T accounts are awesome! T accounts are the most useful tool in accounting.
T accounts are fundamental to your understanding of accounting.
T accounts are helpful in solving any accounting problem.
T accounts are spectacular! OK, that’s enough praise for T accounts.
Let’s get to work. How do you master T accounts?
By taking four simple steps. Stay with me, and let’s get this done!
Here’s a very simple definition of a T account:
a T account is a visual representation of an account, to think through the journal entries
you are going to make to record transactions.
T accounting step one: Take a piece of paper and draw a “t”.
No, not that one. A capital “T”.
Now write: debits on the left, credits on the right.
This is something you need to memorize. Repeat it to yourself fifty times
per day, put post it notes all over your house, or even better: download the Finance Storyteller
lockscreen wallpaper image for your phone, so you can repeat “debits on the left, credits
on the rights” every single time you pick up your phone.
T accounting step two: take a look at this T account and this balance sheet.
Looks pretty similar, right?
That’s because it’s the same basic idea.
Debits on the left, credits on the right.
Asset accounts in their “natural state” have a debit balance,
liabilities and equity accounts in their “natural state” have a credit balance.
You can think of a T account as a mini balance sheet,
for one specific account in the ledger.
Assets go up if you add debits, and down if you book credits.
Liabilities and equity go up if you add credits, and down if you book debits.
Here’s a little secret shortcut that very
few people realize: the two types of income statement accounts revenue and expense are
essentially just a subset of equity. Revenue accounts in their “natural state” have
a credit balance, at the end of the accounting period they will roll up into equity and make
it grow. Expense accounts in their “natural state” have a debit balance, at the end
of the accounting period they will roll up into equity and make it shrink. If revenue
is higher than expenses, you generate a positive net income, which adds to the equity balance.
T accounting step three: for every journal entry that you want to visualize with T accounts,
decide first which type of account you need (asset, liability, equity, revenue, expense),
and then which specific account in that category. Let’s take an example with accounts and
numbers from the “income statement versus balance sheet” video (that I encourage you
to watch first by clicking on the link) to work through some T account examples.
Let’s buy a small building and a forklift truck for one hundred thousand dollars in
total for our chocolate shop, and pay immediately. If you read that sentence carefully, you see
a specific type of assets (things that the company owns) going up in the first part,
and another type of assets going down in the second part. So the type of account is assets
on both the debit and the credit side. More specifically, fixed assets go up, we need
to add debits to this account. Cash is going down, we need to add credits to this account.
Let’s buy a huge amount of product (a hundred thousand dollars’ worth of it) that we plan
to sell to customers later on, and arrange with the supplier to pay his invoice in thirty
days. First part: an asset (more specifically inventory) going up. Second part: a liability
(more specifically accounts payable) going up. Debit inventory, credit accounts payable.
The bank notifies us that the interest on the loan is due, and we pay it immediately.
Debit interest expense, credit cash.
If you credit an asset account like cash, the balance goes down.
T accounting step four: Let’s see what the
T account for cash looks like at the end of the period. We started with two hundred thousand
dollars opening balance (after the company attracted funding), then credited cash when
buying fixed assets by one hundred thousand dollars, and credited cash when paying the
interest to the bank by ten thousand dollars. So the ending balance for cash is ninety thousand
dollars debit balance: 200 minus 100 minus 10. Do this for each of your T accounts, and
you can then proceed to make a trial balance: a listing of all general ledger accounts along
with their respective debit or credit balances for the period.
T accounting in four steps: Debits on the left, credits on the right
A T account is like a mini balance sheet, for one specific account in the ledger
For every journal entry, decide first which type of account you need,
and then which specific account in that category.
To calculate the ending balance for an account,
add up the opening balance and the debits and credits for the period.
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