Ch. 3: Entries, Posting, Ledger, Trial Balance 89
Chapter 3
Journal Entries, Posting, General Ledger, and Trial Balance
In this chapter you will see how accounting systems are organized to process large volumes of data while constantly maintaining the equality of the accounting equation. As you proceed through this chapter, first concentrate on learning how business events affect resources and then learn how to process the events in the financial accounting system.
The Accounting Equation,
Debits, and Credits
Resources and where they come from are at the heart of modern financial accounting systems. The relationship between resources and their sources is represented by the accounting equation:
Assets / = / Liabilities / + / Stockholders' EquityThe accounting equation shows a company's resources (assets) come from borrowing (liabilities), from owners' investments (stockholders' equity), or are generated by management and retained in the company (stockholders' equity). The accounting equation must always be in balance in order for the accounting system to provide useful information.
The double-entry system (debits = credits) was developed to easily maintain the equality of the accounting equation (assets = liabilities + stockholders' equity). The double-entry system is based on the idea that each business event has two parts. One part results in a change in one asset, liability, or stockholders' equity account and the other part results in an equal change in another asset, liability, or stockholders' equity account. It is impossible for an event to result in an increase or decrease in only one account.
The basic element of the double-entry system is the T account. T accounts are used to record the two parts of each business event. The left side of a T account is the debit side and the right side is the credit side. The process of converting each event into equal dollar amounts of debits and credits guarantees that the accounting equation always balances.
The debits equal credits process converts each event into debits and credits as follows:
Account / Debits / CreditsAssets / Increases / Decreases
Liabilities / Decreases / Increases
Stockholders' equity / Decreases / Increases
Revenues / Decreases / Increases
Expenses / Increases / Decreases
Dividends / Increases / Decreases
In accounting for most business events, all you need to remember about debits and credits are the following:
Point 1. Assets increase with debits
Point 2. Debits = credits
The two above points, when combined with an understanding of business and a little basic logic, will enable you to convert most business events into debits and credits and, in so doing, constantly maintain the equality of the accounting equation.
Difficulties Created by
Today's Companies
AT&T, like thousands of other companies, conducts business on a global scale. In fact, AT&T has employees in over 200 different countries. Consider the difficulties they face in trying to account for such wide-spread operations. How feasible would it be for them to use the accounting system we examined in Chapter 2? Could AT&T possibly account for its activities by using one set of T accounts? How many hundred T accounts would be required? Could the T accounts be drawn on one sheet of paper? How long would it take just to put the effects of AT&T's thousands of events into the many T accounts? Surely there must be a more efficient way to account for the events of such large companies.
Financial accounting systems used by companies like AT&T are based on the accounting equation. They make use of the debits equal credits process to maintain the equality of the accounting equation. However, they do not enter dollar amounts directly into T accounts as we did in Chapter 2. Instead of entering dollar amounts directly into T accounts, modern accounting systems record the debits and credits by preparing journal entries in journals. In this way, journals are prepared at numerous locations all around the world. The information is then sent to one location where it is organized and the financial statements are prepared from the organized information.
Modern Accounting Systems
In order to generate the information for financial statements, accounting systems need:
1) to organize the data to be reported. Financial accounting systems use a chart of accounts and a general ledger to organize data.
2) a process for getting data into the organized data system. Financial accounting systems use journals to get data into accounts.
3) a process for verifying that the data in the accounts will result in a balanced accounting equation. Financial accounting systems prepare trial balances to verify the equality of the debits and credits data in accounts.
The following sections examine each of the three above requirements of modern accounting systems.
Organizing Accounting Data
To prepare financial statements, you must know the types of information you want to report in the statements. For example, if you want to generate a cash report, you would accumulate data about cash. In financial accounting systems, because of the importance of resources and their sources, the data to be collected are organized around the accounting equation, assets = liabilities + stockholders' equity. The data are organized into accounts. Accounts are established for any information to be reported in the financial statements. You may remember that the Parks Computer Service Corporation examined in Chapters 1 and 2 had the following accounts: cash, accounts receivable, supplies, accounts payable, common stock, and retained earnings. An account is a data storage device. For example, an account can be as simple as a T account on a page, it could be a whole page in a book, it could be a file folder in a desk drawer, or it could be a data file in a computer.
Chart of Accounts When a list of all accounts in which a company can store accounting data is prepared, it is called a chart of accounts. The chart of accounts for the Parks Computer Service Corporation is presented in Exhibit 3-1.
Exhibit 3-1Parks Computer Service Corporation
Chart of Accounts
Acct. No. /
Account Name
Assets111 / Cash
113 / Accounts Receivable
115 / Supplies
Liabilities
211 / Accounts Payable
Stockholders' Equity
311 / Common Stock
313 / Retained Earnings
315 / Dividends
Revenues
411 / Fees Revenue
Expenses
511 / Supplies Expense
Notice how the accounts in the Parks Computer Service Corporation's chart of accounts are organized. First, the accounts are separated into five categories: assets, liabilities, stockholders' equity, revenues, and expenses. Do not worry if you are unclear about revenues and expenses. You will become quite familiar with these terms as you progress through this and later chapters. At this point, you should note that the categories in the chart of accounts relate directly to the financial statements: revenues and expenses are reported on the income statement, while assets, liabilities, and stockholders' equity are reported on the balance sheet.
A company can have any accounts it wants in its chart of accounts. Information can be gathered for any items in which the company is interested. Remember the process we followed in Chapters 1 and 2 for gathering information for the income statement? In order to calculate total revenues to report on the income statement we had to analyze the retained earnings account for increases. Similarly, we had to analyze retained earnings for decreases in order to calculate expenses. Companies have found it easier and faster to prepare income statements when separate accounts are established to record revenues and expenses, rather than enter the dollar amounts directly into retained earnings. If separate accounts are used to record revenues and expenses, income statements can be quickly prepared by simply using the dollar amounts recorded in the revenues and expenses accounts.
A second point to notice about the chart of accounts is how the accounts are organized within each category. For example, note that the three asset accounts are not listed alphabetically. In fact, the assets are listed by order of liquidity. Liquidity refers to how quickly the assets will be converted into cash or used up in the business. Based on asset liquidity, cash would appear first, followed by accounts receivable (which should be converted into cash soon, possibly in the next 30 days), and supplies (which will be used up in a short time, such as three months). As you progress through later chapters, you will learn the reasons for other accounts appearing in charts of accounts in the order in which they do. At this point in time, however, it is important that you recognize that information to be reported on the financial statements is the reason accounts are listed in the chart of accounts in the order in which they are.
The third point to notice about the chart of accounts is that each account has a number associated with it. As you may expect, these numbers are called account numbers. Account numbers are useful in identifying where a specific account would be in a grouping of other accounts. For example, notice in the Parks Computer Service Corporation's chart of accounts all assets begin with the digit 1 while liabilities begin with the digit 2. In manual accounting systems, account numbers make it easy to find a specific account when all accounts are grouped together in one book called the general ledger, which is discussed in the following section. With modern, computer-based accounting systems, account numbers facilitate the entry of data into the computer system. For example, to debit the accounts receivable account using a computer, it would be necessary only to input the account number 113 rather than inputting the account name, accounts receivable. Such use of account numbers rather than account names allows much faster data input into accounting systems.
** You now have the background to do exercise 3.1.
General Ledger When all accounts are grouped together, they are known as the general ledger. A ledger is simply a grouping of accounts. The general ledger contains all accounts used by a company. For example, in a manual system, the Parks Computer Service Corporation's general ledger would have a separate page for each of its accounts. There would be a separate page for cash, accounts receivable, supplies, accounts payable, common stock, retained earnings, dividends, fees revenue, and supplies expense. For an example of a general ledger page, see the cash account in the Parks Computer Service Corporation's general ledger presented as Exhibit 3-2.
Exhibit 3-2General Ledger Page
Account Name: Cash / Account Number: 111
Posting / Balance
Date / Item / Ref. / Debits / Credits / Debits / Credits
July 1 / Owners' investment / J1 / 5,000 / 5,000
3 / Supplies purchase / J1 / 25 / 4,975
10 / Fees revenue / J2 / 200 / 5,175
16 / Payable payment / J2 / 70 / 5,105
25 / Receivable collection / J3 / 100 / 5,205
31 / Dividend payment / J3 / 75 / 5,130
As you can see from the cash page, the general ledger contains much information about accounts. The account name (cash) and account number (111) appear at the top of the general ledger page. The date column is the date on which an event occurred. The item column has various uses. In some manual systems, this column is blank except for very unusual events. In computer systems, this column often presents a brief description of the event. The posting reference column refers to the page number of the journal in which the event was recorded. (Journals are discussed in the following section.) The dollar amount of the event is recorded in the debits column or the credits column. The balance in the account is reported in the balance columns. There are several different general ledger forms being used by companies, so you should not memorize Exhibit 3-2. At this point you should simply be aware that each account in the general ledger reports, in summary form, the effects of each event that affected the account. The general ledger reports enough information to allow accountants to go to the original records if they want to examine an event more closely. For example, if accountants were interested in the July 16, $70 payable payment, they could tell from the posting reference column to look at J2 (page 2 of the journal) for more detailed information about the event.
Entering Data into the
Accounting System
Once the chart of accounts is developed and the general ledger is organized, the next step in the accounting process is to enter data into the accounting system through the use of the general journal. The general journal is used to record the debits and credits resulting from each event affecting a company. Remember, it is too cumbersome and inefficient to record the events directly into T accounts, as we did in Chapter 2. The process of recording events in the general journal is called journalizing, with the result being a journal entry for each event. A journal entry consists primarily of debits and credits to accounts. For each journal entry, the total dollar amount of debits must equal the total dollar amount of credits. In this manner, the equality of the accounting equation is always maintained.
To illustrate the use of the general journal, we will continue accounting for the Parks Computer Service Corporation by considering events that affected it in September. We will analyze each event in terms of how it affects resources and sources of resources, then record it in the general journal by concentrating on the following two points we memorized in Chapter 2: