Lecture: Recording Transactions: Debits, Credits, and the Trial Balance
Lecture script · about 15–20 minutes spoken · Week 3
Opening
Think about a food truck owner closing out a busy week, or a treasurer keeping the books for a student club. Both of them face the same small problem many times over. Money moves, and someone has to write down where it came from and where it went. Then they need a fast way to check they did not slip. That is what we're going to learn together in this lecture.
Here's where we are. In Week 1 you met the people who read financial statements and the groups that set the rules. In Week 2 you took the bicycle shop's 12 Month 1 transactions and tracked each one in the accounting equation, assets equal liabilities plus stockholders' equity. That shop is illustrative, by the way. It's a made-up business we follow all through this course.
The equation worked for 12 events. But imagine a shop with thousands of events a month. You'd want a separate running record for each item, a rule for where each amount goes, and a quick test at the end. That's this week. I'll take you through the account, the two sides called debit and credit, the rule for which side makes each account grow, the journal and the ledger, and finally the trial balance. And I'll be honest about what that last check can't catch. Next week, in Accrual Accounting and Adjusting Entries, you'll use all of it.
1. The account
Your phone keeps a separate thread for each person you text. You'd never scroll one giant list of every message ever sent to find what one friend said. You open that thread. Accountants work the same way with money.
That separate record has a name. An account is the separate record a business keeps for one item, such as Cash or Service Revenue, showing every increase and decrease in that item and its balance.
The simplest way to picture an account is a T-account. Imagine a capital letter T drawn large on a page. The account's title sits across the top bar. There's a left side under the bar, and a right side. Every amount you record goes on one side or the other.
The bicycle shop uses 12 accounts in Month 1. There's Cash, Accounts Receivable, Supplies, Prepaid Insurance, and Equipment. There's Accounts Payable and Unearned Revenue. There's Common Stock, Dividends, and Service Revenue. And there's Rent Expense and Wages Expense. Each one gets its own T.
Here's one. On Day 3 the shop buys $900 of supplies on account. That's transaction 3. In the Supplies T-account, the $900 goes on the left side, with a small "3" beside it so you can trace it later. Nothing else touches Supplies all month. So the Supplies balance at month-end is $900.
Pause and try this. Which part of the accounting equation does the Supplies account belong to: assets, liabilities, or equity?
Think about what supplies are before you decide.
Here's the answer. Supplies is an asset, because it's a resource the shop controls and will use up later in its work.
Keep that habit. Every T you draw is one line of the equation, opened up so you can see what moved it.
2. Debit and credit
Picture a scoreboard at a soccer game. There's a home side and a visitor side. Those labels tell you where a number goes. They don't tell you whether the number is good news.
Accounting has two words that work exactly like those labels. A debit is an amount written on the left side of an account or in the left amount column of a journal entry. A credit is an amount written on the right side. Whether either one makes an account bigger or smaller depends on the account's type.
That's the whole meaning. When an accountant says "debit Cash", they mean "write it on the left of Cash". When they say "credit Common Stock", they mean "write it on the right of Common Stock". Neither word means increase, decrease, good, or bad on its own.
Let's watch one transaction. On Day 1 the founders put $30,000 of cash into the shop and receive 30,000 shares of common stock. The shop writes $30,000 on the left of Cash, and $30,000 on the right of Common Stock. Now notice something. Both accounts went up. One went up on the left, and the other went up on the right.
Here's a second case, from a campus bookstore in its opening week. The bookstore pays its first month's rent in cash. Rent Expense is debited, and Cash is credited. This time the debit made one account bigger, and the credit made another account smaller.
Pause and try this. In the bookstore's rent payment, Cash was credited. Did Cash go up or go down?
Think about where the money went.
Here's the answer. Cash went down, because the bookstore paid rent out of its cash, and a credit sits on the side that shrinks an asset.
So the word "credit" alone told you nothing. The type of account told you everything. That's our next idea.
3. Normal balances and contra accounts
Here's a picture I like. Imagine two kinds of jars on a shelf. One kind fills from the left. The other kind fills from the right. Once you know which jar you're holding, you know which side adds to it.
Every account is one kind of jar or the other. An account's normal balance is the side, debit or credit, on which it increases and on which its balance usually sits. Assets, expenses, and dividends increase with debits. Liabilities, common stock, retained earnings, and revenues increase with credits.
There's a reason behind the pattern, and it's the equation you already know. Assets sit on the left of the equation, so they grow on the left. Liabilities and equity sit on the right, so they grow on the right. Revenues add to retained earnings, so they grow on the right too. Expenses and dividends take away from retained earnings, so they grow on the opposite side, the left.
Let's try it. On Day 18 the shop does $1,800 of repairs for a delivery company on account. Accounts Receivable is an asset that went up, so it's debited $1,800. Service Revenue went up, so it's credited $1,800. The delivery company now owes the shop, and the shop has earned the revenue, even though no cash has arrived yet.
One more kind of account belongs here. A contra account is an account that reduces another account and so carries the opposite balance. Accumulated Depreciation and Allowance for Doubtful Accounts are contra assets with credit balances. The shop has none in Month 1. You'll meet the first one in Week 4.
Pause and try this. Dividends lowers the owners' equity. So is the normal balance of Dividends a debit or a credit?
Ask whether it adds to equity or takes away.
Here's the answer. Dividends has a debit normal balance, because it works against retained earnings, and retained earnings grows on the credit side.
4. Double-entry bookkeeping
Think of a seesaw. Put weight on one end and it tips, unless you add the same weight to the other end. Recording a transaction works like that seesaw. Whatever goes on the left is matched by the same total on the right.
That's double-entry bookkeeping: the method of recording every transaction in at least two accounts so that the total of its debits equals the total of its credits, which keeps the accounting equation in balance.
This method is old. A book by Luca Pacioli, printed in Venice in 1494, contains the first published description of double-entry bookkeeping. Here's a detail people often get wrong. Pacioli described the method. He didn't invent it. Merchants were already using it, and his book put it into print.
Let's check one entry. On Day 30 the shop pays a $500 cash dividend to its shareholders. Dividends is debited $500, and Cash is credited $500. The debits total $500 and the credits total $500. And remember, a dividend is a payment to the owners, never an expense, because it didn't help earn any revenue.
Some events touch three or more accounts. That kind of entry is a compound entry, a journal entry that affects more than two accounts. It lists all of its debits before all of its credits, and its debits still total the same as its credits.
Pause and try this. A classmate says double entry means writing every transaction down twice. What would you tell them?
Think about what the two entries actually are.
Here's the answer. It means each transaction has at least one debit and at least one credit, recorded once, with equal totals, not two copies of the same thing.
5. The journal, the chart of accounts, posting, and the ledger
A coach keeps two kinds of records during a season. There's a play-by-play log, written in time order as the game happens. And there's a stat sheet for each player, filled in from the log afterward. Accounting keeps the same two kinds of record.
The journal is the book of original entry, where each transaction is first recorded in date order. Each journal entry gives the date or transaction number, the debited account and amount first and flush left, the credited account and amount indented, and a one-line explanation. The chart of accounts is the list of every account a business uses, so each account always gets the same name. Posting is copying each amount from a journal entry to the same side of the named account in the ledger. And the general ledger is the full set of a business's accounts, each showing what was posted to it and its current balance.
Here's how it looks for the shop's first entry. Transaction 1, Day 1. The first line reads Cash, $30,000, in the debit column. The second line, indented, reads Common Stock, $30,000, in the credit column. Then a short explanation: the founders invest cash for shares. To post it, you write $30,000 on the left of the Cash account and $30,000 on the right of Common Stock, each with a "1" beside it.
Now a fresh case, with no amounts. A landscaping company borrows from a bank to buy a riding mower. In its journal, Equipment is debited, and Notes Payable is credited, indented underneath.
Pause and try this. You want to know how much cash the shop has right now. Do you look in the journal or in the ledger?
Think about how each one is organized.
Here's the answer. You look in the ledger, because the ledger is organized by account and shows each account's current balance, while the journal is organized by time.
6. Journalizing and posting the running case
Now we record the whole month. It's the same 12 transactions you analyzed last week, written as journal entries and then posted. Cash is the busiest account, so let's build its T-account together.
On the left side of Cash go the four amounts that brought cash in. There's $30,000 from the founders, $1,200 from the cycling club, $3,500 from walk-in customers, and $1,000 collected from the delivery company. Those are transactions 1, 5, 6, and 10. Add them and the left side totals $35,700.
On the right side go the six amounts that sent cash out. There's $12,000 for equipment, $2,400 for insurance, $1,500 for rent, $600 to the supplier, $1,600 in wages, and the $500 dividend. Those are transactions 2, 4, 8, 9, 11, and 12. The right side totals $18,600.
Here's the step people skip. The balance isn't either total. It's the difference. You take $35,700 and subtract $18,600, and you get $17,100. Because the left side was bigger, that's a debit balance. Cash is an asset, so a debit balance is exactly where it belongs.
Three other accounts have more than one amount. Accounts Receivable got $1,800 on the left and $1,000 on the right, leaving an $800 debit balance. Accounts Payable got $900 on the right and $600 on the left, leaving a $300 credit balance. Service Revenue got two amounts on the same side, $3,500 and $1,800, for a $5,300 credit balance.
Pause and try this. Cash's debit side totals $35,700. Is that the shop's cash balance?
Remember what a balance is.
Here's the answer. No, the balance is $17,100, which is the left total minus the right total, and it sits on the debit side because the left was larger.
A quick habit helps here. After you find a balance, check that it sits on the account's normal side. A Cash balance on the credit side would be a warning sign.
7. The trial balance
Before you hand in a group project, you flip through and check that every page is there. That check doesn't judge whether each page is good. It asks one fast question about all of them at once. Accountants have the same kind of check.
A trial balance is a list of every ledger account and its balance in a debit column or a credit column, used to check that total debits equal total credits. The one you prepare before any month-end updates is the unadjusted trial balance.
For the shop, the debit column holds Cash at $17,100, Accounts Receivable at $800, Supplies at $900, Prepaid Insurance at $2,400, Equipment at $12,000, Dividends at $500, Rent Expense at $1,500, and Wages Expense at $1,600. Add those eight and you get $36,800. The credit column holds Accounts Payable at $300, Unearned Revenue at $1,200, Common Stock at $30,000, and Service Revenue at $5,300. Add those four and you also get $36,800.
The two totals agree. So no entry was posted with one side missing.
Pause and try this. Last week the shop's total assets were $33,200. Why is the trial balance total a different number?
Think about which accounts sit in each column.
Here's the answer. The trial balance total also includes expenses and dividends on the debit side and revenue on the credit side, so it answers a different question than total assets.
8. What a balanced trial balance cannot prove
Spell-check is great at catching a misspelled word. But type "their" when you meant "there", and spell-check says nothing, because both are real words. A trial balance has the same blind spot. It catches an entry with unequal sides. It can't see an entry that's balanced but wrong.
Three errors slip right past it. An omitted entry, which never reaches the journal at all. A duplicated entry, which adds the same amount to both sides twice. And a posting to the wrong account of the same type, which moves an amount without changing either total.
Let's prove the first one with the shop. Suppose transaction 9, the $600 payment to the supplier, never got journalized. Cash would show $17,700 instead of $17,100. Accounts Payable would show $900 instead of $300. And each column would total $37,400. The columns still agree, but two balances are wrong.
Now the third kind. Suppose the mechanic's $1,600 of wages got posted to Rent Expense instead. Rent Expense would show $3,100, Wages Expense would show nothing, and each column would still total $36,800. Every total looks fine, yet a lender would think the shop's rent was more than double what it really was.
Pause and try this. A bookkeeper records the shop's rent payment twice by mistake. Will the trial balance still balance?
Think about what happens to each column.
Here's the answer. Yes, it still balances, because the duplicate adds the same amount to the debit column and the credit column, so both totals rise together.
So here's the plain sentence I want you to carry. The shop's trial balance proves the ledger is in balance, not that every transaction was recorded, recorded once, or put in the right account.
Closing
Let's pull it together. An account is one record for one item, and a T-account is its sketch. Debit means left and credit means right, and neither means more or less on its own. Assets, expenses, and dividends grow with debits, while liabilities, common stock, retained earnings, and revenues grow with credits. Double entry keeps every transaction's debits equal to its credits, the method Pacioli first described in print. The journal records events in time order, and posting copies them into the ledger. You found the shop's Cash balance at $17,100 and its trial balance at $36,800 on each side. And a balanced trial balance is a useful screen, never proof.
Next in this module, read the Readings and Resources page, then work through the lecture tutorial, the practice set, and the quiz, and bring your questions to the discussion and the Accounting Workshop. Next week, in Accrual Accounting and Adjusting Entries, we update these same accounts at month-end so revenue and expenses land in the right period.
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