Double entry accounting: Conceptual framework.
This lesson will reveal THE SECRET of the Accounting Language.
In the previous lessons, it was shown how to tell a business's story using the Balance
Sheet and Income Statement. It will now be shown how to enhance the story
telling by using T-Accounts.
Everything is done the same way as in the last lesson, except, now the accounts within
the Balance Sheet and Income Statement boxes we will represent by drawing a T for each
account.
When a transaction occurs, the change in the affected accounts is shown using the T-Account.
Here is the procedure. There are three steps whenever a transaction
occurs: Step 1 is to determine which accounts are
going to affected. Step 2 is to determine whether the affected
accounts are going to INCREASE or DECREASE as a result of the transaction.
Step 3 is to use the specific T-Accounts to show the INCREASE or DECREASE in each account.
In the previous lessons, it was shown how to complete steps 1 and 2.
Now, it will be shown how to complete Step 3.
In order to use T-Accounts, the following MUST BE MEMORIZED.
Imagine the Balance Sheet, and its two halves. From the center, moving outward, towards the
outsides, means to INCREASE. From the outside, moving inward towards the
center means to DECREASE.
With these rules, T-Accounts can now be used to show how a transaction INCREASES or DECREASES
a particular T-Account.
If we wanted to show that a T-Account on the Asset side was going to INCREASE by 10, we
would write 10 on the LEFT side of the T-Account. It is written on the LEFT side because the
LEFT side is on the INCREASE side.
If we wanted to show that a T-Account in the Liability section was going to increase by
10, we would write 10 on the RIGHT side of the T-Account.
It is written on the RIGHT side because the RIGHT side is on the INCREASE side.
Now, if we wanted to show that a specific Asset account was going to DECREASE by 5,
we would write 5 on the RIGHT side of the T.
It is written on the RIGHT side because the RIGHT side is on the DECREASE side.
If we wanted to show that an Equity account was going to DECREASE by 5, we would write
5 on the LEFT side of the T. It is written on the LEFT side because the
LEFT side is on the DECREASE side.
Now, what about the Income Statement? The Income Statement follows the same rules.
Imagine that the income statement is a part of the Equity section of the balance sheet.
Therefore, the Income Statement increases as you move from left to right, just as the
right side of the balance sheet does.
Any number written on the LEFT side of a T-Account that is on the Income Statement will DECREASE
Net Income. Any number written on the RIGHT side of a
T-Account on the Income Statement will INCREASE Income.
If we wanted to show Revenue of 10 on the Income Statement, we would write 10 on the
RIGHT side of a Revenue T-Account. It is written on the RIGHT side because the
RIGHT side is on the INCREASE side.
If we wanted to show an Expense of 5, we would write 5 on the LEFT side of an Expense T-Account.
It is written on the LEFT side because the LEFT side is on the DECREASE side.
So, as a review, the following must be memorized to use T-Accounts:
From the center of the Balance Sheet moving outward means INCREASE.
From the outside of the Balance Sheet moving towards the middle means DECREASE.
The Income Statement INCREASES from LEFT to RIGHT.
To increase or decrease a T-Account, you must put a number on the RIGHT or LEFT side of
the T, depending on where that account in on the Balance Sheet or the Income Statement.
Once again, there are three steps to use T-Accounts to tell the story of a business:
Whenever a transaction occurs: Step 1 is to determine which accounts are
going to affected. Step 2 is to determine whether the affected
accounts are going to INCREASE or DECREASE as a result of the transaction.
Step 3 is to use the specific T-Account to show the INCREASE or DECREASE in each account.
FINALLY, Here is THE SECRET OF ACCOUNTING.
MEMORIZE THE SECRET: Simply replace the word LEFT with DEBIT,
And RIGHT with CREDIT. Forget everything you know about these words,
DEBIT and CREDIT, And simply see them as meaning, LEFT and RIGHT.
Notice the following examples:
If we want to INCREASE the Asset account by 10, we put a DEBIT of 10.
DEBIT means LEFT. The LEFT side means INCREASE for this account.
If we want to INCREASE the Liability account by 10, we put a CREDIT of 10
CREDIT means RIGHT. The RIGHT side means INCREASE for this account.
If we want to DECREASE the Asset account by 10, we put a CREDIT of 10.
CREDIT means RIGHT. The RIGHT side means DECREASE for this account.
If we want to DECREASE the Equity account by 10, we put a DEBIT of 10.
DEBIT means LEFT. The LEFT side means DECREASE for this account.
If we want to INCREASE a Revenue account by 10, we put a CREDIT of 10.
CREDIT means RIGHT. The RIGHT side means INCREASE for this account.
If we want to DECREASE Income by 5, by adding to an Expense account, we put a DEBIT of 5.
DEBIT means LEFT. The LEFT side means DECREASE Income.
So, to review THE SECRET: LEFT means DEBIT
RIGHT means CREDIT. You must not try to associate ANY OTHER MEANINGS
to the words DEBIT and CREDIT. Do not think of Debit Cards at a bank, or
Credit to your grade. ONLY THINK OF THEM AS MEANING LEFT AND RIGHT.
If you keep all of these rules in mind, using T-Accounts to tell the story of business becomes
very simple. It just requires practice like any language
learning does.