The record used to keep track of the increases and decreases in financial statement items is termed an account. This article explains basic accounting structures that exist in a business organization.
The accounting structure separates financial statement items (accounts) in five groups: ASSETS, LIABILITIES, OWNER’S EQUITY, SALES REVENUE, COSTS.
What is an account?
An account is simply a record used to summarize all increases and decreases in a particular financial statement item. It is a means of accumulating in one place all the information about changes that occur because of transactions in an item. An account will always have two sections: debit and credit.
Each group of accounts will follow particular recording rules according to the nature of the accounts that conforms it and the impact on the company´s results and financial position. The recording rules are based on the account’s type of normal balance, which may be a debit or credit.
A graphic description of an account would be:
| Name of the Account | ||
| Debit | Credit |
The normal balance of an account indicates on which side an account should be increased, the opposite side being the place where decreases should be recorded.
The balance of an account is the difference between the debit and credit entries in the account. If the debit total exceeds the credit total, the account has a debit balance; if the credit total exceeds the debit total, the account has a credit balance.
Double-entry principle in accounting
Double-entry accounting means the equality of debits and credits.
Debit balance = Credit balance
The rules for debits and credits are designed so that every transaction is recorded by equal dollar amounts of debits and credits. The reason for this equality lies in the relationship of the debit and credit rules to the accounting equation:
Assets = Liabilities + Owner’s equity
If this equation is to remain in balance, any change in the left side of the equation (Assets) must be accompanied by an equal change in the right-hand side (either Liabilities or Owner’s Equity). According to the debit and credit rules that we have just described, increases in the left side of the equation (Assets) are recorded by debits, while increases in the right side (Liabilities and Owner’s Equity) are recorded by credits.
The double entry system allows us to measure Net Profit at the same time we record the effects of transactions on the Balance Sheet accounts. Sales Revenue and Expenses have a direct effect on owner’s equity as the difference between these increases or decreases the retained earnings that belong to the owner’s.
Net Profit = Sales Revenue – Costs
The accrual basis of accounting calls for recording Sales Revenue in the period in which it is earned and recording Expenses in the period in which they are incurred. The effect of events on the business is recognized as services are rendered or consumed rather than when cash is received or paid.
