The second step in the accounting system is listed above as “record.” At the beginning of this chapter, a number of transactions were presented and their impact on individual accounts determined. Following this analysis, some method has to be devised to capture the information in an orderly fashion. Officials could just list the effect of each transaction on a sheet of paper: increase inventory $2,000 and increase accounts payable $2,000; increase salary expense $300 and decrease cash $300. However, this process is slow and poorly organized. A more efficient process is required. What is the key to recording transactions after all account changes are identified? Answer: An essential step in understanding the accounting process is to realize that financial information is accumulated by accounts. Every balance to be reported in a company’s financial statements is maintained in a separate account. Thus, for assets, an individual account is established to monitor cash, accounts receivable, inventory, and so on. To keep track of expenses, a number of additional accounts are needed, such as cost of goods sold, rent expense, salary expense, and repair expense. The same is true for revenues, liabilities, and other categories. A small organization might utilize only a few dozen accounts for its entire recordkeeping system. A large company could have thousands.
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The debit and credit rules for these seven general types of accounts provide a short-hand method for recording the financial impact that a transaction has on any account. They were constructed in this manner so that the following would be true: debits must always equal credits for every transaction. At first, the debit and credit rules might seem completely arbitrary. However, they are structured to mirror the cause and effect relationship found in every transaction. This is the basis of what the Venetian merchants came to understand so long ago: every effect must have a cause.
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