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Financial Accounting Unit 2: Debits, Credits, Journals and the Ledger

Double-entry bookkeeping records every transaction with equal debits and credits. This unit covers the rules for each account type and how entries move from the journal to the ledger to the trial balance.

Covers: T-accounts and normal balances, Debit and credit rules, Journal entries, Posting and the general ledger, Chart of accounts, The trial balance, Finding trial balance errors

Study guide

Each account can be pictured as a T-account, with a left side called the debit side and a right side called the credit side. Debit and credit are only positions; whether a debit increases or decreases an account depends on its type. Assets sit on the left of the accounting equation, so they increase with debits and normally carry debit balances. Liabilities and stockholders' equity sit on the right, so they increase with credits and normally carry credit balances. Every transaction is recorded with at least one debit and one credit, and the dollar total of debits must equal the total of credits. This is double-entry accounting, and it keeps the equation in balance.

Revenues, expenses and dividends are really parts of equity, kept in separate accounts so the company can measure performance. Revenues increase equity, so they increase with credits. Expenses and dividends decrease equity, so they increase with debits and normally have debit balances. A handy memory aid is DEALER: Dividends, Expenses and Assets increase with debits; Liabilities, Equity (common stock and retained earnings) and Revenues increase with credits. Contra accounts, which you will meet later, carry balances opposite to the accounts they offset, such as accumulated depreciation, a credit-balance account that reduces equipment.

The recording process has four steps. First, analyze the source document (invoice, receipt, check) to decide which accounts change and by how much. Second, journalize: write the entry in the general journal in date order, listing debits first and credits indented below, with a short explanation. An entry with three or more accounts is a compound entry. Third, post each debit and credit to its account in the general ledger, the collection of all accounts. The chart of accounts lists every account and its number, usually ordered assets, liabilities, equity, revenues, then expenses. Fourth, prepare a trial balance listing each ledger account and its balance.

A trial balance tests whether total debits equal total credits. If they are unequal, an error exists: a one-sided posting, an amount entered on the wrong side, a wrong amount on one side, or an addition mistake. A difference evenly divisible by 2 suggests an amount on the wrong side, because that doubles the gap. A difference divisible by 9 suggests a transposition, such as 540 written as 450, or a slide, such as 540 written as 54. Some errors don't unbalance the totals at all: omitting an entire entry, recording both sides at the same wrong amount, using the wrong account on the correct side, or recording an entry twice.

Common journal entries appear again and again. A cash sale of services debits Cash and credits Service Revenue. Billing a client debits Accounts Receivable and credits revenue; collecting later debits Cash and credits Accounts Receivable, with no new revenue. Buying supplies on account debits Supplies and credits Accounts Payable. Paying in advance for insurance or rent debits a prepaid asset. Receiving cash in advance credits Unearned Revenue. Paying a dividend debits Dividends and credits Cash. Practice deciding the account type first, then the direction, and the entries become automatic.

Key ideas

• Debit means left and credit means right; neither means increase or decrease on its own.
• Assets, expenses and dividends increase with debits; liabilities, equity and revenues increase with credits.
• Every journal entry has equal total debits and credits.
• Transactions are journalized in date order and then posted to ledger accounts.
• A balanced trial balance does not prove the records are free of errors.
• A difference divisible by 2 suggests a wrong-side posting; divisible by 9 suggests a transposition or slide.

Formulas and rules

Common mistakes

• Thinking a debit always means an increase.
• Crediting revenue when collecting a receivable that was already recorded as revenue.
• Debiting an expense when paying in advance, instead of a prepaid asset.
• Assuming a balanced trial balance means every entry is correct.
• Forgetting that expenses and dividends carry debit balances on the trial balance.

Before the test, make sure you can

• State the normal balance and the increase side for any account.
• Write the journal entry for common transactions, including compound entries.
• Calculate an account's ending balance from its beginning balance and postings.
• Prepare a trial balance and solve for a missing balance.
• Identify which errors will and will not unbalance a trial balance.
• Use the divide-by-2 and divide-by-9 tests to locate errors.
• Explain the order of the recording process from source document to trial balance.

Words to know

Debit

An entry on the left side of an account; it increases assets, expenses and dividends.

Credit

An entry on the right side of an account; it increases liabilities, equity and revenues.

T-account

A simple picture of an account with debits on the left and credits on the right.

Normal balance

The side, debit or credit, on which an account's increases are recorded and where its balance usually appears.

Double-entry accounting

The system in which every transaction affects at least two accounts with equal debits and credits.

General journal

The book of original entry where transactions are recorded in chronological order.

Journal entry

A dated record of a transaction listing the accounts and amounts debited and credited, with an explanation.

Compound entry

A journal entry that involves three or more accounts.

General ledger

The complete set of a company's accounts and their balances.

Posting

Transferring the debits and credits from the journal to the matching ledger accounts.

Chart of accounts

A numbered list of all accounts in the ledger, usually ordered by statement category.

Trial balance

A list of all ledger accounts and their balances that tests whether total debits equal total credits.

Transposition error

Reversing two digits of a number, such as 8,640 for 8,460; the difference is divisible by 9.

Slide error

Moving a decimal point, such as entering 2,500 as 250; the difference is divisible by 9.

Source document

Evidence of a transaction, such as an invoice, receipt or bank deposit slip, that starts the recording process.

Contra account

An account with a balance opposite to the related account it reduces, such as accumulated depreciation.

Sample practice questions

30 more questions like these, from level 1 to 5, are in the practice set.