Discusses step 2 of the Accounting Cycle, creating journal entries, the “flow” of data through accounting, and the purpose of debits and credits.
If you’re interested in a more in depth look, have a look at the accompanying textbook Balancing Act: A Practical Approach to Business Event Based Insights, available for download. Specifically, look at Chapter 5, Accounting.
Flow of Data
Bookkeeping is a very sophisticated (even today) method of measuring and tracking changes in quantitative metrics over time. The time aspect to it is what creates a flow of the metrics, into one account, out of that account, into another, and so on.
Money from your employer flows into your checking account, perhaps; it then gets transferred, or some portion of it to savings; it might flow out in an emergency, going to a car repair expense.
Debits and Credits
This flow is what creates the need for two (or more) statements of each transaction. Often the flow can mean something flowed out of one account, and into another account.
The second step in the accounting cycle is to analyzed a transaction and state what the from and to accounts would be.
A common method, even today, for analyzing this flow is to use what are termed T accounts, because of the shape of the diagram used. Under a large T, one places the account title on top of the T, the inflows under the line on the left hand side, and the outflows under the line on the right hand side.
Patterns begin to emerge for similar kinds of transactions. And problems can be spotted, like accounts that have all inflows but no outflows. This would cause the balance to accumulate forever.
Watch the next week episode at Accounting Cycle Step 3: Post to Ledger
Watch the prior week episode at Accounting Cycle Step 1: Execute Business Events
Watch all episodes in order at the Conversations with Kip Playlist