Financial Accounting/T-accounts

Required readings

 * Debits and credits

Summary

 * As we read in a previous section, for every accounting entry we make, there must be another entry (or series of entries) made to another account. More specifically, debits and credits must be in balance.
 * The concept of debits and credits is very important and will be the foundation of your accounting skills. Even accounting professionals still think in terms of debits and credits. These foundation principles are very important to master.
 * At this point, we will start using T-accounts to master the debits and credits. In modern accounting systems, T-accounts are no longer used, however, they are very useful in explaining bookkeeping concepts.
 * The following diagram will help explain the concept. Remember from our normal balance reading in the 5th session that assets and expenses have a normal debit balance and liabilities, equity and revenues have normal credit balances. It is common convention to put debits on the left, and credits on the right. Let's take a look at these in T-account format:

ASSETS                            |                   LIABILITIES |        CASH                ACCOUNTS RECEIVABLE     |     ACCOUNTS PAYABLE            LOAN --       ---     |                       |                          |               |            |                     |          |                          |               |            |                     |           |                          |               |            |                     |          |                          |               |            |                     |                                                     |      INVENTORY                     OVEN             |                       EQUITY --               --          |          |                          |               |     RETAINED EARNINGS |                         |               |    ---          |                          |               |            |          |                          |               |            |                                                     |            |                                                     |            | ____________________________________________________|__________________________________________________                    EXPENSES                         |                   REVENUE |  COST OF GOODS SOLD           ELECTRICITY          |          SALES --          ---          |         ---          |                          |               |            |          |                          |               |            |          |                          |               |            |          |                          |               |            |                                                     |

Examples
We will go through some examples using the T-accounts to illustrate how these debits and credits work. Keep in mind that accounting software will not use the T-accounts, these are just used for illustrative purposes. These are highly effective, however, to learn your debits and credits.


 * Debby starts a bakery. She borrows $4,000 from her father to purchase an oven and some inventory (flour and other ingredients) to start making bread, cupcakes and other baked goods:

ASSETS                            |                   LIABILITIES |        CASH                ACCOUNTS RECEIVABLE     |     ACCOUNTS PAYABLE            LOAN --       ---     |                  4,000|                          |               |            |                     |4,000          |                          |               |            |                     |           |                          |               |            |                     |          |                          |               |            |                     |                                                     |      INVENTORY                     OVEN             |                       EQUITY --               --          |          |                          |               |     RETAINED EARNINGS |                         |               |    ---          |                          |               |            |          |                          |               |            |                                                     |            |                                                     |            | ____________________________________________________|__________________________________________________                    EXPENSES                         |                   REVENUE |  COST OF GOODS SOLD           ELECTRICITY          |          SALES --          ---          |         ---          |                          |               |            |          |                          |               |            |          |                          |               |            |          |                          |               |            |                                                     |


 * Debby purchases an oven for $3,000 cash and $500 worth of ingredients on credit and leaves $1,000 for incidentals:

ASSETS                            |                   LIABILITIES |        CASH                ACCOUNTS RECEIVABLE     |     ACCOUNTS PAYABLE            LOAN --       ---     |                  4,000|                          |               |            |500                  |4,000          |3,000                     |               |            |                     |           |                          |               |            |                     |          |                          |               |            |                     |                                                     |      INVENTORY                     OVEN             |                       EQUITY --               --          |       500|                     3,000|               |     RETAINED EARNINGS |                         |               |    ---          |                          |               |            |          |                          |               |            |                                                     |            |                                                     |            | ____________________________________________________|__________________________________________________                    EXPENSES                         |                   REVENUE |  COST OF GOODS SOLD           ELECTRICITY          |          SALES --          ---          |         ---          |                          |               |            |          |                          |               |            |          |                          |               |            |          |                          |               |            |                                                     |

ASSETS                            |                   LIABILITIES |        CASH                ACCOUNTS RECEIVABLE     |     ACCOUNTS PAYABLE            LOAN --       ---     |                  4,000|                       500|               |            |500                  |4,000          |3,000                     |               |            |                     |           |                          |               |            |                     |          |                          |               |            |                     |                                                     |      INVENTORY                     OVEN             |                       EQUITY --               --          |       500|                     3,000|               |     RETAINED EARNINGS |40                       |               |    ---          |                          |               |            |          |                          |               |            |                                                     |            |                                                     |            | ____________________________________________________|__________________________________________________                    EXPENSES                         |                   REVENUE |  COST OF GOODS SOLD           ELECTRICITY          |          SALES --          ---          |         ---        40|                          |               |            |500          |                          |               |            |          |                          |               |            |          |                          |               |            |                                                     |
 * Debby sells bread to a local restaurant on credit for $500. Using her cost accounting skills, she calculates that this bread costs $40 to make. We will move $40 worth of inventory (ingredients) from assets to cost of goods sold since she no longer has these ingredients available to make more bread. They have now become expenses.


 * A month goes by. In that month Debby collects $500 from her restaurant customer, pays $500 for her inventory that she had bought on credit and sells $2,000 worth of baked goods with a cost of $150 and receives an electricity bill for $175.

ASSETS                            |                   LIABILITIES |        CASH                ACCOUNTS RECEIVABLE     |     ACCOUNTS PAYABLE            LOAN --       ---     |                  4,000|                       500|               |            |500                  |4,000          |3,000                     |500            |         500|                     |        500|                          |               |            |175                  |          |500                       |               |            |                     |     2,000|                          |               |                                                     |      INVENTORY                     OVEN             |                       EQUITY --               --          |       500|                     3,000|               |     RETAINED EARNINGS |40                       |               |    ---          |150                       |               |            |          |                          |               |            |                                                     |            |                                                     |            | ____________________________________________________|__________________________________________________                    EXPENSES                         |                   REVENUE |  COST OF GOODS SOLD           ELECTRICITY          |          SALES --          ---          |         ---        40|                       175|               |            |500       150|                          |               |            |2,000          |                          |               |            |          |                          |               |            |                                                     |

Problems

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Solutions

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