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This post is a quick overview of subjects covered in more detail in other posts. I usually like to see a quick version so I am trying to present that option to others as well.
The Double Entry Accounting System collects, organizes, summarizes and reports on Financial Transaction data.
Financial Transactions: Exchanges of things of value.
There are three basic questions that must be answered for each financial transaction, they are:
- Question 1. How much money changed hands? What is the value of this exchange?
- Question 2: How was the money used? What was either gained or paid for by this exchange?
- Question 3: Where did the money come from? What is the source of funds in this exchange?
- Answer 1: 3,000.00
- Answer 2: Rent
- Answer 3: Checking Account
The answers for each of the financial transaction questions are recorded in Journals. Journals have a grid format with a varying number of columns but to start, we’ll use three columns.
The descriptions that answer questions 2 and 3 are always entered on separate lines to the left of the two numeric columns.
The amount associated with question 2 is entered on the same line as its description and it is always answered in the left (debit) numeric column. The amount associated with question 3 is entered on the same line as its description and it is always answered in the right (credit) numeric column.
General Journal Example:
To ensure that both sides of the transactions are recorded, Total Debits must always equal Total Credits.
Chart of Accounts: The Chart of Accounts is basically a list of the descriptions used to answer Transaction Questions 2 and 3. Each unique description is called an account. One of the best features of the Chart of Accounts is that when you have a new type of transaction you can just add a new description (account).
To keep the Chart of Accounts manageable and meaningful, it is important to strike a balance between having a long specific list and a short general list. To accomplish this objective, the Chart of Accounts should have descriptions for types of things, and not for specific things. You want the Accounts to be specific enough to be useful but not too specific because the fewer accounts you have the better overall picture you can have.
Chart of Accounts Organization: The Chart of Accounts is organized using three different methods.
- First: Accounting Types
- Second: Order of Liquidity - the ease of converting to cash
- Third: Account Numbers
The listing below shows the Chart of Accounts organization along with sample Account Number Ranges.
- Assets: 1000’s
- Current Assets 1000 - 1499
- Fixed Assets 1500 -1999
- Liabilities: 2000’s
- Current Liabilities 2000 - 2499
- Long Term Liabilities 2500 - 2999
- Equity: 3000’s
- Revenue: 4000’s
- Costs of Goods Sold: 5000’s
- I leave the 6000’s open to allow for a Cost of Goods Sold Subtype
- Expenses: 7000’s
- Other Revenue: 8000’s
- Other Expenses: 9000’s
Journals and Ledgers:
There are two types of Ledgers and Journals in the system, General and Subsidiary. If you recall from above, I said that Accounts should only be created in the Chart of Accounts/General Ledger to describe types of things not individual things themselves. Well, in some cases especially in the case of cash substitutes like Accounts Payable and Accounts Receivable more detail is required. So, to maintain the summary nature of the Chart of Accounts/General Ledger and to provide more detail, a Subsidiary System of Journals and Ledgers was developed.
General Ledger: The General Ledger is the combination of the Chart of Accounts, Account Balances and Accounting Periods. The General Ledger maintains the summary balances of ALL financial transactions.
The General Ledger adds the essential organizational element of Time (Accounting Periods) to the Accounting System, so in addition to the original three organizational methods of the Chart of Accounts, the General Ledger is organized in four ways.
- 1. Accounting Type
- 2. Order of Liquidity
- 3. Account Number
- 4. Accounting Periods
Accounting Periods are generally date/time intervals of Months, Quarters and Years. The element of time is essential to accounting. It provides the ability to report balances for any given accounting period as well as the ability to compare the results of different accounting periods against each other.
If the system is going to organize around accounting periods, then we need to add dates to the data we gather with transactions. There can be a variety of dates that are relevant to a transaction, the transaction date, the invoice date, the due date, the expiration date etc. but for purposes of this post, the date we’ll focus on is the transaction date.
The Journal transaction grid introduced in the previous section needs to be expanded to 5 columns to accommodate the new data requirements of date and account number.
General Journal Example:
Subsidiary Journals and Ledgers: The two most common Subsidiary Systems are:
- Accounts Payable
- Accounts Receivable
All financial transactions that involve a general ledger account with an associated subsidiary ledger must be recorded in that subsidiary ledger first.
|Accounts Payable Journal|
|Subledger Account||Invoice #||Transaction Date||Ref||GL Account||Description||Debit||Credit|
|ACEC||123_908||9/01/08||55||2000||Ace Credit Card Corp.||$1,700|
|7300||Credit Card Interest & Fees||$50|
Notice that the Subsidiary Journal uses more columns than the General Journal. It uses the extra columns to track data that is specific to the Subsidiary Ledger as well as to the General Ledger.
The system requires that all financial transactions have an entry in the General Journal as well as in the General Ledger. So, once the entries are posted to the Subledger Journals, they are then summarized and posted to the General Journal.
|9/01/08||AP||55||1520||Furniture & Fixtures||$1,650|
|9/01/08||AP||55||7300||Credit Card Interest & Fees||$50|
Notice the new columns in this General Journal example, they are cross referencing entries to show where the transaction was originally recorded. The Jrnl in this example says AP = Accounts Payable and the Ref (55) is the same as in the AP Journal example above. The Ref is the transaction reference number and will increment for each transaction.
Each financial transaction is recorded in the appropriate Journals and then summarized and posted to the Ledger Accounts.
|Accounts Payable Subledger||Account: ACEC|
|General Ledger||Account: 2000|
|8/01/08||AP||23||Accounts Payable Invoices||$2,500||$2,500|
|9/01/08||AP||55||Accounts Payable Invoices||$1,700||$1,700|
The Subsidiary Ledger (Subledger) is like the General Ledger/Chart of Accounts in that it contains a list of Accounts specific to its purpose. The Accounts Payable SubLedger contains a list of AP Accounts and their balances.
The Total Balance of each Subledger must equal the balance of its related General Ledger Account Balance. All financial transactions are recorded in the General Journal and the General Ledger and only the transactions with a gl account that has a related Subledger are posted to a Subsidiary Journal and Ledger.
If the Subledger does not Balance with its related account on the General Ledger, it means that there may be entries in either the Subledger or the General Ledger that are not in the other. They should each have matching entries and there should be no entries made to the General Ledger for an Account with a related Subledger that are not also made to the Subledger and vice verse.
© 2008-2010 Erin Lawlor
**disclaimer: All information posted on this blog is from my own experience and training. The guidelines I present are general and in my experience, standard practice. I do not write with authority from any Accounting Standards Boards.