Basics of Accounting for Industrial Engineers

Lesson 273 of IEKC Industrial Engineering ONLINE Course Notes.

Lesson of Industrial Engineering Measurements - Online Course Module

Industrial engineers have to measure costs and reduce them. Then they have to measure costs and validate their improvement projects. The cost reduction has to lead to profit sustenance and growth. Hence they have to take interest in profit measurement and confirming that their improvement projects are reflected in the profit statement of the enterprise. Cost measurement and profit measurements are done through accounting records and summaries. Industrial engineers have to understand the basics of the accounting process first.

The basic summary device of accounting is the account. An account is the detailed record of all the changes that have occurred in an individual asset, liability, or owners’ (or stockholders’) equity during a specified period. Business transactions cause the changes in accounts.

Accountants record transactions first in a journal, which is the chronological record of transactions. Accountants then post the data to the book of accounts called the ledger.  One can describe it as copying the journal post in the ledger. A list of all the ledger accounts and their balances is

called a trial balance.

The ledger (book of accounts) contains the accounts grouped under these headings:

● Assets, Liabilities, and Stockholders’ Equity
● Revenues and Expenses

Companies prepare a chart of accounts to show the list of all their accounts along with the account numbers.

Charts of accounts vary from business to business, though many account names are common to all companies’ charts of accounts.


Accounting is based on transaction data. Each transaction represents exchange of value and it has two sides: The receiving side and  The giving side.

Accounting uses the double-entry system, which means that we record the dual effects of each transaction. As a result, every transaction affects at least two accounts. It would be incomplete to record only the giving side, or only the receiving side, of a transaction.

The T-Account
A shortened form of the general ledger account is called the T-account because it takes the form of the capital letter T. The vertical line divides the account into its left and right sides, with the title at the top. For example, the Cash account appears as follows.

Debit Side                   Credit Side
________________________________
                                |
                                |

Increases and Decreases in the Accounts

The account category (asset, liability, equity) governs how we record increases and decreases. For any given account, increases are recorded on one side, and decreases are recorded on the opposite side.

Whether an account is increased or decreased by a debit or a credit depends on the type of account. Debits are not “good” or “bad.” Neither are credits. Debits are not always increases or always

decreases—neither are credits.

The words debit and credit abbreviate the Latin terms debitum and creditum. Luca Pacioli, the Italian monk who wrote about accounting in the fifteenth century, popularized these terms.


The amount remaining in an account is called its balance.


List the Steps of the Transaction Recording Process

In practice, accountants record transactions in a journal. The journalizing process has three steps:

1. Identify each account affected and its type (asset, liability, or stockholders’ equity).
2. Determine whether each account is increased or decreased. Use the rules of debit and credit.
3. Record the transaction in the journal, including a brief explanation. The debit side of the entry is entered first. The credit side is indented. Total debits should always equal total credits. This step is also called “making the journal entry” or “journalizing the transaction.”

Posting (Copying Information) from the Journal to the Ledger

Journalizing a transaction records the data only in the journal—but not in the ledger. The data must also be copied to the ledger. The process of copying from the journal to the ledger is called posting. We post from the journal to the ledger. Debits in the journal are posted as debits in the ledger and credits as credits



Assets = Liabilities + Stockholders’ equity

Assets
DR    CR
+         -


Liabilities
DR   CR
–        +



Common stock
DR      CR
–           +

Retained
earnings
DR    CR
–        +

Revenues
DR     CR  
–           +

Expenses
DR  CR
+       -





The Normal Balance of an Account

An account’s normal balance appears on the side—either debit or credit—where we record an increase (+) in the account’s balance. For example, assets normally have a debit balance, so assets are debit-balance accounts. Liabilities and equity accounts normally have the opposite balance, so they are credit-balance accounts. Expenses are equity accounts that have debit balances—unlike the other equity accounts. They have debit balances because they decrease equity. Revenues increase equity, so a revenue’s normal balance is a credit.

Preparing the Trial Balance from the T-Accounts

As noted earlier, a trial balance summarizes the ledger (T-accounts) by listing all the accounts with their balances—assets first, followed by liabilities, and then stockholders’ equity. In a manual accounting system, the trial balance provides an accuracy check by showing whether total debits equal total credits. In all types of systems, the trial balance is a useful summary of the accounts and their balances because it shows the balances on a specific date for all accounts in a company’s accounting system.

The items for which costs are ascertained are known as cost objectives. The cost of a batch of an item can be the cost objective. In this case in cost accounting records an cost is opened for this batch. All materials issues, machine related expenditure incurred, wages and salaries paid for period for which various persons worked or contributed services to this batch, and other expenses incurred are debited to this accounts. If any credit items like material returned are there, they are credited to this account and the final cost of the batch is determined as the difference between the debit side and the credit side.

Accounting Terms

Account

The detailed record of all the changes that have occurred in a particular asset, liability, or owners’ equity (stockholders’ equity) during a period. The basic summary device of accounting.

Accrued Liability
A liability for which the business knows the amount owed but the bill has not been paid.

Chart of Accounts
A list of all a company’s accounts with their account numbers.

Credit side
The right side of an account.

Debit side
The left side of an account.

Double-Entry System
A system of accounting where every transaction affects at least two accounts.

Journal
The chronological accounting record of an entity’s transactions.

Ledger
The record holding all the accounts and amounts.

Normal Balance
The balance that appears on the side of an account—debit or credit—where we record increases.

Note Receivable
A written promise for future collection of cash.


Notes Payable
Represents debts the business owes because it signed promissory notes to borrow money or to purchase something.

Posting
Copying amounts from the journal to the ledger.

Prepaid Expenses
Expenses paid in advance of their use.

T-account
Summary device that is shaped like a capital “T” with debits posted on the left side of the vertical line and credits on the right side of the vertical line. A “shorthand” version of a ledger.

Trial Balance
A list of all the ledger accounts with their balances at a point in time.

Review notes - Good Notes
http://seattlecentral.edu/faculty/moneil/A210/L2/Horngren02.htm

Presentation slide
http://wps.prenhall.com/wps/media/objects/1838/1883037/powerpoints/ch_03.ppt

An excel tool on HBA alumni site
http://www.alumni.hbs.edu/new_alumni/toolkit/tools/doubleentry.xls

Notes on Analyzing Transactions
http://fgamedia.org/faculty/jnava/ng_courses/1a-b/lec_mat/lec_02.htm

Excerpts
From Financial and Management Accounting
Horngren
Book Referred

Financial, Cost and Management Accounting - Review Notes List