Accounting Unplugged


Chart of Accounts – The Basics

Posted in 3. Chart of Accounts by Erin Lawlor on the August 29th, 2008

<< Double Entry Accounting – Practice >> Chart of Accounts – Organization

This post begins the explanation of the Chart of Accounts.  The Chart of Accounts is part of the second basic function of the Double Entry Accounting System – to organize financial transaction data. The Chart of Accounts provides the organizational structure for another element, the General Ledger which summarizes the Financial Data and produces Financial Reports.

The purpose of this and the next two posts (4-6) is to introduce the organizational structure of the system and for that reason, I do not make a distinction between the Chart of Accounts and the General Ledger until Post # 7.

Review of the Double Entry Accounting Transaction Questions:

  1. How much money changed hands?
  2. Where did the money go?  What was either gained or paid for by this exchange?
  3. Where did the money come from?  What is the source of the value in this exchange?

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).

From the transactions in the previous posts, we have started a Chart of Accounts

  • Rent
  • Checking Account
  • Office Supplies
  • Fuel
  • Repairs & Maintenance
  • Subscriptions
  • Accounts Payable (Credit Card)
  • Accounts Receivable
  • Sales

Let’s review the previous entries and create some additional entries to our transaction example and see how our Chart of Accounts starts to fill out.

The entries below the *******’s are new in this post and record:

  • the receipt of payment for the existing Accounts Receivable Invoice
  • the payment of the existing credit card balance
  • a utilities expense and payment
  • new credit card charges

Description Debit Credit
Rent $3,000
Checking Account $3,000
Office Supplies $300
Fuel $275
Repairs and Maintenance $500
Subscriptions $125
Printer $1,300
Accounts Payable (Credit Card) $2,500
Accounts Receivable $50,000
Sales $50,000
************************** ********* *********
Checking Account $50,000
Accounts Receivable $50,000
Accounts Payable (Credit Card) $2,500
Checking Account $2,500
Utilities $150
Checking Account $150
Chair $750
Desk $900
Credit Card Interest and Fees $50
Accounts Payable (Credit Card) $1,700
Totals: $109,850 $109,850

Current Chart of Accounts:

  • Rent
  • Checking Account
  • Office Supplies
  • Fuel
  • Repairs & Maintenance
  • Subscriptions
  • Printer
  • Accounts Payable (Credit Card)
  • Accounts Receivable
  • Sales
  • Utilities
  • Chair
  • Desk
  • Credit Card Interest and Fees

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.

You wouldn’t add a new account for paper, pens and staples, you would just use one account called office supplies.  So, it is important to reuse accounts when possible, and to simplify entries into more general descriptions like “office furniture” instead of separating the chair and desk purchases.

So, now let’s look at the Chart of Accounts and its Account Balances.

Account Balances
Debit Credit
Checking Account $44,350
Accounts Receivable $0
Office Equipment (Printer) $1,300
Office Furniture $1,650
Accounts Payable $1,700
Sales $50,000
Rent $3,000
Utilities $150
Office Supplies $300
Subscriptions $125
Fuel $275
Repairs and Maintenance $500
Credit Card Interest and Fees $50
Totals $51,700 $51,700

You can see that for even the small number of transactions in this example, The Chart of Accounts is essential in understanding their financial impact.

Notice that the account balances are also separated into the debit/credit columns.  The amounts listed here are the difference between the total debit entries and the total credit entries for each account.  If the amount was higher on the credit side, then the balance is listed in the credit column.  It is also important to note that our Chart of Account balances meet the requirement that total debits equal total credits.

The Chart of Accounts is really comprised of three things for each Account – an Account Number, a Description and an Accounting Type.  The transactions and account balances are part of a ledger called the General Ledger.   The table above is more accurately described as the General Ledger.

** Important Note: Post #6 discusses debit and credit balances in accounts.  In this case, none of the balances in our accounts is cause for concern because their totals are in the correct column for their type.  Accounting Types are explained in more detail in Posts #5 and #6.  Post #7 begins the discussion of the General Ledger and its Balances and Reports.

© 2008 – 2010 Erin Lawlor

Next Up:>> Chart of Accounts – Organization

<< Double Entry Accounting – Practice

**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.

Double Entry Accounting – Transactions – 2 of 2

Posted in 2. Double Entry Transactions by Erin Lawlor on the August 28th, 2008

<< Double Entry Accounting – Basics >>Chart of Accounts – Basics

In these examples, we will continue to focus on the descriptions and the amounts of financial transactions so we will be making entries in a 3 column grid where the left column is for descriptions and the two remaining columns are numeric and are for debits and credits.

Since we’re focusing on only three aspects of the transaction, the three questions that must be answered for each financial transaction in double entry are:

  1. What is the value of the transaction in terms of dollars (how much money changed hands)?
  2. Where did the money go – What was gained or paid for by the exchange?
  3. Where did the money come from – what is the source of the money in this exchange?

The amounts that are associated with question 2 are always entered in the debit (left numeric) column and the amounts associated with question 3 are always entered in the credit (right numeric) column.

Money is not always directly involved in a transaction.  Sometimes the transaction involves a trade or sometimes it involves a money substitute, a promise of future money transfers – as with credit card purchases – but something of value is always exchanged for something else of value in a financial transaction.

In the previous post, the transaction was very simple and money was involved, there was a $3,000 rent charge that was paid in full from the checking account.

Description Debit Credit
Rent $3,000
Checking Account $3,000

What about in the case of a credit card statement where there are many different types of charges made to one credit card.

Answer 1 :            Total Charge on Statement = 2,500
Answer 2a:           Office Supplies
Answer 2b:           Fuel
Answer 2c:           Tires
Answer 2d:           Subscriptions
Answer 2e:           Printer
Answer 3 :            Credit Card

In this case, since there are multiple answers for question 2, the descriptions and the amounts related to each separate part of the answer are listed on separate lines but the total amount associated with Question 2 and with Question 3 will always be equal.

Description Debit Credit
Office Supplies $300
Fuel $275
Repairs & Maintenance (Tires) $500
Subscriptions (Trade Magazines) $125
Printer $1,300
Credit Card Payable $2,500
———- ———-
Totals: $2,500 $2,500

——

Sometimes the promise of future money is not a debt to be paid by you but a debt to be collected by you as in the case of a sale where you bill the customer.

  • Answer 1:  50,000   (The amount of the transaction)
  • Answer 2:  Accounts Receivable  (What was gained?  In this case the gain was a short term promise to pay.)
  • Answer 3:  Sales (Where did the money come from?  What is the source of the money?)
Description Debit Credit
Accounts Receivable $50,000
Sales $50,000

*for readability: traditionally, debits entries are listed above credit entries and the description for the credit entries are traditionally indented.

Double Entry requires a minimum of two lines, or accounts, to fully describe a financial transaction.  In cases where there are multiple answers to one of the questions, the term Double Entry can seem like an inaccurate description but Double Entry does Not refer to the number of lines or accounts required to record the transaction.  It refers to the left/right entries where the full amount of the transaction must be entered in the debit column and again in the credit column – double entry – regardless of the number of lines required to fully describe the transaction.  The philosophy of Double Entry is a balanced financial picture requiring that both the Uses and Sources of funds be recorded.  Debits, Credits and Accounts are just part of the Structure that helps to ensure that balance.

This post completes the most important concepts of double entry accounting transactions. Once transactions are posted, the Chart of Accounts helps to organize and summarize them.  The next post, explains the basics of the Chart of Accounts.

© 2008 – 2010 Erin Lawlor

Next Up: >>Chart of Accounts – Basics

<< Double Entry Accounting – Basics

**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.

Double Entry Accounting – Transaction Basics

Posted in 2. Double Entry Transactions by Erin Lawlor on the August 27th, 2008

<< Accounting Overview >>Double Entry Accounting – More Transactions

The Double Entry System has endured since at least the 12th century because it is a simple, consistent and reliable system of gathering and organizing information and producing financial reports for financial management and for tax and reporting purposes.

The first task of the system is to gather balanced data from financial transactions – to record both what was gained or paid for and the source of funds.  Financial transactions are exchanges of things of value. Even if money is not part of the exchange, a dollar value must be used to represent the exchange.  Since a dollar value must represent the value of each exchange, I’ll often use the terms “money” or “funds” when referring to the value of each financial transaction.

In this post, I’ll explain the method of collecting and posting financial data in the Double Entry Accounting System.  The entire Double Entry System is built around the concept of balance, recording both the Use and the Source of funds.  Once the Double Entry concept is understood, the whole system of data collection, organization and summary is easily understood.  This method is standard and works the same way each time, no exceptions.

There are three basic questions that must be answered for the double entry accounting transactions, 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 the money in this exchange?

Example:

  • Answer 1: 3,000.00
  • Answer 2: Rent
  • Answer 3: Checking Account

The answers for each of these questions are recorded in a journal that has a grid format. The columns of the grid collect a variety of information but for the purpose of this discussion, we’ll use three columns. One column for descriptions and two numeric columns for amounts. The left numeric column is called the “debit” column and the right numeric column is called the “credit” column.

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.

Description Debit Credit
Rent $3,000
Checking Account $3,000

You see that the amount from question one is entered twice (double entry), once in the Debit Column and once in the Credit Column.  If you have answered all three questions for each transaction and both columns always add up to the same number, your books are in balance. This brings us to the most basic rule of accounting.

Rule # 1: Total Debits = Total Credits

To recap: Accounting requires that for each financial transaction, the basic questions of how much money is involved, where the money went and where the money came from are answered.

In order to ensure that these questions are always answered for each transaction, the Double Entry System is used.  The Double Entry Transaction System is a multi-line, two numeric columned system. The left numeric, or “debit” column is always the “where did the money go – what was gained or paid for” column and the right numeric, or “credit” column is always the “where did the money come from – what is the source of money” column. The total of one column must always equal the total of the other.

Double Entry does Not refer to the number of Accounts or Lines required to record a transaction.  Double Entry refers to Debits and Credits (two sides = double).  If you have fully described both the Use and the Source of Funds, you have accomplished the objectives of Double Entry.

© 2008 – 2010 Erin Lawlor

Next up: >>Double Entry Accounting – More Transactions

<< Accounting Overview

**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.

Download Workbook

Posted in Workbook by Erin Lawlor on the May 26th, 2008

Click Accounting Workbook to access .pdf file for the workbook.  If clicking on the link does not open the workbook for you, please try right clicking on the link, select “Save Link As” and then and saving the file to your computer.

I would really appreciate any feedback so please either leave a comment or email feedback via the “Contact Me” link.

Thanks,

Erin

« Previous Page