Browse By

Basic accounting short course: Accounting training for small businesses – Preparing the T-account

In the previous example, we introduced the concept of debit and credit and basic accounting rules. Let’s put them to work and create a T-account.

Here are the rules and the T-account for quick reference

Name of the item

Date
$
Date $
xxxx Other account in the transaction xxxxxxx Other account in the transaction xxx

The left hand side of this account is called the debit side while the right hand side is called the credit side. On top of the T-account we put the name of the account. Every transaction is recorded with the date and the amount and also we put the name of the other account that is being affected as a result of this transaction. For instance, if this was the T-account for cash balance, we would note down the following transactions

  1. Increase in cash by 100,0000 on account of contribution of capital
  2. Decrease in cash by 50,000 on account of purchase of a fixed asset.

Despite the T account we are still missing some basic rules. Do we record the increase and later decrease in cash on the left side or the right side? This is where the basic rules of accounting come in handy. Here is what they look like.

An increase in asset is always debited.

A decrease in asset is always credited.

An increase in liabilities is always credited.

A decrease in liabilities is always debited.

An increase in capital is always credited.

A decrease in capital is always debited.

An increase in expense is always debited.

An increase in revenue is always credited.

And now for our example:

Following are the business transactions of Mr. Mark’s newly formed company Mark and Co. Let us go through these transactions one by one and try recording them

September 2010

Sept. 1 Started business with $70,000 cash.

Sept. 2 Bought machinery on credit from Tom for $15,000.

Sept. 4 Deposited $50,000 cash in the bank account.

Sept. 5 Bought inventory on credit from Jason worth $5,000 and Andrew worth $6,000.

Sept. 7 Bought van for $8,000 and paid by cheque.

Sept. 8 Sold inventory on credit to Wilson worth $2,000 and Chie worth $1,000

Sept. 10 Sold inventory for cash worth $3,000

Sept. 11 Wilson returned inventory worth $2,00 that was sold to him on Sept. 8

Sept. 12 Returned inventory worth $1,00 that was bought on credit from Andrew on Sept. 5

Sept. 13 Wilson cleared his account by cheque.

Sept. 14 Paid cash to Jason $5,000 for the inventory that was purchased on Sept. 5

Sept. 15 Paid Tom $4,000 by check for the machinery purchased on Sept. 2. The balance is yet to be paid.

We need to explain some terms before we start:

Inventory: These are the goods that a business buys or manufactures with the purpose of sale to generate profit. These are treated as an asset.

Accounts receivable: The money owed to the business comes under accounts receivable. This is also an asset for the business.

Accounts payable: The money owed by the business is classified as accounts payable. They are liabilities of the business.

Purchase, sale and return of inventory are treated differently than other accounts. When we purchase inventory, we record it in a ‘Purchases’ account. This is an expense account. When we sell inventory, we record it in a ‘Sales’ account and the nature of this account is revenue.

Similarly, if we return inventory to our supplier then it is recorded in ‘Purchase return’ account which can be thought of as opposite to that of expenses and the inventory that is returned to us by our customers is recorded in ‘Sales return’ account which is opposite in nature to revenue.

It is important to make this distinction because all the revenue and expense items go in the income statement

We will first explain the effects of the transactions and then we will record them in the T-accounts. The process of recording the transaction in the T-accounts is explained for the first two transactions. After that, only the effects of transactions are explained and the T-accounts follow the explanation.

Sept. 1 Started business with $70,000 cash.

This will increase capital and cash by $70,000. So we will debit cash and credit capital (Remember cash is an asset and when asset increases it is debited and when capital increases it is credited). This will be recorded in T-account as follows:

Cash Capital

2010 $2010 $
Sept.1 Capital 70,000
2010 $2010 $
Sept.1 Cash 70,000

Notice how the same transaction has opposite effect on two different accounts. Since we had to increase cash by $70,000, we debited cash account by $70,000. We increased capital by $70000 by crediting capital account by $70,000.

Sept. 2 Bought machinery on credit from Tom for $15,000.

This transaction will increase Machinery account, which is a fixed asset, by $15000 and will also increase Tom’s account (accounts payable), which is a liability, by $15000. Therefore, we will debit Machinery and credit Tom by $15000.

Machinery Tom

2010 $2010 $
Sept.2 Tom 15,000
2010 $2010 $
Sept.2 Machinery 15,000

Sept. 4 Deposited $50,000 cash in the bank account.

In accounting, two separate accounts are made to record cash and bank transactions. In this case, cash is being transferred into bank. We will debit bank and credit cash by $50,000 to increase bank and decrease cash account.

Sept. 5 Bought inventory on credit from Jason worth $5,000 and Andrew worth $6,000.

As explained above, purchase of inventory is recorded in the purchases account. There are two transactions here. We will increase purchases account by $11,000 ($5,000 + $6,000) and increase the accounts of Jason and Andrew (both accounts payable) by $5,000 and $6,000 respectively. So we will debit Purchases account (since it is an expense) by $11,000 and credit both Jason and Andrews’ accounts by $5,000 and $6,000 respectively.

Sept. 7 Bought van for $8,000 and paid by cheque.

Van is a fixed asset while bank is a current asset. We will debit Van account by $8,000 and credit bank account by $8,000.

Sept. 8 Sold inventory on credit to Wilson worth $2,000 and Chie worth $1,000

Sale of inventory will go in to Sales account while Wilson and Chie are our accounts receivables (current assets). Both Sales and account receivables have gone up. We will debit the accounts of Wilson and Chie with $2,000 and $1,000 respectively and we will credit Sales account with $3,000.

Sept. 10 Sold inventory for cash worth $3,000

This will increase Sales account and Cash account. We will debit Cash account and credit Sales account with $3,000.

Sept. 11 Wilson returned inventory worth $200 that was sold to him on Sept. 8

Return of inventory by customer will come under Sales return account. This will increase Sales return and will decrease accounts receivable by $200. We will debit Sales return account and credit Wilson’s account by $200.

Sept. 12 Returned inventory worth $100 that was bought on credit from Andrew on Sept. 5

Return of inventory by us to the supplier will come under Purchases return account. It will increase Purchases return account and decrease accounts payable. Therefore, we will debit Andrew’s account and credit Purchases return account by $100.

Sept. 13 Wilson cleared his account by cheque.

We will debit Bank account and credit Wilson’s account by $1,800 as this is the amount remaining in his account after he returned some inventory.

Sept. 14 Paid cash to Jason $5,000 for the inventory that was purchased on Sept. 5

We will debit Jason’s account and credit cash account by $5000.

Sept. 15 Paid Tom $4,000 by check for the machinery purchased on Sept. 2. The balance is yet to be paid.

We will debit Tom’s account and credit Bank account by $4000.

Having seen the effects of all these transactions, let us now post them into their respective T-accounts.

Cash

2010 $2010 $
Sept. 1 Capital 70,000Sept. 4 Bank 50,000
Sept. 10 Sales 3,000Sept. 14 Wilson 5,000
____ Sept. 30 Balance c/f 18,000
73,00073,000
Oct. 1 Balance b/f 18,000

Note that we have balanced off the accounts with balance c/f (meaning balance carried forward). All the accounts are closed at the end of a period like this. Notice that since cash is our asset it has a debit balance b/f for the next period. Similarly, capital and liabilities will be having credit balances b/f. There are assets whose balance can become a net credit balance at some point where they cease to be assets and are considered liabilities. One such example can be a bank account. Usually, bank will have a debit balance but if we take more money out from our bank than we actually have in it (depending on whether the bank allows it or not) then it is a bank overdraft and is considered as a liability.

Capital

2010 $2010 $
Sept. 30 Balance c/f 70,000Sept. 1 Cash 70,000
Oct. 1 Balance b/f 70,000

Machinery

2010 $2010 $
Sept. 2 Tom 15,000Sept. 30 Balance b/f 15,000
Oct. 1 Balance b/f 15,000

Tom

2010 $2010 $
Sept. 15 Bank 4,000Sept. 2 Machinery 15,000
Sept. 30 Balance c/f 11,000

15,000

15,000
Oct. 1 Balance b/f 11,000

Bank

2010 $2010 $
Sept. 4 Cash 50,000Sept. 7 Van 8,000
Sept. 13 Wilson 1,800Sept. 15 Tom 4,000
Sept. 30 Balance c/f 39,800
51,80051,800
Oct. 1 Balance b/f 39,800

Purchases

2010 $2010 $
Sept. 5 Jason 5,000
Sept. 5 Andrew 6,000Sept. 30 Balance c/f 11,000
11,000 11,000
Oct. 1 Balance b/f 11,000

Jason

2010 $2010 $
Sept. 14 Cash 5,000Sept. 5 Purchases 5,000

Andrew

2010 $2010 $
Sept. 12 Purchases return 100Sept. 5 Purchases 6,000
Sept. 30 Balance c/f 5,900
6,0006,000
Oct. 1 Balance b/f 5,900

Van

2010 $2010 $
Sept. 7 Bank 8,000Sept. 30 Balance c/f 8,000
Oct. 1 Balance b/f 8,000

Sales

2010 $2010 $
Sept. 8 Wilson 2,000
Sept. 8 Chie 1,000
Sept. 30 Balance c/f 6,000Sept. 10 Cash 3,000
6,0006,000
Oct. 1 Balance b/f 6,000

Wilson

2010 $2010 $
Sept. 8 Sales 2,000Sept. 11 Sales return 200
Sept. 13 Bank 1,800
2,0002,000

Chie

2010 $2010 $
Sept. 8 Sales 1,000Sept. 30 Balance c/f 1,000
Oct. 1 Balance b/f 1,000

Sales Return

2010 $2010 $
Sept. 12 Andrew 100Sept. 30 Balance c/f 100
Oct. 1 Balance b/f 100

This completes our review of T-accounts. In the next section we move from T-accounts to ledgers.

Comodo SSL