The Accounting Method: Double Entry Bookkeeping (Part 1)

Hi and welcome back to the introduction to financial accounting course. This video is the start week three - In this session we would focus on how companies record transactions and we would start using the language of bookkeeping. In this session We will look at the instrument namely the Journal that the accounts and the ledger and we would focus on the method which is a double entry bookkeeping system. Let us focus first on the accounting cycle. So far we focused on the substantive transactions

a corporation engages with: namely the operations and financing. Let us now move on how companies formally record transaction. Everything starts with company transactions which is the box in Orange on the top and then you move down to recording using the account and double entry and then you move forward to summarizing through the journal ledger and then use the trial balance prior to getting to financial statements. Let’s have a look again at what happens when we go from transactions to recording. Let’s say a hypothetical case of a company BlueSalt that on May the 3rd buys 80 stand up paddles for its stand up paddle activities. The cost per unit

is at 350 and the payment is settled as following: half through a bank transfer, whereas the other half is through a 60 day payable that is issued. BlueSalt also estimates a useful life of three years for each paddle surf. Now you should be quite accustomed to these kind of transactions. But let’s have a look at what happens a little bit more in detail. Which accounts are involved? First, we know that there are paddle surf - which we can call equipment. Paddle surfs are typically an asset of the company and these asset increases.

What happened to the bank given that there is a bank transfer to one of the suppliers there is a decrease of a bank and bank you know it’s a key asset. And then there are payables that are involved in this transaction payable to our liability and this liability goes up. So there is an increase in asset equipment a decrease in asset decreasing bank and an increase in liability (payables). How do we record this transaction more formally? Now if you then see the diagram below you’ll notice that in the uppermost raw there are some characters in bold. First, we indicate the number of the transaction. In this case this is our first transaction.

And that represents the chronological order of the transaction in a given period. And what is the typical period? It is the fiscal year. Next, we report the date of the transaction. And third, most importantly we use an account titled as an explanation. In this case you’ll notice that in the green area there is equipment, with an A in brackets. And then there is a bank and liabilities and they are written on the left hand side of the same column for a specific purpose That would be clear in a second. Next, we have debits and credits; and you’ll see that the value of equipment goes up.

So we debit 28000 whereas we credit both bank and payables for the same amount 14,000 each. In the blue column. We recorded the amount of transaction affecting each account. Once we’re done with journalizing We can now move to step two which involves using these accounts. So let’s keep using the same example. So same transaction but we represent it differently. As you can see, here we introduce your friend the T account. And here we have three different accounts named after the three items which we have seen already in the previous slide. So we have equipment, which is asset related account, and that relates to the paddle surfs, that we have bank. And then we have payables.

Now we know that a keep in mind is an asset. Bank is an asset payable is a liability. And let’s see how we start moving these accounts with debit equipment for 28,000.

And we credit both bank and liability for the same amount: 14,000 each. Each item has a dedicated account, and the accounts work in the following way. They are debited If we increase the amount in the left column, and they are credited if we increase the amount in the right column. You can start seeing one of the key properties of

the double entry bookkeeping system: the total debits equal the thought of credits. How do we use the T-account? You can clearly see that we have the name of the item on top and then we have two columns the debit on the left hand side and the credit on the right hand side. Now let’s take a hypothetical example of receivables which are an asset. And imagine that the company has gone through a series of transactions in which receivables have been involved. You list them by number, and next to each number you have the equivalent amount that has been called. The key account must always balance

at the end of the period and it does so in the following way: If the total credit is higher than the total debits then we write the balance on the debit side. Instead, If the total debit is higher than the total credit, we write the balance on the right hand side namely we credit. The T-account must balance at the end of the period and we follow the simple rule. So if you do a little bit of calculation here on this account named after receivables, you will notice that the total debit exceeds the total credits. Twenty thousand versus fifteen thousand. How can you balance?

We have to write at the end of the period five thousand among the credit so that the total will be twenty and twenty. Let’s have a look now at the debit and credit framework so that we can have an overarching theoretical approach to follow.

Let’s start with asset: say for example inventory when the company buys inventory the value of inventory goes up. We debit something whereas if the value of inventory goes down,

We credit it: it is quite the opposite. When we look at liabilities say for example payables when there is an increase in payables. For example when a company buys services or product and commits to pay in the future the increase in payables is credited whereas a decrease in payables when the deputies settle is debited Quite similarly works the equity account when there is paying capital. When equity increases, we credit. When there is for instance a distribution dividend. Equity goes down with debit these accounts work in a slightly different way from the accounts that flow into the income statement. Recen revenues like sales for example when the company sales and sales go up.

We credit whereas when there is an adjustment to sales because it doesn’t make quite much sense saying that sales decrease with debit instead when we use expenses account for

Instance with salary: when salary increases we debit, when salaries decrease or are adjusted we credit. Now one thing that is worth noticing in this slide is that we are using different colors for different items that will eventually flow into the balance sheet or in the income statement. The items in the light orange or yellow will go into the balance sheet, whereas the items in light blue will eventually flow into the income statement.