Recording Transactions

Background

We've covered the fact that with financial transactions, two accounts (at least) are impacted. So what types of accounts are there?

Question

What types of accounts are there? Name an example for each. Are the balances in each of them normally debits or credits?

Answer

1. Assets are things we own and are normally debits. Cash is an example.
2. Liabilities are things we owe and are normally credits. Accounts Payable is an example. 
3. Equity is the net value of the business and is normally a credit. Owner's Equity is an example.
4. Income is cash and other consideration we receive in the course of business and is normally a credit. Sales is an example.
5. Expense is what is paid out in cash and other consideration in order to make income and is normally a debit. Salaries is an example. 

Analysis

We've discussed in prior entries about a merchant selling a cow for gold (i.e. cash). Let's talk about some transactions that are a normal part of business and examine the types of accounts that are impacted.

So let's start with that cow we keep talking about. We own it - it's ours. We call something like that an asset. Assets are things we own.

Along with the cow, things we own include cash (gold, silver, money, etc), land, buildings, inventory, and more.

Assets are normally debit balances - and so debits will increase assets and credits will decrease them.

Let's make a little story out of this. Let's say the only thing in the world we own is the cow and we're walking to the market town to sell milk.

Ok - we get to town late. We need to get a room for the night but the innkeeper only wants cash. We say we'll pay him when we sell milk tomorrow. The innkeeper agrees, and so we now owe the innkeeper money. That is a liability. Liabilities are things we owe, such as loans and debts.

Liabilities are normally credit balances - and so credits will increase liabilities and debits will decrease them.

Along with the debt to the innkeeper, we might also owe money to the tax collector, to a landlord, or to others.

At the same time, we now also record an Expense - money or value that we pay in order to make income. Other types of expenses include salaries, utilities, taxes, and more.

Expenses are normally debit balances - and so debits will increase expenses and credits will decrease them.

So let's now talk about what we're worth. Before going to town, we were worth one cow (for ease, let's say the cow is worth $100). And let's also say that we have to pay $1 per night at the inn. So after one night in the inn, we're now worth $99. Our equity is what we own less what we owe. Equity is Assets less Liabilities.

Equity accounts are normally credit balances - and so credits will increase liabilities and debits will decrease them.

We find a butter maker and we sell some milk to them. We get some money (let's say $2) so that is an increase in cash and so a debit. We also record Income. Income is money that we earn.

Income is normally a credit balance - and so credits increase income and debits decrease them.

Vocabulary used:

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Where might you have come from?

Fact-orials Index

Accounting Principles

• Double Entry Accounting

Where might we go?

Accounting Principles:

• Cash vs Accrual Accounting
• Comparability of Transactions