Lesson Objectives:- Accounting cycle steps
- The steps for analysis and journalizing
- Examples of journal entries
- Real world application
Over the next seven lessons, we will be breaking down the seven different parts of the accounting cycle, starting with journal entries. This lesson will be centered around the first step of the cycle which relies on the analysis and journalizing of financial transactions.
The journalizing step is integral to the flow of the remaining steps in the accounting cycle which are depicted in the illustration above. As we move through the accounting cycle, the steps will flow in a clockwise order ending at closing the general ledger account.
Let's review the analysis and journalizing actions by looking at a real-world example of the four steps involved.
Analyze the situation - First, we need to understand what situation, if any, is affecting the company's finances. For our example, let's say Bob's Furniture Store is generating sales of patio furniture. This involves the inflow of revenue which they will be receiving in either cash or receivables.
Decide which accounts are changing - We need to look at the accounts that are being affected. In the case of Bob's furniture, the patio furniture sales affect the cash or accounts receivable and sales revenue accounts.
Determine whether the accounts are increasing or decreasing - For each journal entry, we need to look at whether the account value is increased or decreased as a result of the transaction. The company is receiving an asset of cash or extension of credit to the customer; therefore, the cash or accounts receivable accounts will be increasing. The sales revenue account is also increasing as a result of the patio furniture sales.
Journalize the transaction - Follow the double entry accounting system to record the transactions, both the debit and the credit. Since the assets are increasing, we would debit the accounts receivable or cash. The second entry would be to credit the sales revenue as it falls under equity.
The graphic above depicts how transactions are recorded based on the type of accounting element involved. The key to applying these steps is to follow the direction the balances are going and accurately record the transaction entries.
Let's review another example in the same step-by-step format and see how it is recorded as a journal entry.
What is the situation? - A company is billed for consulting services which is considered an expense as the services were consumed. Instead of paying the funds up front, the company owes the $5,000 as a payable which is a liability because it is due for a future date.
Which accounts are changing? - The company is incurring an expense and changing their accounts payable balance.
Increasing or decreasing? - The expense account under Stockholders' equity- Retained Earnings section is increasing, the accounts payable under liabilities is also increasing.
Journalizing the transaction - First you need to figure out whether the accounts are being debited or credited. As we just mentioned, the expense account is increased, therefore the account would be debited, since an increase in expenses reduces Stockholders' equity. The accounts payable is also increasing, but it will be credited since it is a liability.
The financial accounting equation is shown above.
Now, we will look at how the journal entry is recorded by looking at the sample journal entry above.
As you can see, the date is listed on the far-left hand side and beside the date is the list of debited and credited accounts. Normally, the debits are shown first and the credits on the right hand side of the journal entry. In this example, the $5,000 is debited out of the operating expense account and the $5,000 is also credited for the accounts payable account.
Above is another example that shows common account names and types of events or transactions that can occur. There are potentially hundreds or thousands of other account types but for the purpose of introductory accounting, we will use these as a reference.