The most commonly used system in accounting is the so-called double-entry bookkeeping. The information, i.e. every business transaction has to be recorded into at least two accounts - on the debit side of one account and on the credit side of another. Thus, the entry must be made in two accounts: on the debit side of one account is recorded where the money has been spent and on the credit side of the other account is recorded the source of the money. The information on the use of money and the source of money must be clarified when recording each transaction.
| ALL ACCOUNTS | |
| DEBIT (Use of money) | CREDIT (Sources of money) |
The Use of money is always recorded on the debit side of the account and the Source of money is recorded on the credit side of another account.
EXAMPLE. Let's assume that the company has the following transactions during January:
- 04.01. The owner has invested 20 000 euros in the company's share capital
- 10.01. The company has purchased equipment in cash - 6 000 euros
- 10.01. The company has purchased raw materials in cash - 8 000 euros
- 30.01. The company has sold the goods on cash - 11 000 euros
In this example, each transaction is recorded on two accounts, the use of money on the debit side and the source of money on the credit side. The accounting period is one month. Thus, in our example financial year is just one month and on the last day of the financial year 31.1. accounts have to be closed.
| DATE | CASH ACCOUNT | DEBIT (USAGE) | CREDIT (SOURCE) |
|---|---|---|---|
| 04.01 | Money from the owner | 20 000 | |
| 10.01 | Equipment has been purchased | 6 000 | |
| 10.01 | Raw materials have been purchased | 8 000 | |
| 30.01 | Sold goods | 11 000 | |
| 31.01 | Ending balance | 17 000 | |
| TOTAL | 31 000 | 31 000 |
During the reporting period, there was an increase in cash of EUR 31 000 that has been recorded on the debit side of the Cash account, and decrease in cash of EUR 14 000 which has been recorded on the credit side.
It is important to know how much money is left on the last day of accounting period (31.01). The remaining amount of money is calculated by subtracting the sum showed on the credit side from the sum shown on the debit side. The difference between the sides of our Cash account of EUR 17 000 indicates the amount of money in the cash register. (EUR 31 000 - EUR 14 000 = EUR 17 000)
In such a way calculated difference between two sides of account is called the account residual, i.e. balance.
An account balance is the difference between the debits and credits of an account plus its beginning balance.
An account balance can be determined by subtracting the smaller sum (debit or credit) from the larger sum. Thus, accounts may have either the debit balances or the credit balances, whichever is greater. Debit balance: debit is more than credit; Credit balance: credit is greater than debit.
Let's check our example:
- the Cash account balance is EUR 17 000; debit is more than credit, thus this account has a debit balance
- the Equity account balance is EUR 20 000, credit side is greater than debit one, so, account has a credit balance
- the Equipment Expense account balance is EUR 6 000 and it has a debit balance
- the Raw Materials account balance is EUR 8 000 and it has a debit balance
- the Sales Revenue account balance is EUR 11 000 it has a credit balance
| DATE | EQUITY ACCOUNT | DEBIT | CREDIT |
|---|---|---|---|
| 04.01 | Money from the owner | 20 000 | |
| 31.01 | Ending balance | 20 000 | |
| TOTAL | 20 000 | 20 000 |
| DATE | EQUIPMENT EXPENSE ACCOUNT | DEBIT | CREDIT |
|---|---|---|---|
| 10.01 | Purchased Equipment | 6 000 | |
| 31.01 | Ending balance | 6 000 | |
| TOTAL | 6 000 | 6 000 |
| DATE | RAW MATERIALS ACCOUNT | DEBIT | CREDIT |
|---|---|---|---|
| 10.01 | Purchased Raw materials | 8 000 | |
| 31.01 | Ending balance | 8 000 | |
| TOTAL | 8 000 | 8 000 |
| DATE | SALES REVENUE ACCOUNT | DEBIT | CREDIT |
|---|---|---|---|
| 30.01 | Sold goods | 11 000 | |
| 31.01 | Ending balance | 11 000 | |
| TOTAL | 11 000 | 11 000 |
When the account balance has been calculated, it has to be added to that account side (debit or credit) which is less in amount. In such a way the account be balanced, and this residual balance are called the ending balance (or closing balance).
The accounts are then closed by calculating the totals. As a result, there is same amount on the both sides of the account.