Introduction

to Accounting
Dr. Caterina Pesci

Università Degli Studi di Trento

 Lecture’s Content
1. 1 The account
1.2 Debits and credits
1.3 Equity relationships
1.4 Summary of debit/credit rules.

2. 1The recording process

2.2The journal

3.1 The ledger

3.2 Posting
3.4 Chart of accounts
3.5 The recording process illustrated
 T Accounts

An account is an individual accounting record of increases and decreases in a specific asset,

liability, or equity item.
For example, Softbyte SA (the company discussed in Chapter 1) would have separate
accounts for Cash, Accounts Receivable, Accounts Payable, Service Revenue, Salaries and
Wages Expense, and so on. (Note that whenever we are referring to a specific account, we
capitalize the name.)
In its simplest form, an account consists of three parts: (1) a title, (2) a left or debit side,
and (3) a right or credit side. Because the format of an account resembles the letter T, we
refer to it as a T-account. Illustration 2.1 shows the basic form
 Debits and Credits

The term debit indicates the left side of an account, and credit indicates the
right side.
They are commonly abbreviated as Dr. for debit and Cr. for credit.
They do not mean increase or decrease, as is commonly thought.
We use the terms debit and credit repeatedly in the recording process to
describe where entries are made in accounts. For example, the act of entering
an amount on the left side of an account is called debiting the account. Making
an entry on the right side is crediting the account.
When comparing the totals of the two sides, an account shows a debit balance if
the total of the debit amounts exceeds the credits.
An account shows a credit balance if the credit amounts exceed the debits.
 Debits and Credits
Note the position of the debit side and credit side in Illustration 2.1.
The procedure of recording debits and credits in an account is shown in
Illustration 2.2 for the transactions affecting the Cash account of Softbyte
SA. The data are taken from the Cash column of the tabular summary in
Illustration 1.9.
 Debits and Credits

Every positive item in the tabular summary represents a receipt of cash.

Every negative amount represents a payment of cash. Notice that in the account form,
we record the increases in cash as debits and the decreases in cash as credits. For
example, the €15,000 receipt of cash (in blue) is debited to Cash, and the −€7,000
payment of cash (in red) is credited to Cash.
Having increases on one side and decreases on the other reduces recording errors and
helps in determining the totals of each side of the account as well as the account
balance. The balance is determined by netting the two sides (subtracting one
amount from the other).

The account balance, a debit of €8,050, indicates that Softbyte had €8,050 more
increases than decreases in cash. In other words, Softbyte started with a balance of
zero and now has €8,050 in its Cash account.
 Debit and Credit Procedure
You learned the effect of a transaction on the basic accounting equation.
Remember that each transaction must affect two or more accounts to keep
the basic accounting equation in balance.
In other words, for each transaction, debits must equal credits.
The equality of debits and credits provides the basis for the double-entry
system of recording transactions.

Under the double-entry system, the dual (two-sided) effect of each

transaction is recorded in appropriate accounts.
This system provides a logical method for recording transactions and also
helps ensure the accuracy of the recorded amounts as well as the detection
of errors. If every transaction is recorded with equal debits and credits, the
sum of all the debits to the accounts must equal the sum of all the credits.
The double-entry system for determining the equality of the accounting
equation is much more efficient than the plus/minus procedure.
The following discussion illustrates debit and credit procedures in the
double-entry system

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 Debit and Credit Procedure for assets and liabilities

For Softbyte, increases in Cash—an asset—are entered on the left side, and
decreases in Cash are entered on the right side.
We know that both sides of the basic equation (Assets = Liabilities + Equity) must
be equal. It therefore follows that increases and decreases in liabilities have to be
recorded opposite from increases and decreases in assets.
Thus, increases in liabilities are entered on the right or credit side, and decreases
in liabilities are entered on the left or debit side. The effects that debits and
credits have on assets and liabilities are summarized in Illustration 2.3.

ILLUSTRATION 2.3 Debit and credit effects—assets and liabilities

Debits Credits

Increase assets Decrease assets

Decrease liabilities Increase liabilities

Asset accounts normally show debit balances. That is, debits to a specific asset
account should exceed credits to that account.
Likewise, liability accounts normally show credit balances. That is, credits to a
liability account should exceed debits to that account.
 Debit and Credit Procedure for assets and liabilities

The normal balance of an account is on the side where an increase in

the account is recorded.
 Debit and Credit Procedure for Equity

Shareholders' investments and revenues increase equity.

Dividends and expenses decrease equity.
In a double-entry system, companies keep accounts for each of these types of transactions:
share capital—ordinary, retained earnings, dividends, revenues, and expenses.

Share Capital—Ordinary
Companies issue share capital—ordinary in exchange for the owners' investment paid in to
the company. Credits increase the Share Capital—Ordinary account, and debits decrease it.
For example, when an owner invests cash in the business in exchange for ordinary shares, the
company debits (increases) Cash and credits (increases) Share Capital—Ordinary.
Illustration 2.5 shows the rules of debit and credit for the Share Capital–Ordinary account.

ILLUSTRATION 2.5 Debit and credit effects—share capital—ordinary

Debits Credits

Decrease Share Capital—Ordinary Increase Share Capital—Ordinary

 Debit and Credit Procedure Equity

We can diagram the normal balance in Share Capital—Ordinary as shown

 Debit and Credit Procedure for Retained Earnings

Retained earnings is net income that is kept (retained) in the business. It represents
the portion of equity that the company has accumulated through the profitable
operation of the business. Credits (net income) increase the Retained Earnings
account, and debits (dividends or net losses) decrease it.
 Debit and Credit Procedure for Dividends

A dividend is a company's distribution to its shareholders. The most

common form of a distribution is a cash dividend. Dividends reduce the
shareholders' claims on retained earnings. Debits increase the Dividends
account, and credits decrease it. Illustration 2.8 shows that this account
normally has a debit balance.
 Debit and Credit Revenues and Expenses

The purpose of earning revenues is to benefit the shareholders of the business. When a
company recognizes revenues, equity increases. Therefore, the effect of debits and
credits on revenue accounts is the same as their effect on Retained Earnings. That is,
revenue accounts are increased by credits and decreased by debits.
Expenses have the opposite effect. Expenses decrease equity. Since expenses decrease
net income and revenues increase it, it is logical that the increase and decrease sides of
expense accounts should be the opposite of revenue accounts. Thus, expense accounts
are increased by debits and decreased by credits. Illustration 2.9 shows the rules of
debits and credits for revenues and expenses.

ILLUSTRATION 2.9 Debit and credit effects—revenues and expenses

Debits Credits
Decrease revenues Increase revenues
Increase expenses Decrease expenses
Credits to revenue accounts should exceed debits. Debits to expense accounts should
exceed credits. Thus, revenue accounts normally show credit balances, and expense
accounts normally show debit balances.
 Debit and Credit Procedure for Revenues and Expenses
Credits to revenue accounts should exceed debits. Debits to expense
accounts should exceed credits. Thus, revenue accounts normally show
credit balances, and expense accounts normally show debit balances
 Equity Relationships
Companies report share capital—ordinary and retained earnings in the equity section
of the statement of financial position. They report dividends on the retained earnings
statement. And they report revenues and expenses on the income statement.
Dividends, revenues, and expenses are eventually transferred to retained earnings at
the end of the period. As a result, a change in any one of these three items affects
equity.
 Summary of Dr/Cr Rules
Summary of the debit/credit rules and effects on each type of account.
Study this diagram carefully. It will help you understand the
fundamentals of the double-entry system.
 The recording process
Although it is possible to enter transaction information directly into the
accounts, few businesses do so. Practically every business uses the basic
steps (an integral part of the accounting cycle):
1.Analyze each transaction in terms of its effect on the accounts.2.Enter
the transaction information in a journal.3.Transfer the journal
information to the appropriate accounts in the ledger.
 The Journal
Companies initially record transactions in chronological order (the order in which they
occur).
Thus, the journal is referred to as the book of original entry.
For each transaction, the journal shows the debit and credit effects on specific accounts.
Companies may use various kinds of journals, but every company has the most basic form
of journal, a general journal.
Typically, a general journal has spaces for dates, account titles and explanations,
references, and two amount columns.
Whenever we use the term “journal” in this text, we mean the general journal unless we
specify otherwise.
The journal makes several significant contributions to the recording process:
1.It discloses in one place the complete effects of a transaction.
2.It provides a chronological record of transactions.
3.It helps to prevent or locate errors because the debit and credit amounts for each entry
can be easily compared.
 Journalizing

Entering transaction data in the journal is known as journalizing.

Companies make separate journal entries for each transaction. A
complete entry consists of
(1) the date of the transaction,
(2) the accounts and amounts to be debited and credited, and
(3) a brief explanation of the transaction.
Example: using the first two transactions Softbyte SA.
Recall that on September 1, shareholders invested €15,000 cash
in the corporation in exchange for ordinary shares,
and Softbyte purchased computer equipment for €7,000 cash.
The number J1 indicates that these two entries are recorded on
the first page of the journal.
 Journalizing: example

Date Account titles and Ref Debit Credit

explanation

2020 5

Sept 1 2 Cash 15,000

1 3 Share Capital (ordinary) 15,000

4 Issued shares for cash

Equipment 7,000

Cash 7,000

Purchase of equipment for

cash
 Journalizing: example

1
The date of the transaction is entered in the Date column.
2
The debit account title (that is, the account to be debited) is entered first at the extreme left margin
of the column headed “Account Titles and Explanation,” and the amount of the debit is recorded
in the Debit column.
3
The credit account title (that is, the account to be credited) is indented and entered on the next line
in the column headed “Account Titles and Explanation,” and the amount of the credit is recorded
in the Credit column.
4
A brief explanation of the transaction appears on the line below the credit account title. A space is
left between journal entries. The blank space separates individual journal entries and makes the
entire journal easier to read.
5
The column titled Ref. (which stands for Reference) is left blank when the journal entry is made. This
column is used later when the journal entries are transferred to the individual accounts.
 Simple and compound entries
Some entries involve only two accounts, one debit and one credit.
This type of entry is called a simple entry.
Some transactions, however, require more than two accounts in
journalizing.
An entry that requires three or more accounts is a compound
entry.

Example, assume that on July 1, Butler Shipping purchases a

delivery truck costing £14,000. It pays £8,000 cash now and
agrees to pay the remaining £6,000 on account (to be paid
later). Illustration 2.15 shows the compound entry.
 Journalizing compound entries

Date Account titles and Ref Debit Credit

explanation

2020

July 1 Equipment 14,000

Cash 8,000

Account Payable 6,000

Purchased truck for cash

with balance on account
 Ledger

The entire group of accounts maintained by a company is the

ledger.
The ledger provides the balance in each of the accounts as well
as keeps track of changes in these balances.
Companies may use various kinds of ledgers, but every company
has a general ledger.
A general ledger contains all the asset, liability, and equity
accounts.

Whenever we use the term “ledger”, we are referring to the

general ledger unless we specify otherwise.
Ledger
 Standard Form of Account
The simple T-account form used in accounting texts is often very useful for illustration
purposes. However, in practice, the account forms used in ledgers are much more
structured.
CASH N.101

Date Account titles and Debit Credit Balance

explanation
2020 June 1 25,000 25,000

2 8,000 17,000

3 4,200 21,200

9 7,500 28,700

17 11,700 17,000
250 16,750
20
30 7,300 9,450
 Posting

The procedure of transferring journal entries to the ledger accounts

is called posting.
This phase of the recording process accumulates the effects of
journalized transactions into the individual accounts.
Posting involves the following steps.
1.In the ledger, in the appropriate columns of the account(s) debited,
enter the date, journal page, and debit amount shown in the journal.
2.In the reference column of the journal, write the account number
to which the debit amount was posted.
3.In the ledger, in the appropriate columns of the account(s)
credited, enter the date, journal page, and credit amount shown in
the journal.
4.In the reference column of the journal, write the account number
to which the credit amount was posted.
Posting
 Chat of Accounts

The number and type of accounts differ for each company.

The number of accounts depends on the amount of detail management desires. For example, the
management of one company may want a single account for all types of utility expense.
Another may keep separate expense accounts for each type of utility, such as gas, electricity, and
water.
Similarly, a small company like Softbyte SA will have fewer accounts than a giant company like
Hyundai (KOR). Softbyte may be able to manage and report its activities in 20 to 30 accounts,
while Hyundai may require thousands of accounts to keep track of its worldwide activities.
Most companies have a chart of accounts.
This chart lists the accounts and the account numbers that identify their location in the ledger.
The numbering system that identifies the accounts usually starts with the statement of financial
position accounts and follows with the income statement accounts.

In this and the next two chapters, we explain the accounting for Yazici Advertising A. Ş. (a service
company). Accounts 101–199 indicate asset accounts; 200–299 indicate liabilities; 301–350
indicate equity accounts; 400–499, revenues; 601–799, expenses; 800–899, other revenues;
and 900–999, other expenses.
 Recording process
The basic steps in the recording process, using the October transactions of Yazici Advertising A. Ş. Yazici's
accounting period is a month. A basic analysis and a debit-credit analysis precede the journalizing and
posting of each transaction. For simplicity, we use the T-account form in the illustrations instead of the
standard account form.
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Chart of Accounts
 Thank
you.

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