Principles of Financial Accounting: The Accounting Cycle - Posting to Ledger Accounts

What It Is

Posting to ledger accounts is the process of recording transactions in the general ledger, which is a collection of all the company's accounts. This process is crucial in financial accounting as it ensures that the financial statements accurately reflect the company's financial position and performance. If a company buys $10,000 of inventory, the transaction would be posted to the Inventory account in the general ledger, increasing its balance.

Key Concepts & Formulas

• Debit and Credit Rules: Debits increase asset and expense accounts, while credits increase liability and equity accounts. Example: If a company purchases office supplies for $500, the Office Supplies account would be debited $500.
• Normal Balances: Asset accounts normally have debit balances, while liability and equity accounts normally have credit balances. Example: A company's Cash account has a debit balance of $10,000.
• Journal Entry Format: A journal entry consists of a date, a description of the transaction, and the debit and credit amounts. Example: Dr. Accounts Payable $1,000, Cr. Purchases $1,000
• Posting to Ledger Accounts: Ledger accounts are updated by posting the debit and credit amounts from the journal entry. Example: If a company purchases office supplies for $500, the Office Supplies account would be debited $500 and the Purchases account would be credited $500.
• Gross Profit Formula: Gross Profit = Sales – COGS (Cost of Goods Sold) Example: If a company has sales of $100,000 and COGS of $60,000, its gross profit would be $40,000.
• Debit and Credit Rules for Expense Accounts: Expense accounts are debited when incurred and credited when paid. Example: If a company incurs rent expense of $1,000, the Rent Expense account would be debited $1,000.
• Accrual Accounting: Accrual accounting recognizes revenues and expenses when earned or incurred, regardless of when cash is received or paid. Example: If a company provides services worth $5,000 but has not received payment, the revenue would be recognized and the Accounts Receivable account would be debited $5,000.
• Matching Principle: The matching principle requires that expenses be matched with the revenues they help to generate. Example: If a company purchases equipment for $10,000, the Depreciation Expense account would be debited $1,000 per year for 10 years.

Journal Entry Examples

1. Dr. Accounts Payable $1,000, Cr. Purchases $1,000 Explanation: The Accounts Payable account is debited because it represents an increase in a liability account, while the Purchases account is credited because it represents an increase in an asset account.

2. Dr. Rent Expense $1,000, Cr. Cash $1,000 Explanation: The Rent Expense account is debited because it represents an increase in an expense account, while the Cash account is credited because it represents a decrease in an asset account.

3. Dr. Accounts Receivable $5,000, Cr. Service Revenue $5,000 Explanation: The Accounts Receivable account is debited because it represents an increase in an asset account, while the Service Revenue account is credited because it represents an increase in a revenue account.

Common Mistakes

1. Mistake: Confusing debits and credits for expense accounts. Correction: Expense accounts are debited when incurred and credited when paid. Remember the mnemonic "DEBIT" (Decrease Expense, Balance Increases).
2. Mistake: Not considering the normal balance of an account when determining the direction of the journal entry. Correction: Asset accounts normally have debit balances, while liability and equity accounts normally have credit balances. Remember the mnemonic "ADE" (Assets, Drawings, Expenses).
3. Mistake: Not using the correct account names when preparing journal entries. Correction: Use the correct account names as listed in the chart of accounts. Remember to use the correct account names to ensure accurate financial reporting.

Exam Tips

1. Tip: A debit increases assets AND expenses – remember "ADE" (Assets, Drawings, Expenses).
2. Tip: Reversing normal balances can be a trap – make sure to consider the normal balance of an account when determining the direction of the journal entry.
3. Tip: Accrual accounting recognizes revenues and expenses when earned or incurred, regardless of when cash is received or paid.

Quick Practice

1. What is the adjusting entry for accrued salaries of $5,000? Answer: Dr. Salaries Expense $5,000, Cr. Salaries Payable $5,000 Explanation: The Salaries Expense account is debited because it represents an increase in an expense account, while the Salaries Payable account is credited because it represents an increase in a liability account.

2. What is the journal entry for a company that purchases office supplies for $500? Answer: Dr. Office Supplies $500, Cr. Cash $500 Explanation: The Office Supplies account is debited because it represents an increase in an asset account, while the Cash account is credited because it represents a decrease in an asset account.

3. What is the adjusting entry for unearned revenue of $2,000? Answer: Dr. Unearned Revenue $2,000, Cr. Service Revenue $2,000 Explanation: The Unearned Revenue account is debited because it represents an increase in a liability account, while the Service Revenue account is credited because it represents an increase in a revenue account.

Last-Minute Cram Sheet

1. Dividends are NOT an expense – they go directly to retained earnings.
2. Asset accounts normally have debit balances.
3. Liability and equity accounts normally have credit balances.
4. The matching principle requires that expenses be matched with the revenues they help to generate.
5. Accrual accounting recognizes revenues and expenses when earned or incurred, regardless of when cash is received or paid.
6. Debits increase asset and expense accounts.
7. Credits increase liability and equity accounts.
8. The gross profit formula is Gross Profit = Sales – COGS.
9. The debit and credit rules for expense accounts are debited when incurred and credited when paid.
10. The chart of accounts lists all the company's accounts.