further, then, Revenues increase Owner's Equity and Expenses decrease Owner's Equity. Revenues are what the business earns for doing what it is in business to do. Expenses are the cost of assets the business uses to generate Revenues. The purpose of the accounting system is to keep a record of the changes in Assets, Liabilities and Owner's Equity (including Revenues and Expenses) and to report the effects of those changes. The reports are called financial statements and there are different financial statements to report different things. The Balance Sheet reports what Assets, Liabilities and Owner's Equity the business has as of a certain date. The Income Statement reports the total Revenues and Expenses and the difference (Profit of Loss) for a specific period of time (month, quarter, year, etc.). The Statement of Owner's Equity (sometimes called Statement of Changes in Owner's Equity or Capital Statement) reports why and how Owner's Equity changed for a specific period of time (month, quarter, year, etc.). The Statement of Cash Flows reports the sources and uses of Cash for a specific period of time (month, quarter, year, etc.).

The Accounting Cycle

The accounting cycle is the sequence of procedures used to keep track of what has happened in the business and to report the financial effect of those things. Following is a depiction of the steps in the accounting cycle and a brief description of each. STEP DESCRIPTION Transaction Basically, a transaction is doing business. A financial transaction (which is the kind of transaction we are interested in here) is doing something in business that involves the exchange of money. Business Paper or Computer Record Usually, the accounting department is not where the transaction takes place. It is necessary that a paper or computer record be prepared at the point-of-sale so that the accounting department is aware that a transaction occurred. Analyze When personnel in accounting get the business paper, it is necessary to determine: 1.) What happened? What kind of business took place? Did we charge our customer for something, get money for something, buy something, etc.? 2.) What accounts will change? An account (Asset, Liability, Owner's Equity) is where we keep information on anything we wish to know about individually. For example, we have an account for money (Cash) where we keep track of the increases, decreases and the balance. Any time there is a transaction, at least two accounts will change. 3.) How will they change? Will the account increase or decrease? 4.) Do they get a Debit or Credit? Debits and Credits are discussed in detail in another module. T-accounts may help in the analysis. It is a method to help your thought process without the formality of general journal entries. Journalize The journal we will be discussing is called the General Journal. Journals are also called the "book of original entry" and are basically a chronological list of transactions and the accounts that changed and what to post in them. Post and Balance Posting is the act of transferring the information in the journal to the appropriate accounts. Balancing is adding the increases to and subtracting the decreases from the previous balance in an account. Trial Balance A trial balance is a list of all the accounts and their balances. What we call Debit balances are written in one column and Credit balances are written in one column. Each column is totaled and compared to make sure that Debits = Credits. Adjustments Generally speaking, adjusting entries are made at the end of a period to ensure that Revenues are reported when earned and Expenses are reported when incurred. Adjusted Trial Balance A trial balance after all adjustments have been: Analyzed, Journalized, Posted and the affected accounts Balanced. Close Closing an account means to "bring the balance to zero". We close what we call the temporary (or nominal) accounts. They are the temporary Owner's Equity accounts - Revenues, Expenses and Withdrawals. Post-closing Trial Balance A trial balance after all temporary accounts have been closed. The accounts remaining open are called real accounts and include: Asset accounts, Liability accounts and the Capital account. In other words, the balance sheet accounts remain open. Prepare Financial Statements Financial Statements are used to report the financial position and results from operating a business. They are the Balance Sheet, the Owner's Equity Statement, the Income Statement and the Cash Flow Statement.