3. Bookkeeping Fundamentals

Bookkeeping Fundamentals

  • Introduction to Bookkeeping

    • Presenter: S. Levkoff, PhD, CAP®

    • Institution: UC San Diego, Department of Economics & Rady School of Management

Three Fundamental Equations of Bookkeeping

  • Equation 1: Assets = Liabilities + Equity (h')

  • Equation 2: Liabilities + Equity - Assets = 0

  • Equation 3: Not specified in the provided content

Debits and Credits

  • Debits:

    • Represented on the left side of a T-account

    • Abbreviated as "Dr."

  • Credits:

    • Represented on the right side of a T-account

    • Abbreviated as "Cr."

Understanding the Balance Sheet

  • Starting with the balance sheet identity: Assets = Liabilities + Equity

  • Decomposed Balance Sheet Identity:

    • Assets = Liabilities + Equity + Other Items - Expenses

  • Moving expenses to the left side simplifies:

    • Assets + Expenses = Liabilities + Equity

    • Repetition of the identity indicates a balance in entries.

Rules for Debit and Credit Entries

  • Every transaction must have at least one debit and at least one credit.

  • This indicates the principle of double-entry bookkeeping.

  • Total debits must equal total credits for each transaction.

  • Transactions can only involve non-negative amounts.

Accounts and Balance Formats

  • Normal Balance: Type of balance (debit or credit) an account usually carries.

  • T-Accounts:

    • Formal records of changes in accounting quantities.

    • Debits on the left; credits on the right.

  • Account Balance: Difference between the sum of debits and credits.

Asset and Expense Accounts (Left Side)

  • Normal balance: Debit (left side of T)

  • Effects of Transactions:

    • Debit transactions increase account balance.

    • Credit transactions decrease account balance.

    • Example: Accounts Receivable

Liabilities, Stockholder’s Equity, and Revenue Accounts (Right Side)

  • Normal balance: Credit (right side of T)

  • Effects of Transactions:

    • Debit transactions decrease account balance.

    • Credit transactions increase account balance.

    • Example: Accounts Payable

Super T-Account

  • Overview of Assets, Liabilities & Stockholders' Equity, and their interactions.

  • Utilizes debits and credits for record (-/+) adjustments across categories.

Bookkeeping: Key Questions

  1. Which specific account does the transaction affect?

  2. Does the transaction increase or decrease the affected account?

  3. Should the account be debited or credited?

Journal Entry Format

  • Standard practice involves listing debit entries first, followed by credit entries, often indented.

  • Example Format:

    • Dr. <Account Name> $XX.XX

    • Cr. <Account Name> $XX.XX

Examples of Journal Entries

  • Example 1: Cash from a bank loan:

    • Dr. Cash (+A) 100

    • Cr. Notes Payable (+L) 100

  • Example 2: Pay back cash to bank:

    • Dr. Notes Payable (-L) 20

    • Cr. Cash (-A) 20

  • Example 3: Purchase inventory:

    • Dr. Inventory (+A) 10

    • Cr. Cash (-A) 10

  • Example 4: Issue common stock:

    • Dr. Notes Payable (-L) 80

    • Cr. Common Stock (+SE) 80

  • Example 5-13: Documenting various financial transactions involving assets, liabilities, and equity.

Summary of Key Concepts

  • The interrelationship between journal entries and T-accounts for transaction tracking.

  • Importance of maintaining balance sheet identity.

  • Compliance with the rule that sum of debits must equal sum of credits.

  • Clarification of the roles of debits and credits in increasing or decreasing balances.

  • Normal balance delineation for different types of accounts.

Super T-Account: Summary Format Revisited

  • Reinforcements of Assets, Liabilities & Stockholders' Equity and their operational ties.

  • Reiterates debit and credit significance across financial actions.