Easy Debits & Credits. A Step By Step Guide to Basic Bookkeeping

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1 Easy Debits & Credits A Step By Step Guide to Basic Bookkeeping

2 This workbook, packed with simple explanations and practical activities has been written by Stephen Blacktop. Stephen has many years of experience in accounting and has been a trainer of MYOB for 9 years. Understanding when to use a debit and a credit is a fundamental part of bookkeeping. Once you understand these conventions the rest is relatively easy. Before we go any further, keep this in mind; if you use a computerised accounting system, such as MYOB, you don t need to be an accountant to use it. The huge advantage of MYOB is that most of the transactions are entered into intuitive data screens and MYOB will convert them into a journal for you. But what happens when you need to make an adjustment to an? You will than need to make a General Journal, which involves entering dollar amounts as a debit and an equal amount as a credit; but to which accounts? Well let s explore this with some practical examples. Double Entry Bookkeeping You may have heard of double bookkeeping, this simply means that each transaction, such as writing a cheque to pay Shop Rent, has two entries; a debit and a credit. Furthermore, the debit and credit entries are allocated to accounts in our accounting systems Chart of Accounts. Chart of Accounts The Chart of Accounts is a list of account numbers with a description that describes the type of account. Eg Account number; for our Cheque Account and Account number; is for Shop Rent expense. Why do we use a number instead of just an account name? The number makes it easy for computer systems to sort the transactions; it also helps people mistaking accounts with similar names. The real information lies in the description of the account. eg. The Shop Rent expense account; is used to collect all our payments that we have made for Rent of our premises. The benefit of this is that we can list all the payments we have made and will be able to know how much Rent we have paid during the last 12 months. The listing below shows an example of our Shop Rent expense account, showing the transactions that have been posted to it for twelve months ending 30/6/07; we can see the Total Debits as $4,800. We have paid $4,800 in shop rent. This can be repeated for each of our accounts. Page 2 Copyright 2007 : Business Learning Centre Pty Ltd

3 The Chart of Accounts can thought of as a large data base of accounts, each account is used to collect like transactions so that reports can be easily listed for these accounts. Eg Shop Rent account will only contains payments of rent, and no other type of payment. Note: The Chart of Accounts can be known by other names, such as Accounts List (which is the name used in MYOB), General Ledger or Account Codes; it all means the same. Below is a typical list of Expense accounts. You can look at your own MYOB company file and view the accounts and categories. You should become familiar with the accounts listed in each category.. ` Account Categories Within the Chart of Accounts we have account categories, eg. Shop Rent is an expense to our business, and it is in the Expenses category of our Chart of Accounts. All accounting systems will have the following categories; Assets Liabilities Equity These are Balance Sheet account categories. Income Cost of Sales Expenses These are Profit & Loss account categories. The above figure also displays all the Account Categories, see the various Tab sections. Account Categories is another way of grouping like transactions, again so we can print reports such as a Balance Sheet report or a Profit & Loss report. A Balance Sheet report will list all the accounts in the Asset, Liability and Equity categories. The report will include some calculations so that it will show the Net Assets of a business. A Profit & Loss report will list all the accounts in the Income, Cost of Sales and Expenses categories. Again the report will include calculations so that it will show whether the business has made a profit or a loss. Page 3 Copyright 2007 : Business Learning Centre Pty Ltd

4 Note: A Balance Sheet report can be known by other names; Valuation Statement or Statement of Financial position. Similarly a Profit & Loss report can also be known by; Income Statement, Statement of Financial Performance or Statement of Earnings. Double Entry Bookkeeping and Journals To enter a transaction into our accounting system we use a journal. A journal is the most basic means of entering details of a transaction into our accounting system. Basic Rules of Double Entry Bookkeeping For every transaction, the debit amounts must equal the credit amounts. This means that our transaction or journal will be in balance. How do we determine when to use a Debit and when to use a Credit In order to determine when to use a debit and when to use a credit, we must ask ourselves two questions; What is the category of the account and, What will be the effect on the account? - Will it increase the account balance or decrease it? For Example: Pay rent by a cheque. Firstly, The Shop Rent account is in the Expense category. Secondarily, the payment of rent will increase our Shop Rent expense. Therefore according to bookkeeping rules when an Expense account increases, the will be a debit. The other side of the is the payment by cheque. The cheque account is in our Asset categories and our Cheque account balance will decrease. According to bookkeeping rules when an Asset account decreases the will be a credit. So the a manual journal for the payment of Shop Rent will be; 1/6/ Shop Rent expense $ Cheque Account $400 the payment of Shop Rent for the month of June 2007 MYOB will create an as show below, even though this was entered via the Spend Money command. Note: For simplicity we will ignore GST in these examples. Page 4 Copyright 2007 : Business Learning Centre Pty Ltd

5 What are the Debit and Credit Rules? Assets, Cost of Sales and Expenses if they increase the will be a Debit; if they decrease the will be a Credit. Liabilities, Owners Equity and Income if they increase the will be a Credit; if they decrease the will be a Debit. These rules can be placed in a table for easy reference; Account Category If transaction results in an Increase If transaction results in a Decrease Asset Debit Credit Liability Credit Debit Owner s Equity Credit Debit Income Credit Debit Cost of Sales Debit Credit Expense Debit Credit You must learn this off by heart. It is the most fundamental part of bookkeeping; if you do not know this you will not be able to record journals. Print this out and paste it to your wall, so you can refer to it until it becomes second nature. Transaction Entry Decision Process Each transaction can be placed into a decision making process, as follows; Example 1 Transaction on 15 th June - Paid $550 from our cheque account for newspaper advertising. The cost of advertising is an Increases in Expenses are a Debit: Advertising Expense $550 expense debit The Cheque account is in the Decreases in Assets are a credit Credit : Cheque Account $550 The Journal will be; 15/6/ Advertising expense $ Cheque Account $550 the payment of Advertising for the month of June 2007 Page 5 Copyright 2007 : Business Learning Centre Pty Ltd

6 Example 2 Let s assume our business is a printing business; like Snap Printing. Transaction on 15 th June Banked $3500 being cash sales for printing carried-out for our customers. The Cheque account is in the Increases in Assets are a debit Debit: Cheque Account $3500 The Cash Sale is Income Increases in income are a credit Credit : Sales $3500 The Journal will be; 15/6/ Cheque Account $ Sales $3500 a cash sale. Example 3 Transaction on 18 th June Paid the Telephone bill of $350 The cost of Telephone is an Increases in Expenses are a Debit: Telephone Expense $350 expense debit The Cheque account is in the Decreases in Assets are a credit Credit : Cheque Account $350 The Journal will be; 18/6/ Telephone expense $ Cheque Account $350 the payment of telephone for the month of June 2007 Page 6 Copyright 2007 : Business Learning Centre Pty Ltd

7 Example 4 Transaction on 18 th June Paid wages to staff of $4500 The cost of Wages is an Increases in Expenses are a Debit: Wages Expense $4500 expense debit The Cheque account is in the Decreases in Assets are a credit Credit : Cheque Account $4500 The Journal will be; 17/6/ Wages expense $ Cheque Account $4500 the payment of wages for the week ending of 15 th June 2007 Example 5 Transaction on 19 th June Purchased and Paid $400 for printing materials used to generate our sales. The cost of materials is a Cost Increases in Cost of Sales are a Debit: Materials $400 of Sales account debit The Cheque account is in the Decreases in Assets are a credit Credit : Cheque Account $400 The Journal will be; 19/6/ Purchases $ Cheque Account $400 the payment of printing materials Cash Basis of Record Keeping The above entries have used the cash basis of record keeping. What we mean by this is, In the case of income; the income has been recorded when the money has been received from the customer. In the case of expenses; the expense has been recorded when payment has been made to the supplier. Page 7 Copyright 2007 : Business Learning Centre Pty Ltd

8 Trade Debtors We do not always make cash sales; that is, receive payment for our goods immediately we provide the goods to our customers. Most businesses will sell their goods and services on credit, that is, they allow their customers to pay at a later date eg. 30 days from the date of the invoice. When we do this one part of the journal will be allocated to the Trade Debtors account which is in the. It is an asset as it is owed to us. Assets are items which are owned by a business or owed to the business, eg Money in our bank account, Plant & Equipment and Debtors Example 6: We print 1000 brochures for XYZ Company for a cost of $800 When we provide the brochures to our customer we will provide also a sale invoice for $800 with 30 days to pay. The journal will be; Transaction on 20 th June Printed brochures for $800 and invoiced the customer. The sale is a income Increases in Income are a credit Credit: Sales Incomes $800 The trade debtors is in the Increase in Assets are a debit Debit : Trade Debtors $800 20/6/ Trade Debtors $ Sales $800 the sale to XYZ company of 1000 brochures and the amount they owe us Example 7: Transaction on 8 th July Payment received from XYZ Company for $800 for brochures invoiced on 20 th June. The Cheque account is in the Increases in Assets are a debit Debit: Cheque Account $800 The trade debtors is in the asset category Decreases in Assets are a credit Credit : Trade Debtors $800 20/7/ Cheque Account $ Trade Debtors $800 the receipt of payment from XYZ company Page 8 Copyright 2007 : Business Learning Centre Pty Ltd

9 Trade Creditors We do not always make immediate payments for goods that we buy for our business. Most businesses will buy their goods and services on credit, that is, our suppliers will allow us to pay for our purchases at a later date eg. 30 days from the date of the invoice. When we do this one part of the journal will be allocated to the Trade Creditors account which is in the Liability category. It is a liability as we owe payment to our supplier. Liabilities are amounts that we owe other people eg Loans & Creditors Example 8: We purchase a pallet of printing paper from The Eco Paper Company for a cost of $1500 When we receive the paper our supplier will provide a bill for $1500 with 30 days to pay them. The journal will be; Transaction on 5 th June Purchase printing paper for $1500 and bill from The Eco Paper Company. The purchase is a Cost of Sale Increases in Cost of Sales are a Debit: Cost of Sales $1500 debit Trade creditors is in the Liability category Increase in liabilities are a credit Credit : Trade Creditors $1500 5/6/ Purchases $ Trade Creditors $1500 the purchase of printing paper and the amount we owe The Eco Paper Company Example 9 Transaction on 30 June Payment made to The Eco Paper Company for $1500 for printing Paper invoiced on 5 th June. The trade creditors is in the Decreases in trade creditors are Debit : Trade Creditors $1500 liability category a debit The Cheque account is in the Decreases in Assets are a credit Credit: Cheque Account $ /6/ Trade Creditors $ Cheque Account $1500 the payment of a bill from The Eco Paper Company Page 9 Copyright 2007 : Business Learning Centre Pty Ltd

10 Self Study Exercises Use the same account numbers that have been used throughout this workbook, any accounts not shown refer to the MYOB company file for Clearwater. Note: The learning outcome is for you to understand the decision process in order to determine the journal. Exercise The payment of the mobile phone bill of $250 on 6 June. Use the cash basis of recording Exercise The immediate payment of the Electricity bill of $450 on 6 June. Use the cash basis of recording Page 10 Copyright 2007 : Business Learning Centre Pty Ltd

11 Exercise 3. Payment of Bank Fees of $10 on 1 st June. Use the cash basis of recording Exercise 4. Banked $2500 being a cash sales on 2 nd June Exercise 5. A bill received on 8 June from Total Inks Pty Ltd in the amount of $2000, for ink used in our printing press. We have up to 30 days to pay this bill. Page 11 Copyright 2007 : Business Learning Centre Pty Ltd

12 Exercise 6. Cheque payment of the Total Inks Pty Ltd bill on the 30 June for $2000 Exercise th June We have printed brochures for ABC Company and invoiced the customer for $1100. We allow them up to 30 days to pay this invoice. Exercise 8. Transaction on 10 th July Payment received from ABC Company for $1100 for brochures invoiced on 7 th June. Page 12 Copyright 2007 : Business Learning Centre Pty Ltd

13 Exercise 9. Banked amount of $2500 being cash sales on 15 th June. Exercise 10. Paid rent 15 July for $400 Page 13 Copyright 2007 : Business Learning Centre Pty Ltd

14 Answers to self study questions; Journal 1; 6/6/ Telephone Cheque Account 250 the payment of the mobile phone bill Journal 2; 6/6/ Electricity Cheque Account 450 the payment of the Electricity bill Journal 3; 1/6/ Bank Charges Cheque Account 10 the payment of the bank fees as per bank statement Journal 4; 2/6/ Cheque Account Sales 2500 cash sales Journal 5; 8/6/ Purchases Trade Creditors 2000 purchases from Total inks Pty Ltd and amount we owe them Page 14 Copyright 2007 : Business Learning Centre Pty Ltd

15 Journal 6; 30/6/ Trade Creditors Cheque account 2000 the payment of Total Inks bill Journal 7; 7/6/ Trade Debtors Sales 1100 the invoicing of printing carried-out for ABC company and amount they owe us. Journal 8; 10/7/ Cheque account Trade Debtors 1100 the receipt from ABC company Journal 9; 15/6/ Cheque Account Sales 2500 cash sales Journal 10; 1/7/ Shop Rent Cheque Account 400 cash sales Page 15 Copyright 2007 : Business Learning Centre Pty Ltd

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