How to record a financial transaction
Today I will show you how to record financial transactions into their ledger accounts in 4 easy steps.
STEP 1
- Identify the two items that are affected
STEP 2
- Which of them is Increasing or Decreasing
STEP 3
- Decide on whether to Debit or Credit keeping in mind your DEADCLIC/ALORE mnemonic
STEP 4
- Make sure there has being a debit and credit entry and they are both of the same amount
It is as easy as that! Just follow this 4 simple steps and you are ready to go!
How to DEBIT and CREDIT
This is probably one of the earliest problems students face in accounts. So today I will try and ease your way through learning how to debit and credit as well as sharing with you all of my tips to remember what to do exactly.
First of I will like to clear something,
- The effects of DEBITs and CREDITS vary between the different ledgers
- Their main purpose is to either INCREASE or DECREASE values depending on the accounts in which they are used.
I will show you the first method I use to help me know where to debit and credit. It is another mnemonic called D.E.A.D.C.L.I.C.
This mnemonic applies for every transaction* which requires an increase in value.
I will illustrate it in a table below:
DEBIT anything which is..
E- Expense
A- Asset
D-Drawings
And
CREDIT anything which is …
L- Liability
I- Income
C –Capital
And obviously for a decrease you will do the reverse.
So that is the first method, let us go on to the next method I promised to teach you.
It is another mnemonic which I mentioned earlier probably in a previous post. This one is A.L.O.R.E.
Where the following keys are used;
CR-Credit
DR-Debit
A-Asset
L-Liability
O-Owners equity/capital
R-Revenue
E-Expenditure
So basically all you have to remember is that to increase the value of an asset or expenditure account or drawings you will always have to DEBIT. From here you can then deduce that to reduce its value you will have to CREDIT, and all other accounts follow the complete opposite, just as shown in the image above.
Double entry bookkeeping
Transactions are being recorded when they occur in ledger accounts. This ledger accounts are then balanced off and sent over to the trial balance, and from there, adjustments are made and the financial statements can now be prepared.
The movement can be shown as follows:
- Transactions occur
- The effects are recorded in the Ledger accounts
- Ledger accounts are closed and balanced off.
- These balances are sent to the trial balance
- Any required adjustments are made
- The Financial Statement can now be PREPARED
- Finish!
There is one important thing you should take note of in your double entry bookkeeping, and that is the Duality Concept*
* This concept states that each transaction has 2 impacts. E.g. the business sells goods: there will be a reduction in stock/inventory and there will be an increase in cash. You will never have any transaction with one impact/effect, all transactions have got a double impact hence the Duality Concept.
These 2 effects/impacts are referred to as DEBIT and CREDIT.
In the next post we will talk more about the accounting for different transactions.
For best results it is advised to view this slide in full screen mode.
Uploaded on authorSTREAM by theaccountingstudent
Ledger Accounts
Transactions are being recorded in 5 different types of accounts namely:
- Asset
- Liability
- Owners Equity/ Capital
- Revenue
- Expenses
To remember this I use the following mnemonic A.L.O.R.E , later I will explain why I placed them in the following order.
So here is the format in which your ledger accounts (commonly called T-accounts) should look like:
Ledger Account
So now you know how your ledger account should look like, congrats!
The Basic elements of the Statement of Financial Position
As earlier said in the previous post, the SFP is a snapshot of the business at a point in time showing its ASSETS, LIABILITIES and CAPITAL.
In today’s post, we will be breaking down these various terms, explaining what they all mean and how they come about.
*Take note, this are basic explanations as we are still at the start of learning accounting.
So first of we will deal with ASSETS
ASSETS
An asset is a resource an entity controls as a result of past events (past transactions) which future economic benefits (like revenue $$) are expected to flow to the entity.
There exist 2 types of assets namely NON CURRENT ASSETS AND CURRENT ASSETS.
Non-Current Assets:
These are any intangible asset acquired on a long-term basis to be used in providing service to the business.
In other words, a non-current asset is any purchase used to generate revenue for the business.
Please take note of the key terms(italic) used above, in the definition.
Current Assets:
These are assets which are expected to be use in the business’ day to day transactions
In the SFP this are listed in order of liquidity1 starting with the least liquid item , inventory.
1Liquidity : is the ease with which the item can be converted into cash.
| Assets | Examples |
| Non-current | Plant, machinery ,equipment ,motor vehicle etc. |
| Current | Inventory, cash in hand, cash at bank, receivables. |
LIABILITIES
Like assets, there exist two types of liabilities too. Namely NON CURRENT LIABILITY and CURRENT LIABILITY. When looking at these two, the main thing to look at is the time, this greatly helps in differentiating which one is a non-current or current.
Non-current Liabilities:
In simple words, these are the all the things owed by the company to 3rd parties which they can repay after 12 months.
More technically, non-current liabilities are long term liabilities (debts) payable in more than 12 months (the accounting period)
Current Liabilities:
Unfortunately with these ones, the business has less than 12 months to meet the payments.
Current liabilities are those liabilities which are payable within 12 months of incurring it.
Examples
| Liabilities | Examples |
| Non-current | Loans(long-term) |
| Current | Payables, bank overdraft, loan(short-term) |
CAPITAL
Capital is a type of liability as it is money owed to the Business owner.
So there you go! You now know all the basic elements of the statement of financial position.
The Statement of Financial Position Part 1
The statement of financial position (International Terminology) otherwise known as the Balance sheet in the UK accounting terminology is a snapshot of your business at a specific date/time (usually the accounting year end1)
1Accounting Year End: This is the given time at which the accounting books are closed.
The statement of financial Position revolves around 1 main accounting formula, and trust me, knowing it will help you a lot. So here it is:
Assets2 = Capital3 (Proprietor’s Capital) + Liabilities4
2Asset: In simplest terms, an asset are things a business owns e.g machines, cars etc
3Capital: This is money put in by the owner of the business at the start or during the course of the business’ life.
4Liability (Plural-ies): In simple terms too, a liability are things a business owes to 3rd parties e.g. suppliers etc
So basically the above formula is what makes of the Statement of Financial Position (SFP). This formula can be rearranged in various manners, but they will still mean the same. Here are examples of how you may see this formula
A = C + L
C = A – L
L = A – C
They all mean the same, they are just different ways of playing around with the + and – signs.
I will show you how the format of the SFP looks like so that you may have a feel on how the accounting formula is put into use:
Basic SFP Pro-forma
| Assets | ||
| Non-Current Assets | ||
| Plant | x | |
| Property | x | |
| Equipment | x | |
| Machinery | x | xx |
| Current Assets | ||
| Receivables | x | |
| Cash at bank | x | |
| Cash in hand | x | xx |
| xx | ||
| Capital | ||
| Capital Account | ||
| Balance at start of year | x | |
| Plus Net Profit/Less Net Loss | x | |
| Plus Increase in Capital | x | |
| Less Drawings | x | xx |
| Liabilities | ||
| Non-Current Liabilities | ||
| Loan (more than 1 year) | x | |
| Current Liabilites | ||
| Payables | x | xx |
| xx |
Do not be scared by the names you see in the above pro-forma, in the next post I will detail out all what they are and how they arise.
But this are the general stuffs you will find in an SFP, mind me, there are more to this, but this are the basics.
The Pro-forma above used the Accounting Formula :
Assets = Liabilities + Capital
That is why I highlighted the two blue XX’s as they have got to balance i.e have the same value.
This pro-forma can be rearranged using the Accounting formula in which ever way you like but take note:
Whatever way you choose, they MUST BALANCE!
Income Statement Part 2 :
In the previous post (i.e. IS Part 1) I talked about the basics of the income statement. Today I will continue talking about the elements of the income statement and other things you should take note of.
Firstly you should already know that the income statement records all the financial transactions of a company. These transactions are in the form of revenues and expenditure.
Revenue is an increase in economic benefits to the business during the period in the form of inflows or enhancements of assets or decreases in Owings that result in an increase in capital.
Whereas expenditure is a decrease in economic benefits to the business, or depletions of assets or increases in debts that result in a decrease in capital .
There are other things you should take note of when preparing your of Income Statement;
- The 1accrual concept is used when preparing the income statement
1The accrual concept states that income and expenses are recorded as they are earned / incurred NOT when you receive the cash or payout cash.
- And as earlier stated, the Income statement is divided into 2 parts, the first resulting in the Gross Profit and the second resulting in the Net Profit
The formula below should summarise it ;
Sales – Cost of Sales = Gross Profit – Other Expenses = Net Profit
You can use this formula to deduce any figure you want by playing around with the + and – signs.
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