Finances   30.9.2019

What are T Accounts and Why are they Important?

Ever wondered what’s going on behind the scenes when you enter information into an accounting software? Although the numbers seem simple on the surface, the double-entry accounting that takes place might be more complicated than you think! If you’ve ever taken a beginner’s accounting course, T accounts were likely part of your introduction to the accounting cycle. They don’t get used much in day-to-day accounting, but do illustrate nicely how the account is being balanced as transactions happen, and as such are useful to anyone curious about how double-entry accounting works. You also won’t see T accounts in accounting software, because they are visualizations of accounting processes that the software does automatically for you.

T accounts illustrate how the account is being balanced as transactions happen and it’s useful to anyone curious about how double-entry accounting works. (© unsplash.com)

Accounting Basics

To get started, it’s important to become familiar with some accounting basics. You might have heard the expression “balance the books” before; this refers to the process whereby the two sides of the accounting equation ASSETS = LIABILITIES + OWNER’S EQUITY are balanced. The equation, in a sense, means that everything that has been put into the business—all of the loans and cash from the owner—has to be equal to everything the business owns. When, for example, the business turns a profit from sales, the Cash account under Assets increases, as does the Retained Earnings under the Equity side, and the equation remains balanced.

The General Ledger

Assets, Liabilities, and Equity consist of subcategories known as general ledger accounts. These accounts usually have both a name and an arbitrarily assigned number—for example, Accounts Payable might be numbered as 126, and represents a particular type of liability which generally includes bills that need to be paid by the business. Accounts Receivable generally includes money owed on invoices but not yet paid, and falls under the Assets category.

One of the main principles under which accounting operates is that money never disappears completely—it simply gets transferred into its equivalent in goods or services. Each time a ledger account is debited or credited, an opposite transaction is recorded in another account to represent the flow of money from one account to another. So, for example, if you buy office supplies with cash from the business, the cash account will decrease in value, but the office supplies account will increase in value.

Debits and Credits

Debits and credits don’t mean the same thing in accounting as they do to your bank account. This is where accounting gets confusing for some people! While you may typically associate credits with an increase to your account and debits with a decrease to your account, in accounting they can do either, depending on which side of the accounting equation they belong to. Debits and credits exist in accounting to represent the flow of money from one side of the equation to the other, so some accounts increase in value with debits, while some accounts increase with credits. Generally, Asset accounts increase with debits and decrease with credits, while liabilities and owner’s equity accounts decrease with debits and increase with credits. T accounts are a useful way to illustrate this, and also to illustrate how different transactions affect general ledger accounts.

T Account Format

T accounts are always drawn in the same format, with the name of the ledger account on the top, debits on the left, and credits on the right. For example, the account Cash would look like this:

107 Cash
DebitsCredits

In the event that there is a transaction, the balance would appear on the bottom under the line in which it is positive. Since Cash is an Asset account that increases with Debits and decreases with Credits, a positive Debit balance would mean there’s money in the bank, whereas a positive Credit account would mean it’s overdrawn.

Now, let’s use a T account to illustrate a transaction. Say, for example, you invoice a client for your work. When you finalize the invoice amount in your accounting software, the software would debit Accounts Receivable and Credit Revenues, indicating an increase in Accounts Receivable and a corresponding increase in Revenues—and also a balanced debit and credit.

117 Accounts Receivable
DebitsCredits
100.00
Balance 100.00
135 Revenues
DebitsCredits
100.00
Balance 100.00

Once the client pays the invoice, however, it’s no longer a receivable – it’s cash. So the Accounts Receivable account would receive a credit to reverse the debit, and instead the account Cash would be debited to reflect the increase in cash as a result of the customer’s payment:

117 Accounts Receivable
DebitsCredits
100.00100.00
107 Cash
DebitsCredits
100.00

Ultimately, then, Revenues and Accounts Receivable both increase when you invoice, but when the client pays, the amount is reversed out of Accounts Receivable and added to the Cash account, leaving the Revenues and Cash accounts with an increase of $100.00 on both sides of the accounting equation—but for Cash, the increase is represented as a debit, and in the Revenues account, it’s a credit.

Although they may be interesting to explore, you don’t have to understand these concepts thoroughly in order to use accounting software like Billomat. The bottom line is that accounting software balances your accounts in this way so that your reports reflect a balanced accounting equation. When you enter invoices and then mark them as paid, your Accounts Payable, Revenues, and Cash accounts are all updated accordingly as you do so. Accounting records not only monetary value, but also money’s various physical transformations over time—and Billomat helps you watch it happen!

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