Getting in touch with your hidden debits and credits: how to use accounting software

Accounting software works exactly like the old leather-bound ledgers you used to see being hauled out, paged through, and carefully written in (using red and black ink) by green eye-shaded accounting clerks.  Unfortunately, many who now use accounting software have no accounting training or knowledge, but are not worried because “the software will take care of that”.  We’ll see.

Let’s take an example of what happens when an untrained person tries to make a “simple entry” such as recording a check to pay a bill.  First of all, it is a duplication of effort if a hand-prepared a check was written when your software can do it for you.  Probably, you failed to set up your vendor data base correctly, so you don’t have a vendor list from which to pull down the vendor name, address, and general ledger posting information.  And, you undoubtedly did not post the original vendor invoice correctly, so that this payment will not be properly credited to the invoice, and this will cause your accounts payable aging to go out of balance from the general ledger.

So, here is what should happen when a check is written to pay an invoice:

Step 1:  Set up the vendor in your vendor data base (name, address, etc.).  In this part of the software you can also specify:  1099 information and federal id number (if applicable), general ledger posting account, and other helpful information.

Step 2:  Record the vendor invoice.  Select the vendor from the drop down list.  Enter the date of the invoice (not today’s date!) so that the item is recorded in the period in which it was incurred.  Enter the amount, and double check to see that the general ledger account is the correct account for this expense.

Here is what has now happened in your software:

Accounts payable has been credited.  An expense account has been debited (or other account you specify).  In your vendor sub-ledger, an amount due to this vendor and the related date has been recorded.  This sub-ledger needs to agree to your accounts payable in the general ledger.  Here is how it looks using “T accounts” where the left side of the account is a debit, and the right side is a credit, and assuming we just paid the Verizon phone bill in the amount of $300.  Note that Accounts Payable (A/P) is a Balance Sheet account (a liability), and Telephone expense is an Income Statement account.

                  Accounts Payable                      Telephone expense

                  Dr          ¦        Cr                           Dr          ¦          Cr

                                     $300                         $300                  

                Verizon (A/P sub-ledger) 

                Dr              ¦    Cr                 

                                     $300     

When you make one entry – these three postings will occur.  Now, let’s pay the invoice.  We’ll select this bill to pay, probably from a drop down list in the Payables or Purchases module of whatever software you use.  We’ll check that the appropriate bank account appears as the bank from which we are writing a check.  We’ll make sure that the check number is correct, that it is the next one in the sequence and available to be printed.  Then we’ll pay the invoice and print the check.  Here is what has happened in the accounting software:

                              Accounts Payable           Cash in Checking

                               Dr          ¦        Cr                  Dr          ¦        Cr      

                              $300                                                         $300

     Verizon (A/P sub-ledger)  

         Dr          ¦        Cr           

        $300     

Now, the end result of all of these two entries:  Cash is less by $300,  telephone expense is more by $300.  Accounts Payable are zero, because we paid the bill.  The Verizon sub-ledger is zero, but reflects the complete history of the invoice and the payment for later reference.

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