As a small business owner/manager you must have an understanding
of the financial end of your business. Certainly, you have
a decent grasp of how the business operates, but are you able
to visualize an accounting framework that your transactions
fit into? To do this requires becoming familiar with how your
financial statements are structured and knowing the rules
for recording transactions.
Financial statements consist of a Balance Sheet and Profit
& Loss Statement. These two reports act as a "container"
for all your business transactions. Each transaction is recorded
according to a set of rules called "The Accounting Model".
The Accounting Model is made up of three very simple parts:
The first part is a ledger page with a line drawn down the
middle (like a big T) automatically creating a left and right
side of the dividing line. However, in accounting language
the word "debit" is used instead of "left"
and the word "credit" is used instead of "right".
The trick here is to not make this anymore complicated than
it really is. Don't try to use the words debit and credit
to mean increase or decrease like you see on your bank statement.
You can do this later when you fully understand how to work
with these terms.
The second part is that there are five of these ledger T's
that relate to the five sections found in a set of financial
statements. They are:
Assets;
Liabilities;
Equity;
Revenue;
Expense.
The first three relate to the Balance Sheet and last two
relate to the Profit & Loss Statement.
The third part is a rule that states: Any transaction that
pertains to a section (Assets, Liabilities, etc.) that results
in an increase or decrease has to be recorded on either the
left or right side of the ledger page.
Go to the following URL to see an example of the Accounting
Model, you can print out a copy if you like:
The next step is to memorize the model so you can visualize
where transactions are to be recorded. Have you ever tried
to learn how to use a ten-key calculator or computer keyboard?
At some time you have to stop looking at the keys and allow
your mind to memorize the keyboard. That's when you get fast
and efficient. Memorizing the accounting model is no different.
Let's try a sample transaction so you can see how this works.
A great technique is to think about what actually happened
"physically" in a transaction. This is an important
step because doing this will tell you what you need to know
in order to convert the physical event into an accounting
transaction.
For example, let's say in your business you had a customer
who walked in the door, bought some merchandise and handed
you a check for $100. You deposited the $100 check in your
bank account and recorded the sale in your sales journal.
Keep in mind that each transaction has two parts, a debit
(left side)and a credit (right side), and that double-entry accounting
requires each side of the ledger to equal each other when
the transaction is completed.
The first step is to identify the parts of the transaction
and determine in which of the five sections each part belongs.
For instance, you know that your $100 cash received is an
Asset and your sale is Revenue.
The second step is to identify whether the transaction resulted
in an increase or decrease to cash and the sale. In the sample
transaction, it is obvious that cash was increased and sales
were increased.
The third step is to look at the accounting model and let
it tell you on which side of the ledger to record the transaction.
Try it now. The model tells you that cash, being an Asset,
goes on the left (debit) side when increased, and sales, being
Revenue, goes on the right (credit) side when increased.
Since the debits equal the credits the books are said to be
"in balance". This gives you a brief idea about
how the Accounting Model is used as a cipher to tell you where
to record transactions in your general ledger (GL). All you
have to do next is to practice using this system so that you become familiar
with all of your GL accounts. Then the day will come when
you become aware that you are no longer looking at the "keyboard"
and realize that the accounting framework is fully integrated
into your thinking process.
John W. Day, MBA is the author of two courses in accounting
basics: Real Life Accounting for Non-Accountants (20-hr online)
and The Heart of Accounting (4-hr PDF). Visit his website
at http://www.reallifeaccounting.com
to download for Free his 3 e-books pertaining to small business
accounting and his monthly newsletter on accounting issues
