Following on the debit and credit framework. Let’s try to introduce also the accounting identity so that we can get the full picture. If you remember from previous week how the accounting identity works, We are repeating it here. On the left hand side We have asset and expenses, and they work exactly the same way when assets go up increase, we debit.
Likewise, the expenses when assets go down and decrease: we credit.
And likewise with expenses: on the right-hand side we have liabilities equities and revenues.
And they work much like in similar fashion: when revenues increase, we credit when liabilities increase. We credit when equity increases. We credit. Likewise when Liabilities Equity and revenues decrease we debit in the same way. To summarize and bringing together the concepts from the double entry bookkeeping system and accounting identity we can summarize as follows.
Assets and expenses account: when there is an increase they are debited. So you move something in the left hand side of the column. When there is a decrease, They are credited and you write something in the right column. Usually the debits exceed the credit for those account. Liabilities, Revenues and stockholders equity - instead - in presence of increases are credited. So, you read something in the right column of the account whereas if there is a decrease they are debited. So you write something in the left column usually the credits exceed the debits for those account let’s move on to the accounting method and something that is called double entry bookkeeping system. Well, we know that this is an awkward name.
Why. Double entry what does that mean? Well, you may have noticed that each accounting relevant transaction involves at least two items. You’re right because we never made it so explicit, but the time is now. Let’s have a look at the very simple transaction. BlueSalt pays a three thousand as a salary to its employees, and the payment is by via bank transfer. Which are the two accounts involved? We know that salary which is an expense account goes up. So it will be debited for 3,000. What has bank which is an asset account will be credited and will go down in value by the same amount 3,000 for the items here are clearly two.
Second example: BlueSalt sells services for nine thousand eight hundred of which half are cashed in immediately. Has the remaining half will be paid by the customer in 30 days. Some of you may notice that here the accounts involved are three. Why? Because we have sales in which there is a revenue account an increase in a revenue account is credited for nine thousand eight hundred and correspondingly
We have two accounts which are debited: the bank - which is an asset account - will go up by 4,900, and the receivables which is a sort of a credit will go up by the same amount. Now you realize that in the example one an example to the total amount of credit and total amount of debt being equaled for every transaction. The total amount of debit and credit will always balance and I go back to the previous example with blueSalt selling Services for 9,800 of which half have been paid now and half in 30 days. As you can see in the blue row, the total amount of credit and debit equal to 9,800.
This is a fundamental property of the double entry bookkeeping system. Bear it in mind. Rule number three says that at any point in time the total amount of debit and credit for all items or accounts that have been created will balance. For instance, BlueSalt pays three thousand salary payment is by a bank. BlueSalt sell the services for nine thousand eight hundred of which half are cash eighteen. Via a bank transfer. Where has the remaining amount is settled via a receivable.
See what happens here when we record the two transactions: the total amount of debits and the total amount of credit for all the accounts involved equals 12,800. So, the third property is quite fundamental to make sure and double check on the integrity of the system. The mechanism here is a safety net to ensure that no material mistakes have occurred throughout the period. Step 3. Let’s have a look at the ledger. The ledger is something that summarizes all the transactions.
The way it looks like and you can tell by the account is quite similar to the accounts that we have seen In step two; even though we use it in a different way because the ledger accumulates and records each and every transaction over time. So in that regard these is quite different from the T-account the ledger allows us to keep track of the value of each item and each account at any point in time.
And let’s have a look at the following example: And I know that some of you may wonder well what’s the difference with the T-accounts. Just be patient for one more slide. Let’s have a look at how the ledger helps us. We know that on July the 30th blueSalt pays a supplier by a bank transfer for the previously acquired paddle surf; but if you remember BlueSalt already paid half of the paddle surf to the customer therefore you wouldn’t notice that in the bank account you will have transaction number one crediting for fourteen thousand and you have a similar transaction for the time when blue sold settle is payables the payables go down by fourteen thousand with transaction two.
But if you remember we used the payable account upon the first transaction when initially blueSalt bought the paddle surf. Then BlueSalt paid the salaries and the salaries involve
a decrease in the bank account which is recorded as transaction number three: crediting that corresponds to an increase in the value of
salaries which is an expense account: when expense account go up we debit. The ledger helps us keeping track of the value of each item and each account at any point in time. And also it helps us ensuring that we haven’t made any mistake. Summary of
the ledger here: through the three transactions that have involved bluesalt.
So far we have used four different accounts: We have an equipment - which is an asset account - we have bank, which is an asset account. We have payables, which is a liability account and
salaries, which is an expense account: they work in the following way: The increase in the debt of equipment is debited. This is labeled as transaction number one an increase in the rate of equipment for 28000.
Let’s have a look at the bank account: the bank account as being involved three times. Transaction number one decrease of 14000; transaction number to decrease of the same amount; transaction three decrease of six thousand. There are only crediting in the bank account because the resources have been employed by the company. Then payables. Payables is a liability account that goes up at the time of the purchase of the paddle surf. That’s when we credit and then at the time in which the company settled its payables the value goes back to zero. And in fact we debit for 14,000. So, as you can see the payables account will be on balance by default.
The salaries account has been debited by 6,000 through the transaction number three. A fundamental property of the ledger is allowing us to check whether the total value of debits and credits equal. And you should go and check it yourself. Now your turn to practice.