Accounting for the Math Challenged

Accounting is a Information System.

Asset Accounts

Asset's are what the companies own.

A company must keep records of the increases and decreases in cash. Cash consists of any medium of exchange that a bank or other financial institution will accept at face value for deposit.

Owner's Equity Accounts

For income tax reporting, financial reporting, and other reasons, the law requires that capital (cash) contributions and withdrawals be separated from revenues and expenses.

Liability Accounts

Another word for liability is debt.

Liabilities are what the company owes to others.

Capital Account

When someone invests in his or her own company, the amount of the investment is recorded in a capital account.

Withdrawals Account

A person who invest in a business usually expects to earn an income and to use at least part of the assets earned from profitable operations to pay personal living expenses.

This is not described as a salary, although the owner might think of such withdrawals as such, because there was no change in owner ship.

This type of account is not used by corporations.

Relationships of Owner's Equity Accounts

Double-Entry System

In the double-entry system each transaction must be recorded with at least one debit and one credit, in such a way that the total dollar amount of debits and the total dollar amount of credits equal each other.

That sounds simple and clear. The problem is what Accountants consider 'debit' and 'credit'.

In accounting terms 'debit' means 'left side' or 'to', and 'credit' means 'right side' or 'from'.

Thus any entry made on the left side of the account is a debit, and any entry made on the right side of the account is a credit.

The important thing for us non-accountant types is that debit means 'left' and 'credit' means 'right', these words in accounting terms do not mean 'increase' or 'decrease'. Understand this single paragraph will help you as a mere-mortal, IE: a non-accountant, come to terms with the double-entry system of accounting.

• 1. Increases in assets are debited to asset accounts. Decreases in assets are credited to asset accounts.
• 2. Increases in liabilities and owner's equity are credited to liability and owner's equity accounts. Decreases in liabilities and owner's equity are debited to liability and owner's equity accounts.

One of the more difficult points to understand is the application of these rules to the owner's equity components of revenues, expenses and withdrawals. Since revenues increase owner's equity and expenses and withdrawals decrease it, the following relationships hold:

A transaction that increases revenues by a credit also increases owner's equity by a credit. However, expenses and withdrawals, which are increased by debits, decrease owner's equity. In other words, expenses and withdrawals are increased by debits, the more these debits decrease owner's equity; and the more expenses and withdrawals are decreased by credits, the more these credits increase owner's equity.

The reason for this seeming contradiction in logic is that expenses and withdrawals are components of owner's equity, which is on the right hand side of the of the equal sign (=) in the accounting equation.

Examples

Assets increased: Increases in assets are recorded by debits. Increases in owner's equity are recorded by credits.

Expense paid in advance like office rent: Increases in assets are recorded by debits. Decreases in assets are recorded by credits.

Purchase of equipment: Increases in assets are recorded by debits. Decreases in assets are recored by credits. The physical assets went up because you now have equipment, but your cash went down to pay for the equipment.

Buy equipment now, pay for it later: Increases in assets are recorded by debits. Increases in liabilities are recored by credits.

Paid off part of the Buy Now Pay Later equipment: Decreases in assets are recorded by credits (cash went down). Decreases in liabilities are recorded by debits (you owe less money).

Actually made some money: Increases in assets are recorded by debits (debit cash). Increases in owner's equity are recorded by credits (credit Fees Earned).

Paid secretary: Decreases in assets are recorded by credits (cash goes bye-bye). Decreases in owner's equity are recorded by debits (cash is gone).

Get money to do job up front, before job: Increases in assets are recorded by debits (cash goes up). Increases in liabilities are recorded by credits (we need to get this work done!).

 Summary of Effect's

• 1. Increase both assets and liabilities
• 2. Increase assets and owner's equity
• 3. Decrease both assets and liabilities
• 4. Decrease both assets and owner's equity
• 5. Increases one asset and decreases another
• 6. Increases one liability or owner's equity and decrease an other liability or owner's equity.

 Summary:

You must always have at least one 'left' and at least one 'right'.