Accounting is commonly referred to as the language of business. It is a language of numbers, filled with debits and credits that portray the financial story of an entity. There are different categories or genres of accounting per se. Financial accounting is for profit oriented entities. Governmental accounting is for governmental and not for profit entities. Managerial accounting is for internal and is mainly concerned with production. Federal income tax accounting is for both personal and corporate taxes.
Assets = Liabilities + Equity
- This formula is the backbone of the balance sheet.
Journal entries are very critical in accounting. They are in essence the fundamental building blocks of financial accounting. One journal entry can change an account balance from a positive balance to a negative balance; therefore it is very crucial to obtain a good understanding of the fundamentals of journal entries and how debits and credits alter account balances. Each journal entry tells a financial story. It is very important to note that debits and credits in accounting do not mean the same thing as in finance and personal banking; its best to avoid approaching debits and credits of accounting with that background. You do not want to mix the two up, it can cause many serious journal entry mistakes.
Assets are increased with a debit, and are reduced with a credit. Contra asset accounts are increased with a credit, and reduced with a debit. The diagram on the bottom illustrates how an asset account's balance increases and decreases. It is important to note that an asset account ultimately retains a debit balance and a contra asset account has a credit balance.
Liability and equity accounts increase with a credit, and are reduced with a debit. Contra liability and equity accounts are increased with a debit, and reduced with a credit. The diagram on the bottom illustrates how a liability and equity account's balance increases and decreases. It is important to note that a liability and equity account ultimately retains a credit balance and a contra liability and equity account has debit balance.
Journal Entry 1:
Adequate Disclosure, Inc. invests $3,000 into the company. Record the journal entry.
Adequate Disclosure, Inc. purchases equipment for $50,000 in cash.
Journal Entry 3:
Adequate Disclosure, Inc. sells its office building for $150,000, in cash.
Journal Entry 4:
Adequate Disclosure, Inc. purchases inventory on credit for $60,000.
It can be difficult for a student to picture the cash balance increase and decrease through this journal entry format. So a simple way to see these financial transactions alter the cash balances is through the use of T-Accounts. A T-Account displays how an account increases and decreases through financial transactions.
Here is a sample template of a T-Account. It show how it increases and decreases through debits and credits.
Now going back to the sequence of journal entries:
- Journal Entry 4 does not affect the Cash account, therefore will not be displayed on the Cash T-Account
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