ACCOUNTING or BOOK-KEEPING PRIMER

Book-keeping is a way to record financial transactions of a business entity and to determine particularly its profits, assets, capital and liabilities at a particular interval.

The first record is to record the capital introduced to start the business. The capital usually is in the form of assets (cash, vehicle etc). So, the first record look like this :

CAPITAL=ASSETS

Ie CAPITAL is stated on the left side while ASSETS is stated on the right side, It has become a standard that the CAPITAL side is called CREDIT side and the ASSETS side is called DEBIT side. It may be written this way :

ASSETS=CAPITAL

Ie ASSETS is stated on the left side while CAPITAL is stated on the right side, but the fact remains that the CAPITAL side is called CREDIT side and the ASSETS side is called DEBIT side.

In other way, we also say that CAPITAL is a CREDIT item (because it always appear on the credit side) while ASSETS is a DEBIT item (because it always appear on the debit side).

A business is an entity separate from the person who provide the capital for the business to start. The CAPITAL of the business is an amount OWED BY THE BUSINESS to the person who provide it. To the business, the CAPITAL is an amount LENDED BY the person who provide it. The provider can take back the capital (in whatever form), at any time. So, the CREDIT side is extended to show amount owed by the business to another entity (not only amunt owed to the capital provider but including supplier of goods on credit, etc), while the DEBIT side is to show what assets the business has (not only cash that the business has but also what customer owed to the business).

A book-keeper must be able to differentiate at all time a financial transaction whether it is related to a business entity or to its capital provider, because he wants to record transactions of the business, not the capital provider.

Over time, purchases and sales occur. These processes is simply a conversion of one form of assets into another form. For example, when the business use cash to buy goods, it convert cash into goods, but the equation of CAPITAL=ASSETS still holds true. Now assets side is represented by cash (reduced) and goods (increase).

CAPITAL = ASSETS (in the form of cash and goods).

When the business entity sell the goods for cash, we convert the goods into cash. The equation of CAPITAL=ASSETS still holds true.

Most of the time, a business entity sells their goods with price higher than the price it initially purchases the goods. The difference is a PROFIT. The PROFIT is represented in the form of cash (a form of assets). The PROFIT is effectively belong to the provider. It increases the value of the CAPITAL. That's why PROFIT is written in the same side as CAPITAL, ie CREDIT side. Now the position is :

CAPITAL + PROFIT = ASSETS (partly from Capital and partly from Profit in the form of cash and goods).

Sometimes, a business entity sells its goods with price lower than the price it purchases the goods. The difference is a LOSS. The LOSS is represented in the form of the reduced cash (a form of assets). The LOSS is effectively burdened to the provider. It decreases the value of the CAPITAL. That's why LOSS is written in the same side as CAPITAL, ie CREDIT side. Now the position is :

CAPITAL - LOSS = ASSETS (partly from Capital reduced by the Loss).

Sometimes a business borrows money from a bank. So, the business does not only owes money to the provider but also to a bank. (Remember, the money owed by a business is shown on the CREDIT side). When a business borrows money from a bank, its assets (cash) increases and its liability (amount owed) also increases by the same amount. So, the DEBIT side and the CREDIT side will always equal.

CAPITAL + increase in amount borrowed = ASSETS + increase in cash

Sometimes a business buy goods on credit from a supplier. So, the business owes money to the supplier. (Remember, the money owed by a business is shown on the CREDIT side). When a business entity buys goods on credit from a supplier, its assets (goods) increases and its liability (amount owed to the supplier) also increases by the same amount. So, the DEBIT side and the CREDIT side will always equal.

CAPITAL + increase in amount owed to supplier = ASSETS + increase in goods

Sometimes a business sells goods on credit to a customer. So, the business has assets with the customer. (Remember, assets of a business is shown on the DEBIT side). When a business entity sells goods on credit to a customer, its assets (goods) change into another form of assets (debtor).

CAPITAL = ASSETS + increase in debtor but decrease in goods

The term ASSETS is too broad. Usually, further breakdown into categories is identified, eg FIXED ASSETS, CURRENT ASSETS, INVESTMENTS etc. And it can further broken down into more identifiable sub-categories. The least category is called ACCOUNTS.

The term LIABILITY is also too broad. Usually, further breakdown into categories is identified, eg CURRENT LIABILITY, LONG TERM LIABILITY, etc. And it can further broken down into more identifiable sub-categories. The least category is called ACCOUNTS.

When a Credit item increases (eg due to credit purchase), we say we credit the credit item. When a Credit item decrease (eg due to payment of liability), we say we debit the credit item. When a Debit item increases (eg due to a purchase), we say we Debit the debit item. When a Debit item decrease (eg due to selling of goods), we say we Credit the debit item. So, debiting a credit item will decrease the amount of the credit item. Crediting a credit item will increase the amount of the credit item. Debiting a debit item will increase the amount of the debit item. Crediting a debit item will decrease the amount of the debit item.

Over time, we want to keep track transactions which give rise to PROFIT or LOSS. For this, we use special book we call PROFIT & LOSS ACCOUNTS to record items which give rise to PROFIt or LOSS. Another statement, BALANCE SHEET is to record items which not give rise to PROFIT or LOSS. The BALANCE SHEET will show the position of CREDIT side items and DEBIT side items. The net of PROFIT and LOSS will appear in the CREDIT side of the BALANCE SHEET.