In the world of accounting, every transaction must be accurately recorded to ensure proper record keeping. A business cannot accurate track its finances otherwise, and that could spell trouble when figuring up a current budget plan or trying to look to the future when planning financial commitments.
Accountants record each individual transaction as it occurs in the form of a journal entry, and then transfer it to the ledger at the end of the month. These accounts could be assets, liabilities, or stockholders’ equity in the event they are balance sheet accounts, while income statement accounts would include things like revenues and expenses, whether in the form of operating or non-operating.
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With an asset account, the debit transactions are on the left side of the ledger provide extra value to the company. Conversely, the credit transactions on the right signify that money was outbound. There are several types of asset accounts that might show up on the general ledger, such as cash (actual money the company has on hand), accounts receivable (money that is due to the company and technically counted but not physically on hand), office supplies, and prepaid rent (when rent is paid months in advance, the extra months count as an asset until the time a particular month’s rent would be due).
While compiling the ledger entries when it comes time to close out the previous month’s transactions in the books, businesses simply track all activity on each asset account and put inbound money on the debit (left) side and outbound money on the credit (right) side. Then comes the point to add up the columns. For instance, the cash account may have three debits for $100 each and two credits for $50 each. The general ledger would show a net debit (increase) of $200 for the month. This is the exact same concept behind figuring up the other ledger accounts as well.
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Obviously, the process is very similar when it comes to inputting liability accounts on the general ledger. The main difference to keep in mind with liability accounts is that unlike asset accounts, credits (right column) increase their value to the company rather than the debit side. There are several possibilities when it comes to liability accounts: accounts payable (money owed by the company that has not yet been paid), notes payable (money owed to a banking institution for borrowed funds), utilities payable (money owed in the form of utilities), and unearned revenue (money that the company has received in advance for providing a service it has not yet actually provided).
Take accounts payable for an example. If a business owes one entity $500 and another entity $1,000, both of these would appear as debits on the left side of the ledger column. If the business had cleared the $500 debt over the course of the month, that cost would be offset with a $500 credit in the right column beside it. Assuming the $1,000 debt had not been cleared, that would leave a $1,000 debit on the general ledger for the accounts payable account, indicating the company would need to subtract $1,000 from their assets when figuring up total value.
Income Statement Accounts
There are other accounts that could show up on a general ledger as well. All revenue coming into the company, as well as the expenses going out, have their own accounts. For instance, the money a business earns providing its services or goods to the public all goes into a service revenue account as a credit. A business may also receive dividends from its investments; as this is a stockholders’ equity account, an increase to the balance would go on the debit side of the ledger.
Businesses also have various expenses, and any time money is physically sent out, it goes from being owed (when it would have been classified as a liability) to an expense account. This could be anything, from wages expense (money paid to employees in exchange for doing the tasks they were hired for), to telephone costs to electricity expense. Expense accounts are all treated as debits, while all revenue accounts are treated with credits.
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