Preparation of Accounting Entries for Transactions in General Journal Format and the Posting

Prepare accounting entries for transactions in general journal format and post to the general ledger

Contents Introduction 3 Debits versus credits 3 How do we explain the credit balance in our bank statement? 5 Preparing journal entries 5

Prepare accounting entries for transactions in general journal format and post to the general ledger 1 © NSW DET 2006 2006/053/12/2006 LRR 4665/4668

Introduction From earliest times, the operation of bookkeeping systems has recognised the opposite nature of income (revenue) and expenses, which was essential if they were to be ‘set-off’ to arrive at the profit or loss for a period.

Debits versus credits In the formalisation of the ‘double-entry’ bookkeeping system, the acceptance of these opposites as ‘debits’ and ‘credits’ was fundamental.

Traditionally, a ‘debit’ entry is an entry on the left-hand side of an account and a ‘credit’ entry is an entry on the right-hand side of an account. A greater value of ‘debit’ entries will result in an account having a ‘debit’ balance; a greater value of ‘credit’ entries will result in a ‘credit’ balance.

As the majority of transactions were income or expense items, the principle of income as ‘credit’ and expenses as ‘debit’ was established. (It could just as easily have been the other way around!).

The extension of the ‘debit’ and ‘credit’ principle to assets and liabilities followed logically. It is in this area that students of accounting have difficulty.

The acceptance of income items as ‘credits’ and expense items as ‘debits’ sits satisfactorily with the natural concept of credits are good and debits are bad. This concept has developed because the most common experience that we have is with the debits and credits to our bank account or our credit-card account.

We understand that amounts deposited increase the balance of our bank account or reduce the liability on our credit-card accounts, and these we know as being ‘credited’. Amounts which reduce our bank account—ie cheques drawn, bank fees and charges, or purchases which are charged on our credit-card—are ‘debited’ against our account.

What students find contradictory to the credits are good and debits are bad concept is the treatment of assets and liabilities, which has asset accounts as a ‘debit’ (balance) and liability accounts as a ‘credit’ (balance). The answer lies in the essential need for consistency.

The following example may clear the picture.

2 Prepare accounting entries for transactions in general journal format and post to the general ledger © NSW DET 2006 2006/053/12/2006 LRR 4665/4668

Example

On one day in the life of a business, the following cash transactions occurred.

(a) Paid wages of employees $1 000 (b) Purchased a cash register $1 400 (c) Cash sales to customers $3 500 (d) Borrowed from Shylock Finance $8 000

Solution

(a) Paid wages

The basic principle of ‘expenses as debits’ results in:

Wages (account) $1 000 debit And to complete the double-entry: Bank (account) $1 000 credit (b) Purchased a cash register

As the recording of transactions in terms of ‘debits’ and ‘credits’ has to be consistent, the payment for the cash register, in its effect on the Bank (account), must be the same as for the ‘payment of wages’, ie, the Bank (account) must be ‘credited’, thus:

Bank (account) $1 400 credit And to complete the double-entry Cash register (account) $1 400 debit

(c) Cash sales to customers

The basic principle of ‘income as credits’ results in: Sales (account) $3 500 credit And to complete the double-entry: Bank (account) $3 500 debit

(d) Borrowed from Shylock Finance

Again, the need for consistency in the recording of the transactions as ‘debits’ and ‘credits’ must have the receipt of the $8000 from Shylock Finance affect the Bank (account) in the same way as the receipt from Sales —ie the Bank (account) must be ‘debited’.

Bank (account) $8 000 debit And to complete the double-entry: Loan fro Shylock Finance (account) $8 000 credit The amount ‘credited’ to the Loan from Shylock Finance (account) has an important difference to the amount ‘credited’ to Sales (account). This important difference is that the $8000 will have to be repaid at some time in the future, thus constituting it as a liability (with a ‘credit’ balance).

Conversely, the Bank (account), an asset account, will have a ‘debit’ balance of $9100. As the sum of the ‘debit’ entries for cash received from Sales ($3500) and the Loan from Shylock Finance ($8000), a total of $11 500, exceeds the sum of the ‘credit’ entries for cash paid for Wages ($1000) and the purchase of the cash register ($1400), a total of $2400, by $9100.

You need to realise that it is the consistency requirements of the double- entry that result in Asset accounts having ‘debit’ balances and Liability accounts having ‘credit’ balances.

How do we explain the credit balance in our bank statement? As you know, when we receive our bank statements from the bank account having a ‘credit’ balance when we have money in our account? How do we explain the dilemma that we might face in respect of the bank (account) as an asset and having a ‘debit’ balance and, on the other hand, our day-to-day experiences of our bank account having a ‘credit’ balance when we have money in our account? It is because whatever records we see in our day-to- day experiences (with our bank account) are prepared by the bank and are from the bank’s point of view. If we have money in our account, the bank owes to us and sees us as a liability and our account will have a ‘credit’ balance. The reverse applies on our credit-card accounts as invariably those accounts will have ‘debit’ balances because we owe on those accounts and we will be seen as an asset.

Preparing journal entries Before we deal with the preparation of journal entries, we need to understand the following principles:  Expense accounts and asset accounts will have debit balances.  Income accounts and liability accounts will have credit balances.

4 Prepare accounting entries for transactions in general journal format and post to the general ledger © NSW DET 2006 2006/053/12/2006 LRR 4665/4668

This is logical when we understand that expenses and assets both represent outlays of resources; one (expenses) benefits the business in the short-term and the other (assets) benefits the business in the long-term. Also, income and liabilities represent receipts of resources; one (income) belongs to the business and the other (liabilities) has to be repaid in the future.

It follows also, again importantly, that:  To increase a debit balance will require a debit entry.  To reduce a debit balance will require a credit entry.  To increase a credit balance will require a credit entry.  To reduce a credit balance will require a debit entry.

Therefore:  a debit entry will increase a debit balance or reduce a credit balance.  a credit entry will reduce a debit balance or increase a credit balance.