Welcome to week 3
Week 2: Task 1 answer: The account name: How about ‘Money I Put Into My Business’. And the account group? It’s Equity of course. Equity is what the business owes its owners (you). Well done if you got that right. As to the name of the account (Money I Put… etc), well, it could be anything you like as long as it makes sense to you. However, there are conventional names for this. A typical example is Capital Introduced. If this was a limited company, then it may be called Shareholders Capital or a variety of other names. Remember there are no laws on account naming, only conventions. Choose a name that means something to you. That way you can explain it to anyone who needs to know.
So to summarise, the money in this transaction came from Capital Introduced and went to Bank. And that leads us nicely on to our first transactions and exactly how and what the terms credit and debit mean.
Transactions
Every transaction involves 2 accounts and sometimes more. However, thinking in terms of every transaction involving just 2 accounts will really help you understand the logic of double-entry.
A transaction is a recording of the flow of money between 2 accounts. It shows where the money came from and where it went to. It is this from and to concept that the term double-entry refers to. You can think of it as 2 entries = 1 transaction. Each entry affects 1 account. So, 2 entries = 2 accounts = 1 transaction.
Lets take a look at a typical set of accounts written in an off-the-shelf analysis book available from most stationers. Note we have deliberately reduced the number of columns to keep it simple:
| Date | Bank | Cash | Rent | Other expenses… |
| xx.xx.xxxx | 100 | 100 |
It may not be obvious at first, but there are 2 accounts here: Bank and Rent. We know the amount is 100 and we know it took place on such and such a date.
Lets look at how that transaction would appear in a traditional double-entry system using something called a Journal.
| Date | Account | Debit | Credit |
| xx.xx.xxxx | Rent | 100 | |
| xx.xx.xxxx | Bank | 100 |
A Journal is exactly what it says. Somewhere to record something. Many bookkeepers and accountants refer to ‘a journal’ as the actual entry itself, which is fine, but it is important that you understand it is also the name of the book that you write entries in to.
There are many other names for ‘journals’. Day books, cash book, sales book and many more. But they all do the same thing: record day to day transactions.
In practice, you will find most people think of the journal as a special place. Somewhere where you record things that don’t obviously go into any other book. For example, if you make a sale you may record it in your day book. If you receive some money from a customer, it may go into your cash book. But if you later find you have made a mistake somewhere, an accountant or bookkeeper will immediately refer to making a journal to reverse and correct it.
Ultimately, it makes no difference what you call these things. They are simply books that you record transactions in. So you could have a ‘cash book journal, a ‘day book journal’, a ‘general journal’ etc.
Credits and Debits
This next section is the most important in this book. Understand this part, and you will have no problem with debits and credits in the future. And the great part is, it is really, really simple, provided you use our simple memory aid. Keep reading…
Remember that a transaction records the flow of money, from somewhere to somewhere else. The somewheres’ are accounts. Lets look at our first transaction again, but transformed slightly. There are 3 steps to this transformation. Don’t worry you will not have to do this everytime you try to understand what’s going on. This is just a way to help you see the logic of double-entry. Stay with it:
Step 1
| Date | Debit | Credit | Amount |
| xx.xx.xxxx | Rent | Bank | 100 |
Look carefully at step 1. The debit and credit columns now contain an account instead of an amount.
Step 2
| Date | To | From | Amount |
| xx.xx.xxxx | Rent | Bank | 100 |
In step 2 we replace the words debit and credit with to and from.
Step 3
| Date | From | To | Amount |
| xx.xx.xxxx | Bank | Rent | 100 |
This is the big one. In step 3 we swap the debit and credit columns around. This makes the flow of money much simpler to follow. We are tracking the flow from somewhere to somewhere else. For Western eyes, reading from left to right, top to bottom is natural. When we describe pretty much any type of ‘journey’ in real life, it is always from somewhere to somewhere else. We never say “I went to work from home”.
So, what matters is how to remember how to convert credit and debit to from and to. And here’s the trick: alphabetically, Credit is before Debit. And it just so happens, that From is also before To. So:
Credit = From
Debit = To
Whether you follow any of the above does not matter too much. What is vital to passing any bookkeeping exam, reducing bookkeeping mistakes to the minimum, or simply carrying out a task such as entering a transaction, is to remember:
- The flow of money
- Credit = From
- Debit = To
Tasks
There are five tasks in this section. In the first two you will see the transaction in journal format. Your job is to transform them into our new simpler format. The remaining three tasks are there for you to create both tables. This will greatly help you understand debits and credits, how they look in traditional form, and how they look when transformed into something more logical. In the future, for bookkeeping exams, or when using a traditional system, you will apply this in reverse. That is, you will start with some document (eg. a sales invoice), transform that into our new from/to format, then apply our simple rule, and hey presto, you will get your double-entries spot on. This is truly double-entry made simple.
Task 1:
You sell 1,000 worth of goods and bank the money. We need 2 accounts to record this. One of them is obvious: Bank. The other we shall call Sales. Here’s the transaction in journal form:
| Date | Account | Debit | Credit |
| xx.xx.xxxx | Bank | 1000 | |
| xx.xx.xxxx | Sales | 1000 |
Task 2:
You sell 500 worth of goods on credit (the customer has not yet paid you). You will need a new account, which is conventionally called Debtors.
| Date | Account | Debit | Credit |
| xx.xx.xxxx | Debtors (Unpaid Invoices) | 500 | |
| xx.xx.xxxx | Sales | 500 |
Task 3:
You sell consultancy time for 300 which is paid direct to your bank. You will need a new account called Consultancy.
Task 4:
You pay 60 for Fuel from your Bank. You will need a Fuel account.
Task 5:
You pay off 600 from your bank to your credit card. You will need a Credit Card account.
Next Week
Posting and Ledgers. What exactly is posting and what is a ledger?
Plus how do journals and other entries end up in ledgers, and why?