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As known, in everyday life we often record the transaction as: the income of everyday, how much is the cost and calculate the profit. For example, if you’v made an income of $500 today, the cost is $300, you’ll calculate that you earn $200($500-200=$300). But this is not rigorous, especially when you’re operating a big business. Because you don’t know how the cost is created, where the cost is spent, and how to control the cost to add your profit maximumly.
Using the bookkeeping principles, you can see the secret in your business anywhere. You’ll know do what and in where that can reduce the cost, improve the income. Because every transactions is recorded through double entry bookkeeping, and the all adjustment is shown in the financial statements by accounting records.
How do the accountants record the transactions in bookkeeping?
Transactions–>Journals–>Ledger accounts–>Financial statements
Journals record the transactions everyday, it’s an initial information of the business transactions. Here, the professional accountants record all the transactions with double entry bookkeeping. You must know when a transaction ocurred, there’ll be ocurred an invoice. When a business sells goods or services to a customers it sends a sales invoice the customer. The sales invoice record lots of detailed information about the transaction, e.g:
- name and address of seller and purchaser
- date of sale
- reference to order
- description of goods
- amount due
- terms of payment.
For example, if a business has a sale of $500 today, according the sales invoice, the accounting record should be:
$
Dr cash 500
Cr revenue 500
The accounting records record where the cash come from. It means that the business made a revenue of $500, so the cash added $500. Here, “cash” “revenue” are the names of ledger accounts. Cash is an item of asset in balance sheet, revenue is an item of income statement. In the items of asset in balance sheet, “Dr”(Debit) means adding. In the income statement, “Cr”(Credit) means adding too.
So it’s a balance. The revenue added $500, the cash added $500. Each aspect is recorded in the relevant ledger account. Each account has two sides: the debit side and the credit side.
Ledger account
Debit side(Dr) Credit side(Cr)
The debit is on the left hand side, the credit is on the right side. For some ledger accounts, the debit side means adding, the credit side means decreasing. For other ledger accounts, the debit side means decreasing, the credit side means adding. It sounds so strange. But it’s very easy to understand.
In balance sheet, there is an accounting equation:
Assets = Liabilities + Proprietor’s capital.
In the left items of the equation, “Dr” means adding, “Cr” means decreasing. In the right items of the equation, “Dr” means decreasing, “Cr” means adding.
For example, a business has borrowed a loan of $5000. It means the business add $5000 in its cash item, and made a loan of $5000. The accounting record is:
$
Dr cash 5000
Cr loan 5000
The account “loan” is an item of liabilities. So the two sides of the accounting equation are in balance.
In income statement, there is an other accounting equation:
Revenue – Cost = Profit
You can see it as: Revenue = Cost + Profit.
Here, in the left items of the equation, “Dr” means adding, “Cr” means decreasing. In the right items of the equation, “Dr” means decreasing, “Cr” means adding.
So, there’re two accounting equations:
- Assets = Liabilities + Proprietor’s capital.
- Revenue = Cost + Profit.
In the left items of the equations, “Dr” means adding. In the right items of the equations, “Cr” means adding.
These are bookkeeping principles. It records all the transtions in the business through double entry, every transtions recorded in the invoice, the transtions are shown in the journals by accounting record. The journals is the basic of calculating the ledger accounts. According to the ledger accounts, we can prepare the financial statements.
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