Debits and Credits: Round 3
Ding! Ding! Ding! It's time for the third and final round of the Debit and Credit Showdown, which means you're one step closer to understanding debits and credits. During Round 1, we learned some of the big punches that debits and credits pack. In Round 2, we bobbed and weaved our way around the double-entry system, and for Round 3 it's time to pull out our big guns because we're going to knock out the recording process.
There are three steps to the recording process:
- Analyze how transaction affects accounts
- Adding debits and credits to a journal
- Transfer journal information into ledger account.
Thankfully, we can enter this information into our financial management software once, and it takes care of everything else instantaneously. But in order to truly understand how it works, it is best if we understand what goes on behind the scenes.
The most important part of that process is to understand how the transaction will affect the debits and credits.
Let's say you invest $10,000 into your boxing glove company- Acme Boxing Gloves. First, we would debit cash to show an increase of an asset, and we credit owner's equity to show increase of capital.
The second step is to record the transaction into a journal. The general journal requires the date of the transaction, the name of accounts affected, the amount debited/credited and an explanation of the transaction. Let's use this as an example: You invest $10,000 into Acme Boxing Gloves (ABG), and then purchase some equipment for $5,000 and office necessities for $1,500 both with cash. You then purchase additional equipment for $1,200 and office supplies for $300 all on an account. It would look something like this in your journal:
Seeing how the transactions are recorded in the journal helps to understand that "law of conservation" effect we talked about in Round 2.
The third step is to transfer all of the entries into a ledger, which contains the sum of all of your T-Accounts. Acme Boxing Glove's Cash account would look like this:
In the cash account you enter all cash inflows and outflows for the period into the T-Account under either debit or credit. After adding each side together, the cash account should have a debit balance of $3,500. That means that during that specfic point in time, Acme Boxing Gloves has a cash balance of $3,500.
It may not have been a total knock out, but if you made it through these 3 rounds and came out with a better understanding of debits and credits, you've won the fight. If not, there's always a chance for a rematch, just make sure you train properly.