Accounting transactions track a company’s assets, liabilities, and equity. Debits increase assets or decrease liabilities, while credits decrease assets or increase liabilities. Transactions must have an equal effect on both sides of the equation, and common transactions include issuing stock, receiving payment for services, and paying expenses.
Accounting transactions are used to keep track of a company’s assets, liabilities, and shareholders’ equity. Most businesses record accounting transactions in a ledger that reflects debits and credits. Financial documents, such as the balance sheet, income statement, and statement of cash flows, are based on transactions recorded in the general ledger. The basic types of transactions that could occur will affect a company’s cash, accounts receivable, and accounts payable.
When accounting transactions are made, debit entries increase assets or decrease liabilities. Credits made to general ledger accounts decrease assets or increase liabilities. In terms of equity, debits decrease common shares and retained earnings, while credits increase them. Revenues are increased by credit entries and expenses are increased by debits.
At all times, assets must equal liabilities plus shareholders’ equity. Therefore, any accounting transaction that takes place must have an equal and opposite effect on both sides of the equation. For example, when a company issues common stock, two separate entries must occur. The first would be an increase in cash for the amount of payment received and the second would be an increase in common shares to reflect the new monetary amount of shares outstanding.
Similarly, when a business receives payment for services that have not yet been provided, two accounting transactions will take place. One will be made to increase cash. Another will increase the amount of unearned income. This account classification is considered a liability as the business still needs to perform the services.
Expense payments tend to result in two transactions that decrease both assets and shareholders’ equity. For example, when a business pays rent, it will make a transaction to decrease cash by the amount of the expense. A corresponding entry will be made to decrease shareholders’ equity by the same amount.
Typical transactions against accounts payable may involve the purchase of office supplies on credit. This will result in an entry to increase supplies by the monetary amount that was purchased. Since supplies are considered an asset, liabilities will also need to be increased. Given this scenario, accounts payable would increase by the same amount.
In the event that a business renders services and sends an invoice for payment, accounts receivable would be increased instead of cash. This is due to the fact that the payment has not yet been received, but an asset account still needs to be debited. The corresponding entry would be an increase in stockholders’ equity from service income.
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