Table 2-5 Journal Entry 2: Recording the Inventory Purchase
Table 2-6 Journal Entry 3: Recording the Advertising Expense
By tallying the debits and credits to an account, you can calculate the account balance. Suppose that before Journal Entries 1, 2, and 3, the cash balance equals $2,000. Journal Entry 1 increases cash by $1,000 (this is the debit). Journal Entries 2 and 3 decrease cash by $1,000 each (these are the $2,000 credits). If you combine all these entries, you get the new account balance. The following formula shows the calculation:
Beginning balance of cash $2,000
Plus cash debit from Journal Entry 1 $1,000
Minus cash credit from Journal Entry 2 –$1,000
Minus cash credit from Journal Entry 3 –$1,000
Ending cash balance $1,000
When I learned about double-entry bookkeeping, I stumbled over the terms debit and credit. The way I’d heard the terms used before didn’t agree with the way that double-entry bookkeeping seemed to describe them. This conflict caused a certain amount of confusion for me. Because I don’t want you to suffer the same fate, let me quickly describe my initial confusion.
If you look at Table 2-3, you see that an increase in an asset account is a debit and a decrease in an asset account is a credit. This means that in the case of your cash account, increases to cash are debits and decreases to cash are credits.
However, you’ve undoubtedly talked at some time to the bank and heard someone refer to crediting your bank account – which meant increasing the account balance. And perhaps that someone talked about debiting your account – which meant decreasing the account balance. So what’s up with that? Am I wrong, and is the bank right?
Actually, both the bank and I are right. And here’s why. The bank is talking about debiting and crediting – not a cash account and not an asset account, but a liability account. To them, the money that you’ve placed in the bank is not cash (an asset) but a liability (money that the bank owes you). If you look at Table 2-3, you see that increases in a liability are credit amounts and decreases in a liability are debit amounts. Therefore, from the bank’s perspective, when the bank increases the balance in your account, that increase is a credit.
Your assets may represent another firm’s liabilities. Your liabilities will represent another firm’s assets. Therefore, whenever you hear some other business talking about crediting or debiting your account, what you do is exactly the opposite. If the business credits, you debit. If the business debits, you credit.
Do you see how that works? You start with $2,000 as the cash account balance. The first cash debit of $1,000 increases the cash balance to $3,000 and then the cash credit of $1,000 in Journal Entry 2 decreases the cash balance to $2,000. Finally, the cash credit of $1,000 in Journal Entry 3 decreases the cash balance to $1,000.
You can calculate the account balance for any account by taking the starting account balance and then adding the debits and credits that have occurred since then. By hand, this arithmetic is a little unwieldy. Your computer (with the help of QuickBooks) does this math easily.
Almost a Real-Life Example
To cement the concepts that I talk about in the preceding paragraphs of this chapter, I want to quickly step through the journal entries, or bookkeeping transactions, that you would record in the case of the hot dog stand business discussed in the preceding chapter. To start, you need to know that the balance sheet shown in Table 2-2 is the balance sheet at the start of the day. This means that the account balances in all the accounts appear as shown in Table 2-7. This list of account balances is actually called a trial balance. It shows the debit or credit balance for each account.
Table 2-7 A Trial Balance at the Start of the Day
Recording rent expense
Suppose that the first transaction to record is a $1,000 check written to pay rent. In this case, the journal entry appears as shown in Table 2-8. In this example, $1,000 is debited to rent expense, and $1,000 is credited to cash.
Table 2-8 Journal Entry 4: Recording the Rent Expense
Recording wages expense
If you need to record $4,000 of wages expense, you use the journal entry shown in Table 2-9. This journal entry debits wages expense for $4,000 and credits cash for $4,000. In other words, you use $4,000 of cash to pay wages for the hot dog stand business.
Table 2-9 Journal Entry 5: Recording the Wages Expense
Recording supplies expense
To record $1,000 of supplies expense paid for by writing a check, you record the journal entry shown in Table 2-10. This transaction debits supplies expense for $1,000 and credits cash for $1,000.
Table 2-10 Journal Entry 6: Recording the Supplies Expense
Recording sales revenue
Suppose that you sell $13,000 worth of hot dogs. To record this transaction in a journal entry, you debit cash for $13,000 and credit sales revenue for $13,000, as shown in Table 2-11. I should tell you, however, that in the case of the hot dog stand selling hot dogs for a dollar or two apiece, you wouldn’t necessarily use a single journal entry to record sales revenue amounts. Though you could use a single journal entry that tallied the entire day’s sales, if you’re selling hot dogs at a dollar a dog, you could also record 13,000 one-dollar transactions. Each of these one-dollar transactions debits cash for a dollar and credits sales revenue for a dollar.
Table 2-11 Journal Entry 7: Recording the Sales Revenue
Recording cost of goods sold
You must record the expense of the hot dogs and buns that you sell. You must also record the fact that if you use up your inventory of hot dogs and buns, your inventory balance has decreased. Table 2-12 shows how you record this. Cost of goods sold gets debited for $3,000, and inventory gets credited for $3,000.