Analyzing Business Transactions Using T-accounts T Accounts

The simplest account structure is shaped like the letter T. The account title and account number appear above the T. Debits (abbreviated Dr.) always go on the left side of the T, and credits (abbreviated Cr.) always go on the right.

Accountants record increases in asset, expense, and owner's drawing accounts on the debit side, and they record increases in liability, revenue, and owner's capital accounts on the credit side. An account's assigned normal balance is on the side where increases go because the increases in any account are usually greater than the decreases. Therefore, asset, expense, and owner's drawing accounts normally have debit balances. Liability, revenue, and owner's capital accounts normally have credit balances. To determine the correct entry, identify the accounts affected by a transaction, which category each account falls into, and whether the transaction increases or decreases the account's balance. You may find the following chart helpful as a reference.

Source: Cliffnotes.com

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Analyzing Business Transactions Using T-accounts

Occasionally, an account does not have a normal balance. For example, a company's checking account (an asset) has a credit balance if the account is overdrawn.

The way people often use the words debit and credit in everyday speech is not how accountants use these words. For example, the word credit generally has positive associations when used conversationally: in school, you receive credit for completing a course, a great hockey player may be a credit to his or her team, and a hopeless romantic may at least deserve credit for trying. Someone who is familiar with these uses for credit but who is new to accounting may not immediately associate credits with decreases to asset, expense, and owner's drawing accounts. If a business owner loses $5,000 of the company's cash while gambling, the cash account, which is an asset, must be credited for $5,000. (The accountant who records this entry may also deserve credit for realizing that other job offers merit consideration.) For accounting purposes, think of debit and credit simply in terms of the left-hand and right-hand side of a T account.

I. Introduction to T accounts.

a. Is a visual representation that shows the effect of increases and

decreases to asset, liability, and owners equity accounts.

b. Used by accountants to analyze transactions

c. Follows the rules of the double-entry system

ASSETS = LIABILITIES + OWNER'S EQUITY +--+-+

Record Record Record Record Record Record Increases Decreases Decreases Increases Decreases Increases

Source: Cliffnotes.com

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Analyzing Business Transactions Using T-accounts

OWNER'S ASSETS = LIABILITIES + EQUITY

d. Use T account to illustrate $100,000 initial investment by the owner

Cash = Asset

+-

(a) 100,000

Owner's Capital -+

(b) 100,000

Increases in asset accounts are recorded on the left side of the T-account. In order to follow the rules of double-entry accounting, the Owners Capital

Source: Cliffnotes.com

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Analyzing Business Transactions Using T-accounts

must show an equal amount, in this case, $100,000 and on the right side of the T-account for the Owners Equity T-account as illustrated above. In fact, increases in the owners capital account are recorded on the right side of the T-account.

e. Recording purchase of an asset using a T-account using cash

Equipment = Asset +-

(c) 10,000

Cash = Asset +-

(d) 10,000

Based on the Fundamental accounting equation Assets = Liabilities + Owners equity

Cash + Equipment = 0 + O.E. 90,000 + 10,000 = 0 + 100,000

In the above example, the business purchased equipment, an asset, in the amount of $10,000 using cash. As illustrated, since the equipment is an asset, any increase to an asset account is recorded on the left-hand side

Source: Cliffnotes.com

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Analyzing Business Transactions Using T-accounts

of the T-account. While cash is also an asset, the corresponding double entry of $10,000 is recorded on the right-hand side of the T-account. Recall, decreases to asset accounts are recorded on the right-hand side of the T-account.

f. Recording a credit purchase of equipment (borrowed money)

Equipment = Asset +-

(e) 12,000

Accounts Payable = Liability

-+

(f) 12,000

When our fictitious company purchases equipment for $12,000 on credit, notice that the asset account, Equipment has a recorded $12,000 on the left-hand side of the T-account. Since the purchase was made on credit, this creates a debt or liability for the company. As mentioned earlier, increases to our liability accounts are recorded on the right-hand side of the T-account, as shown above. Furthermore, the T-account for equipment when considering the earlier purchase of $10,000 would show the T-account for equipment as follows:

Source: Cliffnotes.com

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Analyzing Business Transactions Using T-accounts

Equipment

+-

(a) 10,000

(e) 12,000

Supplies = Asset +-

(g) 5,000

Cash = Asset +-

(h) 5,000

What is the new balance for equipment T-account? $22,000

g. Purchasing supplies worth $5,000.00 using cash

Source: Cliffnotes.com

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Analyzing Business Transactions Using T-accounts

Under T-account, the left-hand side is debit (DR) and right-hand side is credit side (CR)

Determining the balance of a T-account Cash = Asset

Debit side (DR)

250,000 150,000 75,000

475,000

Credit side (CR)

100,000

100,000

So what is the balance of the cash T-account? The balance is $375,000. So we can that the cash account has a debit balance of $375,000.

Two customers, one received an invoice for $15,000, giving them 30 days to pay. Another customer received an invoice for $10,000, giving them 30 days to pay. Show that in a T-account.

Day 1

A/R = Asset

Debit Credit side (DR) side (CR)

15,000 10,000 25,000

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Analyzing Business Transactions Using T-accounts

Day 30

A/R = Asset

Debit side (DR)

15,000 10,000 25,000

Credit side (CR)

7,500 10,000 17,500

So the business received $17,500 in payment from customers. So the balance for A/R T-account is now reduced to $7,500. So I can also say my A/R T-account has a debit balance of $7,500.

Day 31

A/R = Asset

Debit Credit side (DR) side (CR)

7,500

Cash = Asset

Debit Credit side (DR) side (CR)

17,500

Source: Cliffnotes.com

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Analyzing Business Transactions Using T-accounts

Debits = Credits

If you have a credit balance of 17,500 in your A/R T-account, then you have to have a matching debit.

So continuing from our example from the textbook, after purchasing office equipment for $10,000 and supplies worth $3,000, our T-account for cash looks like this:

Cash

Debit (dr) Credit (cr) (a) 90,000 (d) 10,000

(h) 3,000

(90,000 - 13,000 so the balance of the cash account is a debit balance of $77,000). Recall that the business, JT Consulting purchased a piece of equipment on credit in the amount of $12,000, creating an account payable. The T-account for the transaction looked like this:

Accounts Payable = liability

Debit (dr) Credit (cr) (f) 12,000

The company decided to pay $5,000 for the liability. In this case, we record the payment of $5,000 on the debit side of the accounts payable T-account. As we discussed, a liability account increases on the credit side but decreases on the debit side. So the T-account for accounts payable looks like this:

Source: Cliffnotes.com

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Analyzing Business Transactions Using T-accounts

Accounts Payable

Debit (dr) Credit (cr) (j) 5,000 (f) 12,000

The new balance for the accounts payable T-account is now $7,000 ($12,000 -$5,000)

Since we made a payment, this transaction also affects the cash T-account, which now looks like this:

Cash

Debit (dr) Credit (cr) (a) 90,000 (d) 10,000

(h) 3,000

(i) 5,000

Prepaid rent, as we discussed is an asset. In the case where the company paid two months rent for $7,000, the T-account for the prepaid rent account looks like this:

Prepaid Rent = Asset

Debit (dr) Credit (cr)

(k) 7,000

Since the firm paid cash to the landlord in advance, we have to record the $7,000 payment on the credit side of the T-account for cash.

Source: Cliffnotes.com

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Analyzing Business Transactions Using T-accounts

Bal. 65,000

Cash = Asset

Debit (dr) (a) 90,000

Credit (cr) (d) 10,000 (h) 3,000

(i) 5,000

(l) 7,000

25,000 Footing

Setting Up T-accounts for Revenue and Expense Accounts

As we continue to move along with our T-account presentations, it should be clear by now that every transaction gets its own T-account including revenue (income accounts) and expenses. In accounting, as a rule, any revenue account whether it is called revenue, sales or fee income is recorded as a credit.

In the example from the textbook, JT Consulting Services earned $26,000 in fee income from clients in the month of December, who paid in cash. Obviously, we need to record this transaction. As mentioned, fee income will have its own T-account, and as a rule, the $26,000 will be recorded on the credit side of the T-account as shown below:

Fee Income

Debit (dr) Credit (cr)

(n) 26,000

As we know, since accounting is built as a double-entry system, you cannot have a credit of $26,000, in this case, to fee income and not have a corresponding debit. As indicated in the above statement, JTs clients paid in cash. Therefore, we must record the other side of this transaction, which will be a corresponding debit to match the credit to fee income. Since the

Source: Cliffnotes.com

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Analyzing Business Transactions Using T-accounts

company received cash, we must record the increase to cash on the debit side of the T-account for cash as shown below.

Debit (dr) (a) 90,000 (m) 26,000

116,000

Cash

Credit (cr) (d) 10,000 (h) 3,000

(i) 5,000

(l) 7,000 25,000

So the new cash balance is $91,000 ($116,000 - $25,000).

In December, JT Consulting earned $9,000 from various charge clients. In this particular case, since the clients have not yet paid, the company must set up a T-account for accounts receivable, which is shown below.

Accounts Receivable

Debit (dr) Credit (cr)

(o) 9,000

Remember, accounts receivable is an asset account and increases to asset accounts are recorded on the debit of the T-account. Also, because we need a corresponding credit to match our debit, we must record the credit to the T-account for fee income, as indicated below.

Fee Income

Debit (dr) Credit (cr) (n) 26,000

(p) 9,000

Source: Cliffnotes.com

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Analyzing Business Transactions Using T-accounts

Soon thereafter, some of JT Consultings clients paid $4,000 of the $9,000 owed. What is the effect on the company? If a customer pays on an account receivable, this means that the companys cash will increase by $4,000. As we know, any increases to our asset cash will be reflected as a debit. What happens to accounts receivable? In this case, it will be reduced by the $4,000 to reveal a new balance of $5,000 ($9,000 - $4,000). The T-account presentation follows.

Accounts Receivable

Debit (dr) Credit (cr) (o) 9,000 (r) 4,000

Remember that decreases to asset accounts are recorded on the credit side of the T-account. In this case, our asset, accounts receivable decreased by $4,000, which is why the $4,000 is recorded on the credit side. By now you should know that for every credit, we need a matching debit. In this case, JT received a $4,000 payment from customers that increased its cash position. This increase is reflected in the T-account for cash below.

Cash

Debit (dr) Credit (cr)

Bal. 65,000

(m) 26,000

(q) 4,000

What happens when JT has to record salaries expense? Lets talk about expenses in general. As a rule, all expenses are recorded as debits. We will talk about when you should record an expense as a credit; however, the normal balance for expense accounts is a debit balance.

In this instance, JT Consulting had to pay $7,000 in salaries. For this, well set up a T-account for the salaries expense shown below.

Source: Cliffnotes.com

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Analyzing Business Transactions Using T-accounts

Salaries Expense

Debit (dr) Credit (cr)

(t) 7,000

As we know, we need a credit to match the $7,000 debit to salaries expense. In this case, we need to credit cash, as cash is being used to pay the employee salaries. Therefore, the cash account would reflect the payment on the credit side of the T-account for cash.

Cash = Asset

Debit (dr) Credit (cr) Bal. 65,000 (s) 7,000

(m) 26,000 (q) 4,000

JT Consulting also had to pay $500 for utilities. In this case, we set up a T-account for utilities expense. As indicated, the normal balance for expense accounts is on the debit side. In this case the $500 payment looks like this:

Utilities Expense

Debit (dr) Credit (cr)

(v) 500

Cash = Asset

Debit (dr) Bal. 65,000

(m) 26,000 (q) 4,000

Credit (cr) (s) 7,000 (u) 500

Source: Cliffnotes.com

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Analyzing Business Transactions Using T-accounts

Setting Up a T-account for the Drawing Account

As discussed previously, the owners equity (capital) as a rule, is recorded as a credit. However, when an owner withdraws money from the business for personal use, a special account called a drawing account also referred to as owners withdrawal reduces the owners capital. To reflect the decrease in the owners capital account, we set up a T-account called owners drawing with a debit balance.

Continuing with the example from the textbook, Jason Taylor of JT Consulting withdrew $4,000 for personal use. Here we set up a T-account called Jason Taylor, Drawing, which looks like this:

Jason Taylor, Drawing

Debit (dr) Credit (cr)

(x) 4,000

Subsequently, because Jason took money out of the business, we must reflect this decline in

cash. Therefore the T-account for cash is as follows:

Cash

Debit (dr) Bal. 65,000

(m) 26,000 (q) 4,000

Credit (cr)

(s) 7,000

(u) 500

(w) 4,000

The Trial Balance

After all of the T-account balances have been determined, accountants prepare a trial balance. Because all of our debits and credits must match, the trial balance should show an equal amount for our debits and credits. If the debits and credits do not equal, then an error has been made. The trial balance is another way for accountants to check the accuracy of their work.

Below is a sample trial balance for JT Consulting Services Source: Cliffnotes.com

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Analyzing Business Transactions Using T-accounts

JT Consulting Services

Trial Balance December 31, 2019

Account Name

Cash

Accounts Receivable Supplies

Prepaid Rent Equipment

Accounts Payable Jason Taylor, Capital Jason Taylor, Drawing Fees Income

Salaries Expense Utilities Expense Totals

Debit Credit 83,500

5,000

3,000

7,000 22,000

90,000 4,000

35,000 7,000

500

132,000 132,000

7,000

The use of computer software has significantly reduced accounting errors. For example, most accounting programs will not allow you to enter when a debit and credit are not equal. Still, human error does exist. For example, adding trial balance columns incorrectly, recording half of the transaction and not the other, etc.

If the trial balance is correct, we can proceed to create our financial statements.

Source: Cliffnotes.com

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Analyzing Business Transactions Using T-accounts

Chart of Accounts

The chart of accounts is a list of accounts used by a business. It may vary from business to business. For example, a grocery stores chart of accounts would look much different than a tech companys chart of accounts. Each account has a number and a name. The balance sheet accounts are listed first, followed by the income statement accounts.

Asset Accounts Liability Accounts

Owner's Equity Accounts

100-199 Revenue Accounts

200-299 Expense Accounts

300-399

400-499 500-599

Based on the example from the textbook, JT Consultings cash account is assigned account number 101. Fee income is assigned account number 401. All the expense accounts begin with account numbers 500 and end with 599. Owners equity, or in this case Jason Taylor, Capital is assigned account number 301 while Jason Taylor, Drawing receives account number 302.

Permanent and Temporary Accounts

The accounts that appear on the balance sheet are carried at the end of the accounting period. These accounts: cash, accounts receivable, supplies, prepaid rent, and equipment, accounts payable, owners equity are referred to as permanent accounts. On the contrary, revenue and expense accounts are referred to as temporary accounts (show up on the income statement) because the balances are transferred to the owners capital account at the end of the accounting period. In the next accounting period, these accounts start off as zero balances.

Source: Cliffnotes.com

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