T-Accounts: The Real Change-Makers

The first change-making tool is T-accounts, named for their T-like shape. We will give every account a T, including assets like cash, accounts receivable, inventory, buildings, and investments; liabilities like accounts payable, sales tax payable, and employee salaries payable; and equity accounts. The account name will show at the top of the T, and there will be numbers on each side of the middle line. Here’s an example T-account for Cash. In this example, the balance of cash is $1,234.

The first three steps in using T-accounts are:

1. Write the T.
2. Write the account name on top of the T (Cash in our example).
3. Enter the opening balanceOpening Balance:
   Balance in an account before transactions are journalized. Usually an opening balance is the balance at the beginning of a period: month, fiscal quarter, or fiscal year. ($1,234 in our example).

Wait, what’s an opening balance? It’s the value of what we owe and own before we make any changes. We need to post these balances. But what side of the T will we post to: the left or the right? The answer lies in how each account is categorized: asset, liability, or equity. Asset balances are on the left-hand side. When we post a number on the left-hand side, we call it a debitDebit:
Left-hand side of a journal entry or T-account. Assets and Expenses/Losses accounts increase with a credit. Liabilities, Equity, and Revenue/Income/Gain decrease with a credit.. Liability and equity balances are on the right-hand side. When we post to the right-hand side, we call it a creditCredit:
Right-hand side of a journal entry or T-account. Liabilities, Equity, and Revenue/Income/Gain accounts increase with a credit. Assets and Expenses/Losses decrease with a credit.. We know from the previous chapter that Cash, A/R, and Inventory are assets, so naturally their balances will be debits, entered on the left-hand side. On the other hand, A/P is a liability and retained earnings is equity, so these will be entered as credits on the right-hand side.

Confusing? Ok, let’s look at an example. Our sample company is Simply Bricks Co, a retailerRetailer:
A company whose business model is selling inventory to the final customer. A retailer will often sell a variety of products and brands. For example, St. John’s Music is a retailer of Yamaha products, but they also sell Fender and Roland brand equipment. of patio bricks. Simply Bricks Ltd.’s Statement of Financial Position, as at 31 March, 20X8, showed:

• Cash of $75,000,
• Accounts Receivable of $30,000,
• Inventory of $50,000,
• Accounts Payable of $20,000, and
• Retained Earnings of $135,000.

Let’s complete our three steps: (1) write the T, (2) write the account name, and (3) enter the opening balance. I’m also going to write a DR on the left-hand side and a CR on the right-hand side because the idea of debit and credit is not going away. We might as well get comfortable with this terminology and integrate it into our work. Please note that o/b stands for Opening Balance.

Great start! We’re all set up to record transactions for the next month: April. But first, let’s discuss how we increase or decrease accounts. Assets increase with debits, which makes sense because assets have a debit balance and decrease with credits. So, let’s write a plus (+) on the debit side of each asset T-account and a minus (-) on the credit side for these asset accounts. Liabilities and equity are just the opposite: they increase with credits and decrease with debits. So, let’s write a minus (-) on the debit side and a plus (+) on the credit side of the liability and equity accounts.

Okay, back to Simply Bricks Ltd. The following transactions took place in April:

• Collection of A/R
• Receipt of Inventory
• Sales
• Payment of A/P

10 April:

Received $5,500 from a customer to pay off his account.

15 April:

Received inventory costing $37,000. The supplier charged this inventory to our account.

17 April:

Sold bricks and received $30,000 in cash. The costCost:
The historical purchase price of an asset. For long-lived asset such as PPE, cost includes all cash outlays to purchase the asset and prepare it for use. of bricks sold was $20,000.

20 April:

Sold bricks for $15,000 on account. The cost of bricks sold was $5,000.

30 April:

Paid back amount owing on account for $25,000.

Let’s record these transactions. I’ll explain the transaction, and the T-accounts with the adjustments follow the explanation. The events are marked with an icon indicating the type of event (check the legend for more information), so take a look at the 10 April explanation and then jump to the T-accounts to see how the T-accounts are affected. Then move on one transaction at a time.

10 April:

The 10 April transaction increases cash and decreases the amount the customer owes on account (A/R). So, we’ll enter $5,500 on the debit side in cash; and $5,500 on the credit side in A/R.

15 April:

On 15 April we got inventory, so let’s increase the Inventory account with a debit. We also need to record that we owe the supplier cash with an increase to A/P: credit.

17 April:

This transaction is a bit more difficult conceptually. Every time we have a sale of inventory, we need to record the transaction in two steps:

We receive cash, so we’ll increase the Cash account with a debit of $30,000. The credit is more abstract: let’s think about who gets the benefit when we make a sale. That’s right—our shareholders! So, we’ll credit Retained Earnings, an Equity account, for $30,000.

We also shipped out $20,000 worth of inventory, so our inventory has decreased. Let’s record a credit to Inventory to reflect that we have less inventory now. Where does the debit go? Remember back to the credit of $30,000 in Retained Earnings? Do our shareholders really benefit $30,000? No—their benefit is the selling price less the cost of the bricks. This difference of $10,000, calculated as $30,000—$20,000, is value Simple Bricks Ltd. creates for shareholders. So, let’s record $20,000 as a debit (decrease) to Retained Earnings. Now the combined change in RE is $10,000: exactly how we want it!

20 April:

This is another sales transaction, so we have two steps. The difference in this transaction is that we’re not receiving the cash now; so instead of debiting Cash for $15,000, we’ll debit Accounts Receivable. The credit is still Retained Earnings for $15,000. Onto the second step: recording inventory. Let’s decrease our Inventory with a credit of $5,000 and decrease our Retained Earnings with a debit of $5,000. Now the combined change to RE, which is value created for shareholders, is $5,000.

30 April:

Bear with me, this is our last transaction. The company pays back $25,000 of Accounts Payable. This will decrease their total amount owing, so we debit A/P. And their cash balance will be lower to reflect the payment: a credit to Cash of $25,000.

The last step is to add the (+) side of each T-account and subtract the (-) side. We’ll write a line at the bottom of the account and do the math. Get out your calculator 😊

Here are the totalled T-accounts for Simply Bricks:

You may have noticed that every transaction has a debit side and a credit side, and the debits amount entered always equal the credits (debits = credits). This is a very cool aspect about accounting. We’ll talk a lot about balancing in this course, but it basically means that the debits = credits, and therefore Assets continue to equal Liabilities + Equity. Cool right?!?

Now that you’ve seen an example of posting to T-accounts, here are two examples for you to try: