Bookkeeping

Before computers were in common use, bookkeeping was done by an actual bookkeeper. This person kept a company's day-to-day financial records by manually recording every business transaction into a journal. The journal entry included the date, the name of the accounts to be debited and credited, and the amounts. The bookkeeping process further required that all journal amounts be rewritten in (or "posted" to) the company's general ledger and subsidiary ledger accounts.

With the writing and rewriting of so many amounts (as well as the manual calculations) it was realistic to assume that some errors would occur in the bookkeeping process. This potential for errors created the need to periodically "prove" that a company's accounts were "in balance," meaning the total of the debit balance accounts was equal to the total of the credit balance accounts. An internal document called a trial balance was designed to give that proof. If the trial balance did not balance, the bookkeeper had to go back, transaction by transaction, to find and correct the cause of any disparity. Once the trial balance was in balance, the bookkeeping phase was completed and the "books" were turned over to the company's accountant for the preparation of financial statements.

Bookkeeping Test Our bookkeeping test (PDF Format) has a total of 175 questions and answers. View Sample Questions

With the arrival of computers and accounting software, bookkeeping errors decreased and efficiency increased. For example, the accounting software will refuse a journal entry if the debit amount entered does not equal the credit amount entered. Further, because journal amounts are posted electronically and account balances are calculated electronically, the potential for human error in these tasks is eliminated.

As an example of how bookkeeping has become more efficient, consider that the following tasks now occur simultaneously when a credit sale is processed with accounting software:

1. A sales invoice is prepared
2. The general ledger account Sales is credited
3. The general ledger account Accounts Receivable is debited
4. The customer's account in the subsidiary ledger is updated.
5. In some situations, the Inventory account is updated.

At large companies, the bookkeeping function is likely to be divided among a number of clerking specialists, such as accounts payable clerks, accounts receivable clerks, payroll clerks, and accounting clerks, each of whom use the accounting software to carry out their specific responsibilities.

Whether bookkeeping tasks are performed manually by a bookkeeper or electronically by clerks, one thing remains the same: every business transaction involves at least two accounts. This is known as double entry bookkeeping (or "double entry accounting"). Double entry bookkeeping requires that for each transaction, one (or more) account must be debited, and one (or more) account must be credited.

When you are using accounting software, it may not be obvious to you that two accounts are involved with each transaction. This is because the software often updates one of the two accounts automatically. For example, whenever you enter an amount from a vendor's invoice, the computer "recognizes" it as an Accounts Payable and automatically enters the amount as a credit in that account. What you see on the computer screen is a prompt to enter only the "other" account, the one to be debited. Similarly, if you use software to generate checks, the system will automatically credit Cash and prompt you to enter only the account (or accounts) to be debited.

Every account has two "sides," a right side and a left side. A debit refers to an entry on the left side of an account, and a credit refers to an entry on the right side of an account. Double entry bookkeeping requires that for every transaction, there is an entry to the left side of one (or more) account, and a corresponding entry to the right side of another account(s).

Below are some facts that will help you determine which side of an account to use:

• Expenses are always debits
• Revenues are always credits
• Debit the Cash account when cash is received
• Credit the Cash account when cash is paid out

Here are some additional facts...

• A debit will increase these accounts:
  • Assets (Cash, Accounts Receivable, Inventory, Land, Equipment, etc.)
  • Expenses (Rent Expense, Wages Expense, Interest Expense, etc.)
  • Losses (Loss on Sale of Assets, Loss from Lawsuit, etc.)
  • Sole proprietor's Drawing account

• A debit will decrease these accounts:
  • Liabilities (Notes Payable, Accounts Payable, Interest Payable, etc.)
  • Stockholders' Equity (Common Stock, Retained Earnings)

• A credit will increase these accounts:
  • Liabilities (Notes Payable, Accounts Payable, Interest Payable, etc.)
  • Revenues (Sales, Service Revenues, Fees Earned, Interest Revenues, etc.)
  • Gains (Gain on Sale of Assets, Gain on Retirement of Bonds, etc.)

• A credit will decrease these accounts:
  • Assets (Cash, Accounts Receivable, Supplies, Inventory, Land, etc.)

We can illustrate double entry bookkeeping with the following sample transactions:

• If a company borrows $10,000 from its bank, the company debits its Cash account for $10,000 and credits its Notes Payable account for $10,000.
• When a company records wages for hourly employees, it debits Wages Expense and credits Wages Payable.
• If a company makes a sale "on credit," it debits Accounts Receivable and credits Sales.

(Debits and credits are covered in greater detail in the Explanation of Debits and Credits.)

A chart of accounts is a listing of all the accounts available to a company to record and sort its business transactions. A chart of accounts is generally customized by an accountant to fit the needs of the company and can be modified when necessary. For example, if a new product line is introduced or a new department is started, accounts can be added to accommodate the change.

The chart of accounts consists of two types of accounts: (1) balance sheet accounts, and (2) income statement accounts. Account categories are generally listed in the following standardized order:

Assets
Liabilities
Stockholders' (or Owner's) Equity
Revenues
Expenses
Gains
Losses

(The chart of accounts is covered in more detail in the Explanation of Chart of Accounts.)

Accounting software has simplified the process of preparing financial statements. The balances in the asset, liability, and stockholders' equity accounts can be programmed to appear in a balance sheet format. The balances in the revenue, expense, gain, and loss accounts can be programmed to print in a variety of income statement formats. As a result, many company accountants are spending less time with the tedious and mechanical work of financial statement preparation, and more time on other responsibilities.

Financial statements are covered in detail in the following topics:

• Explanation of Balance Sheet
• Explanation of Income Statement
• Explanation of Cash Flow Statement

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