Welcome back to Part 3 of this series. I have posted Part 1 – the rules of debits and credits, and Part 2 – understanding double-entry accounting. I recommend reading the earlier articles if you have not already as they will help you understand part 3 titled – understanding the T-accounts. All three parts are related and work together to give you a strong foundation in accounting basics.
Part 1 goes through what debits and credits are and their importance in accounting while Part 2 goes through the importance of double-entry accounting and how debits and credits affect different accounts.
To quickly recap the last two articles:
- By debiting an asset or expense account you increase its value
- By debiting a liability, equity, or revenue account you decrease its value.
- By crediting an asset or expense account, you reduce its value.
- By crediting a liability, equity, or revenue account, you increase its value.
- whilst at least one other will always be credited, hence the name “double-entry”. These entries show the movement of value around the business.
In this article, we are going to be putting all that knowledge into practice by learning about T-accounts. We are going to go through what they are and how they are used in accounting.
What is a T-account?
A T-account is a visual way of displaying the transactions occurring within a single account.
Any transaction a business makes will need to be recorded in the company’s general ledger. The general ledger is divided up into individual accounts which categorise similar transaction types together.
The reason it is called a T-account is simply that it is shaped like a T.
These diagrams can be used to map out transactions before they are posted into the company’s ledgers to ensure they are correct.
Due to the simplistic nature of T-accounts, they are also used as a learning tool to practice transactions and double-entry accounting.
T-accounts are common practice. They can be found drawn on a scrap piece of paper to templates made in accounting software.
A T-account has three sections. The top is the name of the account. The left-hand side is where you enter debits whilst the right-hand side is where you enter credits.
T-accounts are used to track debit and credit made to an account.
Each T-account will only display one account.
If you remember from my earlier posts “rules of debits and credits” and “understanding double-entry accounting”, we went through how every debit must have a matching credit and vice versa. When one account is debited, another account will be credited.
So, to show this, T-accounts are usually displayed in pairs to show the impact of a complete business transaction in your accounts.
How to use T – Accounts in Accounting?
We will go through different types of transactions and see how to use T-accounts to display the movement of value through the business. Let us use Zobo Drink shop to represent a business throughout these examples.
Example 1 – Selling Zobo Drink
Transaction 1: I sell a cup of Zobo Drink to a customer for
N500. What happens in the accounts?
As you can see, my bank account (an asset account) is debited
N500, increasing its value. My income account (Revenue account) is being credited N500, increasing its value, and making the transaction balanced.
Transaction 2: I use some inventory for instance Sugar worth
N50 when making the Zobo drink. What happens in the accounts?
The ingredients for the cup of Zobo drink are recorded as inventory (Asset account) and also expense. They come from my store cupboard. My inventory is reduced each time I sell a cup of Zobo drink, so I need to credit the inventory account by
N50, reducing its value, and record a debit of N50 in the Expense account. This is a double-entry, and the accounts are balanced.
Example 2 – Purchasing a Zobo Drink Filling machine
Transaction 3: My Zobo Drink shop purchases another machine for
N50,000. However, I sign an agreement to pay for the machine next month. So, what happens to the accounts?
As I have received the filling machine, I have gained
N50,000 worth of fixed asset (my fixed asset account has been debited).
I have agreed to pay for the machine next month so my accounts payable is increased (credited) by
N50,000. Accounts payable is a liability account, keeping track of bills I still have to pay in future.
Transaction 4: A month passes, and I pay
N50,000 for the machine.
My bank account is credited
N50,000 (reducing its value) as I am now paying for the coffee machine.
With the outstanding bill paid, the accounts payable account is debited by
N50,000, reducing its value and showing that I no longer owe this amount.
Any accounting transactions can be recorded in a T-account no matter how complex it is. It is always good and recommended to try to draw out all transactions in T-accounts before they are committed to the company records.
When multiple transaction entries are recorded in a T-account, a balancing number on either debit or credit is calculated in order to balance both sides. This will result in a trial balance account. We shall be discussing this in our future article.
What is this all for?
Is this worth understanding if you are not an accountant?
Whether you are an accountant or a decision-maker the language of business finance is rooted in accounting. Whatever your role is in the business, it is worth grasping the basics of this language.
Every transaction a company makes, whether it is selling Zobo drink, taking out a loan, or purchasing an asset, has a debit and a credit. This ensures a complete record of financial events is tracked and can be accurately represented by financial reports.
The key financial reports, your cash flow, Income (Profit or Loss) statement, and balance sheet are organised representations of these fundamental accounting records. They are built from the ground up by these debits and credits. You will be analysing these reports to aid your decision-making process.
Your profit or loss statement organises your revenue and expense accounts whilst your balance sheet organises your Asset, Liability, and Owners Equity accounts. The Double-entry process connects these reports together.
A single transaction will have impacts across all reports due to the way debits and credits work. So, grasping these basics helps you delve into these reports and understand the financial story they tell.
When you enter any transaction correctly in the T-accounts, the double-entry process is completed correctly, and your trial balance is correct. You will save a lot of time and have confidence in your numbers. It means you can spend more time analysing the results rather than looking for the missing number that is making your account, not balance.
Conclusively, I recommend that you lay your hands on T-accounts by trying out to record your transactions using what you have learned in Part 1 “Rule of Debits and Credits”, Part 2, “Understanding Double-Entry Accounting”, and Part 3 “Understanding T-Account”.
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Written by Hay-R-Hay