Explanation of T Account, Debit and Credit, and Double Entry Accounting System
What are T Accounts?
If you want a career in accounting, T Accounts may be your new best friend. The T Account is a visual representation of individual accounts that looks like a “T”, making it so that all additions and subtractions (debits and credits) to the account can be easily tracked and represented visually.
Debits and Credits for T Accounts
When most people hear the term debits and credits, they think of debit cards and credit cards. In accounting, however, debits and credits refer to completely different things.
Debits and Credits are simply accounting jargon that can be traced back hundreds of years and that is still used in today’s double-entry accounting system. A double-entry accounting system means that every transaction that a company makes is recorded in at least two accounts, where one account gets a “debit” entry while another account gets a “credit” entry.
These entries are recorded as journal entries in the company’s books.
Debits and credits can mean either increasing or decreasing for different accounts, but their T Account representations look the same in terms of left and right positioning in relation to the “T”.
T Accounts Explained
The left side of the Account is always the debit side and the right side is always the credit side, no matter what the account is.
For different accounts, debits and credits can mean either an increase or a decrease, but in a T Account, the debit is always on the left side and credit on the right side, by convention.
Let’s take a more in-depth look at the T accounts for different accounts namely, assets, liabilities, and shareholder’s equity, the major components of the balance sheet or statement of financial position.
For asset accounts, which include cash, accounts receivable, inventory, PP&E, and others, the left side of the T Account (debit side) is always an increase to the account. The right side (credit side) is conversely, a decrease to the asset account. For liabilities and equity accounts, however, debits always signify a decrease to the account, while credits always signify an increase to the account.
In double-entry bookkeeping, a widespread accounting method, all financial transactions are considered to affect at least two of a company’s accounts. One account will get a debit entry, while the second will get a credit entry to record each transaction that occurs.
The credits and debits are recorded in a general ledger, where all account balances must match. The visual appearance of the ledger journal of individual accounts resembles a T-shape, hence why a ledger account is also called a T-account.
A T-account is the graphical representation of a general ledger that records a business’ transactions. It consists of the following:
- An account title at the top horizontal line of the T
- A debit side on the left
- A credit side on the right
Why Do Accountants Use T Accounts?
Accountants use T accounts in order to make double entry system bookkeeping easier to manage.
A double entry system is a detailed bookkeeping process where every entry has an additional corresponding entry to a different account. Consider the word “double” in “double entry” standing for “debit” and “credit”. The two totals for each must balance, otherwise there is an error in the recording.
A double entry system is considered complex and is employed by accountants or CPAs (Certified Public Accountants). The information they enter needs to be recorded in an easy to understand way. This is why a T account structure is used, to clearly mark the separation between “debits” and “credits”.
It would be considered best practice for an accounting department of any business (that is not using a single entry method of accounting) to employ a T account structure in their general ledger.
Introduction to Debits and Credits
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What are debits and credits?
Debits and credits are terms used by bookkeepers and accountants when recording transactions in the accounting records. The amount in every transaction must be entered in one account as a debit (left side of the account) and in another account as a credit (right side of the account). This double-entry system provides accuracy in the accounting records and financial statements.
The initial challenge is understanding which account will have the debit entry and which account will have the credit entry. Before we explain and illustrate the debits and credits in accounting and bookkeeping, we will discuss the accounts in which the debits and credits will be entered or posted.
The Double-Entry Accounting System
Double-entry bookkeeping was developed in the mercantile period of Europe to help rationalize commercial transactions and make trade more efficient. It also helped merchants and bankers understand their costs and profits. Some thinkers have argued that double-entry accounting was a key calculative technology responsible for the birth of capitalism.
The accounting equation forms the foundation of the double-entry accounting and is a concise representation of a concept that expands into the complex, expanded and multi-item display of the balance sheet. The balance sheet is based on the double-entry accounting system where total assets of a company are equal to the total of liabilities and shareholder equity.
Essentially, the representation equates all uses of capital (assets) to all sources of capital (where debt capital leads to liabilities and equity capital leads to shareholders’ equity). For a company keeping accurate accounts, every single business transaction will be represented in at least of its two accounts.
For instance, if a business takes a loan from a financial entity like a bank, the borrowed money will raise the company’s assets and the loan liability will also rise by an equivalent amount. If a business buys raw material by paying cash, it will lead to an increase in the inventory (asset) while reducing cash capital (another asset). Because there are two or more accounts affected by every transaction carried out by a company, the accounting system is referred to as double-entry accounting.
This practice ensures that the accounting equation always remains balanced – that is, the left side value of the equation will always match with the right side value.