Saint Mary’s

University
School of Accountancy & Business

FINANCIAL ACCOUNTING & REPORTING

JOHN LINDY R. SORIANO, CPA

TOPIC 2: THE RECORDING PROCESS

LEARNING OBJECTIVES:
1. Describe how accounts, debits, and credits are used to record business transactions.
2. Indicate how a journal is used in the recording process
3. Explain how a ledger and posting help in the recording process
4. Prepare a trial balance

LO1: Describe how accounts, debits, and credits are used to record business transactions.

THE ACCOUNT

An account is an individual accounting record of increases and decreases in a specific asset,

liability, or owner’s equity item. In its simplest form, an account consists of three parts: (1) a title,
(2) a left or debit side, and (3) a right or credit side. Because the format of an account resembles
the letter T, we refer to it as a T-account.

DEBITS AND CREDITS

The term debit indicates the left side of an account, and credit indicates the right side. They are
commonly abbreviated as Dr. for debit and Cr. for credit. They do not mean increase or decrease,
as is commonly thought. We use the terms debit and credit repeatedly in the recording process
to describe where entries are made in accounts.

When comparing the totals of the two sides, an account shows a debit balance if the total of the
debit amounts exceeds the credits. An account shows a credit balance if the credit amounts
exceed the debits.

Every positive item in the tabular summary represents a receipt of cash. Every negative amount
represents a payment of cash. Notice that in the account form, we record the increases in cash
as debits and the decreases in cash as credits.
 Saint Mary’s
University
School of Accountancy & Business

Having increases on one side and decreases on the other reduces recording errors and helps in
determining the totals of each side of the account as well as the account balance. The balance is
determined by netting the two sides (subtracting one amount from the other).

DEBIT AND CREDIT PROCEDURE

The equality of debits and credits provides the basis for the double-entry system of recording
transactions. Under the double-entry system, the dual (two-sided) effect of each transaction is
recorded in appropriate accounts. This system provides a logical method for recording
transactions and also helps ensure the accuracy of the recorded amounts as well as the detection
of errors. If every transaction is recorded with equal debits and credits, the sum of all the debits
to the accounts must equal the sum of all the credits.

DR./CR. PROCEDURES FOR ASSETS AND LIABILITIES

Asset accounts normally show debit balances. That is, debits to a specific asset account should
exceed credits to that account. Likewise, liability accounts normally show credit balances. That
is, credits to a liability account should exceed debits to that account. The normal balance of an
account is on the side where an increase in the account is recorded.

DR./CR. PROCEDURES FOR OWNER’S EQUITY

OWNER’S CAPITAL. Investments by owners are credited to the Owner’s Capital account. Credits
increase this account, and debits decrease it.

OWNER’S DRAWINGS. An owner may withdraw cash or other assets for personal use.
Withdrawals could be debited directly to Owner’s Capital to indicate a decrease in owner’s equity.
However, it is preferable to use a separate account, called Owner’s Drawings. This separate
account makes it easier to determine total withdrawals for each accounting period. Owner’s
Drawings is increased by debits and decreased by credits. Normally, the drawings account will
have a debit balance.
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University
School of Accountancy & Business

REVENUES AND EXPENSES. The purpose of earning revenues is to benefit the owner(s) of the
business. When a company recognizes revenues, owner’s equity increases. Therefore, the effect
of debits and credits on revenue accounts is the same as their effect on Owner’s Capital. That is,
revenue accounts are increased by credits and decreased by debits. Expenses have the opposite
effect. Expenses decrease owner’s equity. Since expenses decrease net income and revenues
increase it, it is logical that the increase and decrease sides of expense accounts should be the
opposite of revenue accounts. Thus, expense accounts are increased by debits and decreased by
credits.

LO2: Indicate how a journal is used in the recording process.

STEPS IN THE RECORDING PROCESS

1. Analyze each transaction for its effects on the accounts.
2. Enter the transaction information in a journal.
3. Transfer the journal information to the appropriate accounts in the ledger.

The recording process begins with the transaction. Business documents, such as a sales receipt,
a check, or a bill, provide evidence of the transaction. The company analyzes this evidence to
determine the transaction’s effects on specific accounts. The company then enters the
transaction in the journal. Finally, it transfers the journal entry to the designated accounts in the
ledger.

THE JOURNAL

The journal is referred to as the book of original entry. For each transaction, the journal shows the
debit and credit effects on specific accounts. Companies may use various kinds of journals, but
every company has the most basic form of journal, a general journal. Typically, a general journal
has spaces for dates, account titles and explanations, references, and two amount columns.
 Saint Mary’s
University
School of Accountancy & Business

The journal makes several significant contributions to the recording process:

1. It discloses in one place the complete effects of a transaction.
2. It provides a chronological record of transactions.
3. It helps to prevent or locate errors because the debit and credit amounts for each entry
can be easily compared.

JOURNALIZING

Entering transaction data in the journal is known as journalizing. Companies make separate
journal entries for each transaction. A complete entry consists of (1) the date of the transaction,
(2) the accounts and amounts to be debited and credited, and (3) a brief explanation of the
transaction.

1. The date of the transaction is entered in the Date column.

2. The debit account title (that is, the account to be debited) is entered fi rst at the extreme
left margin of the column headed “Account Titles and Explanation,” and the amount of the
debit is recorded in the Debit column.
3. The credit account title (that is, the account to be credited) is indented and entered on the
next line in the column headed “Account Titles and Explanation,” and the amount of the
credit is recorded in the Credit column.
4. A brief explanation of the transaction appears on the line below the credit account title. A
space is left between journal entries. The blank space separates individual journal entries
and makes the entire journal easier to read.
5. The column titled Ref. (which stands for Reference) is left blank when the journal entry is
made. This column is used later when the journal entries are transferred to the ledger
accounts.

It is important to use correct and specific account titles in journalizing. Erroneous account titles
lead to incorrect financial statements. However, some flexibility exists initially in selecting
account titles. The main criterion is that each title must appropriately describe the content of the
account.

SIMPLE AND COMPOUND JOURNAL ENTRIES

Some entries involve only two accounts, one debit and one credit. This type of entry is called a
simple entry. Some transactions, however, require more than two accounts in journalizing. An
entry that requires three or more accounts is a compound entry.

In a compound entry, the standard format requires that all debits be listed before the credits.
 Saint Mary’s
University
School of Accountancy & Business

LO3: Explain how a ledger and posting help in the recording process.

THE LEDGER

The entire group of accounts maintained by a company is the ledger. The ledger provides the
balance in each of the accounts as well as keeps track of changes in these balances. Companies
may use various kinds of ledgers, but every company has a general ledger. A general ledger
contains all the asset, liability, and owner’s equity accounts.

Companies arrange the ledger in the sequence in which they present the accounts in the financial
statements, beginning with the balance sheet accounts. First in order are the asset accounts,
followed by liability accounts, owner’s capital, owner’s drawings, revenues, and expenses. Each
account is numbered for easier identification. The ledger provides the balance in each of the
accounts.

STANDARD FORM OF ACCOUNT

The simple T-account form used in accounting textbooks is often very useful for illustration
purposes. However, in practice, the account forms used in ledgers are much more structured.

This format is called the three-column form of account. It has three money columns—debit, credit,
and balance. The balance in the account is determined after each transaction. Companies use
the explanation space and reference columns to provide special information about the
transaction.

POSTING

Transferring journal entries to the ledger accounts is called posting. This phase of the recording
process accumulates the effects of journalized transactions into the individual accounts. Posting
involves the following steps.

1. In the ledger, in the appropriate columns of the account(s) debited, enter the date, journal
page, and debit amount shown in the journal.
2. In the reference column of the journal, write the account number to which the debit
amount was posted.
3. In the ledger, in the appropriate columns of the account(s) credited, enter the date, journal
page, and credit amount shown in the journal.
 Saint Mary’s
University
School of Accountancy & Business

4. In the reference column of the journal, write the account number to which the credit
amount was posted.

Posting should be performed in chronological order. That is, the company should post all the
debits and credits of one journal entry before proceeding to the next journal entry. Postings should
be made on a timely basis to ensure that the ledger is up to date.

The reference column of a ledger account indicates the journal page from which the transaction
was posted. The explanation space of the ledger account is used infrequently because an
explanation already appears in the journal.

CHART OF ACCOUNTS

Most companies have a chart of accounts. This chart lists the accounts and the account numbers
that identify their location in the ledger. The numbering system that identifies the accounts
usually starts with the balance sheet accounts and follows with the income statement accounts.
 Saint Mary’s
University
School of Accountancy & Business

THE RECORDING PROCESS ILLUSTRATED

Study these transaction analyses carefully. The purpose of transaction analysis is first to identify
the type of account involved, and then to determine whether to make a debit or a credit to the
account. You should always perform this type of analysis before preparing a journal entry.

Transaction #1: Investment of cash by owner

Transaction #2: Purchase of office equipment

Transaction #3: Receipt of Cash for future service

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University
School of Accountancy & Business

Transaction #4: Payment of monthly rent

Transaction #5: Payment for insurance

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University
School of Accountancy & Business

Transaction #6: Purchase of supplies on credit

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University
School of Accountancy & Business

Transaction #7: Hiring of employees

Transaction #8: Withdrawal of cash by owner

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University
School of Accountancy & Business

Transaction #9: Payment of salaries

Transaction #10: Receipt of cash for services performed

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University
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SUMMARY ILLUSTRATION OF JOURNALIZING AND POSTING

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University
School of Accountancy & Business

LO4: Prepare a trial balance

A trial balance is a list of accounts and their balances at a given time. Customarily, companies
prepare a trial balance at the end of an accounting period. They list accounts in the order in which
they appear in the ledger. Debit balances appear in the left column and credit balances in the right
column.

The trial balance proves the mathematical equality of debits and credits after posting. Under the
double-entry system, this equality occurs when the sum of the debit account balances equals the
sum of the credit account balances. A trial balance may also uncover errors in journalizing and
posting. In addition, a trial balance is useful in the preparation of financial statements.

Steps in preparing a trial balance:

1. List the account titles and their balances in the appropriate debit or credit column.
2. Total the debit and credit columns.
3. Prove the equality of the two columns
 Saint Mary’s
University
School of Accountancy & Business

LIMITATIONS OF A TRIAL BALANCE

1. A transaction is not journalized.

2. A correct journal entry is not posted.
3. A journal entry is posted twice.
4. Incorrect accounts are used in journalizing or posting.
5. Offsetting errors are made in recording the amount of a transaction.

The trial balance does not prove that the company has recorded all transactions or that the ledger
is correct.

LOCATING ERRORS

Errors in a trial balance generally result from mathematical mistakes, incorrect postings, or simply
transcribing data incorrectly. determine the amount of the difference between the two columns
of the trial balance. After this amount is known, the following steps are often helpful:
1. If the error is $1, $10, $100, or $1,000, re-add the trial balance columns and recompute the
account balances.
2. If the error is divisible by 2, scan the trial balance to see whether a balance equal to half
the error has been entered in the wrong column.
3. If the error is divisible by 9, retrace the account balances on the trial balance to see
whether they are incorrectly copied from the ledger. For example, if a balance was $12
and it was listed as $21, a $9 error has been made. Reversing the order of numbers is
called a transposition error.
4. If the error is not divisible by 2 or 9, scan the ledger to see whether an account balance in
the amount of the error has been omitted from the trial balance, and scan the journal to
see whether a posting of that amount has been omitted.

PESO/DOLLAR SIGNS and UNDERLINING

Note that peso/dollar signs do not appear in journals or ledgers. Peso/dollar signs are typically
used only in the trial balance and the financial statements. Generally, a peso/dollar sign is shown
only for the first item in the column and for the total of that column. A single line (a totaling rule)
is placed under the column of figures to be added or subtracted. Total amounts are double-
underlined to indicate they are final sums.