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Double-entry and T accounts

The transactions relating to Geo ppv from notes 01 and 02 are listed briefly below:-
01 Set up business with £6000 cash in the bank.
02 Paid £2000 cash for purchase of leasehold premises.
03 Paid £500 cash for purchase of stock (inventory).
04 Acquired oven for £2000 (£500 cash) & balance £1500 on credit payable later
05 Cash loan advanced to DEF Ltd of £1000 due back in 3 months time.
06 Rent paid in advance £500.
07 Sells one half of the stock for £4250 cash and £4000 on credit
08 Prepaid rent used up.
09 Accrued £300 telephone expenses in the accounting period.
10 Accrued £1000 legal expenses in the accounting period.
11 Amortise leasehold premises cost over 5 years (straight line).
12 Depreciate gas oven equipment cost over 10 years (straight line).

We solved this problem using the rationale underlying the accounting equation, namely,

Assets = Liabilities + Equity

In the real world accountants solve such problems, and in general keep accounting records, through
a system known as "double entry" book-keeping. This method may be thought as a series of named
ledgers, or accounts, known as "T" accounts.

The eponymous "T" account is a device for recording the asset and liability transactions of a
business by according asset or liability status to a transaction through its position in the named or
specified "T" account,

Thus left hand side entries in a "T" account are thought of as asset entries, and right hand side
entries as liability entries. In this way, the entries (numbers) have direction (plus or minus), and
depending upon whether the name of the account or ledger is an asset account or a liability account
the increasing or decreasing balances of the ledgers are inferred from the accounting entries posted
to them, and so trace out the economic events that gave rise to them.

Here is a "T" account schema:-

Name of Account
Asset Side, or Liability Side, or
(Dr) Debit Side, (Cr) Credit Side,
or, Plus side or, Minus side

Taking transaction 01 above, "set up business with £6000 cash in the bank", this infers from our
knowledge of the accounting equation that the asset of cash increased by £6000 and the (undated
obligation) owner equity (OE) also increased by £6000.

The accounting entry approach would be:-

Transaction + Assets - + Liabilities - + Equity -
Cash at Bank [Rec'd] 6000
OE (Cash introduced) 6000

We capture exactly the same information using "T" accounts as follows:-

Cash at Bank (BS) Owner Equity (BS)

[transaction no. 01
01 6000 in this case, serves 6000 01
only to identify the
transaction]

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Cash at bank represents an asset account, thus a left hand side, asset, debit or plus entry
posted to an asset account indicates that there has been an increase in the asset of cash
of £6000 for the business arising from this transaction entry.

By similar argument, Owner Equity represents an obligation (or liability) account, so a right hand
side, liability, credit or minus entry posted to an obligation account indicates that there has been an
increase in the obligation or liability of owner equity of £6000 for the business arising from this
transaction.

Taking transaction 02, "Paid £2000 for purchase of leasehold premises."

The accounting equation entry would be:-
Transaction + Assets - + Liabilities - + Equity -
Purchase of Leasehold 2000
Cash at Bank [Paid] -2000

We capture this transaction using "T" accounts as follows:-

L/hold Premise (BS) Cash at Bank (BS)

02 2000 2000 02

Leasehold Premises represents an asset account, thus a left hand side or debit entry posted to an
asset account indicates that there has been an increase in the named asset account of £2,000 for
the business.

By similar argument, Cash at Bank also represents an asset account, so a right hand side, liability,
credit or minus entry posted to an asset account indicates that there has been a reduction or
decrease in the asset of cash at bank of £2000 for the business arising from this transaction.

Thus we can see that this system is a "four-way" model which permits only two possible entries,
Debit or Credit, to be posted to ledger accounts which are denominated as either Asset Accounts or
Liability Accounts. Thus a left hand side debit or plus entry increases asset accounts but decreases
Liability Accounts. Similarly a right hand side credit or minus entry increases Liability accounts but
decreases Asset accounts.

To work the system all items must fit this categorisation [asset, liability, debit entry or credit entry];
so, since equity represents amounts owed to the owners by the business [recall, as discussed in
note 1, it represents their stake or investment in the business], similar in principal to any creditor
account, ie an amount owed by the business to third parties [in this case, the owners], then for the
purpose of operating the double entry system we regard Equity as a Liability account [see 01 above]
We may now complete the double entry book-keeping for the rest of these transactions 03 - 12:

The accounting equation entry for transaction 03 is:-

Transaction + Assets - + Liabilities - + Equity -
Purchase of Stock 500
Cash at Bank [Paid] -500
The "T" account entries for transaction 03 are:-
Cash at Bank (BS) Stock of Pies (BS)
01 6000
2000 02
500 03
03 500

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The accounting equation entry for transaction 04 is:-

Transaction + Assets - + Liabilities - + Equity -
Purchase of Oven 2000
Cash at Bank [Paid] -500
Oven Creditor 1500
The "T" account entries for transaction 04 are:-
Gas Oven (BS) Crs - Gas Oven (BS)

04 2000
1500 04

Cash at Bank (BS) [Crs = Creditors]

01 6000
2000 02 [Drs = Debtors]
500 03
500 04

The accounting equation entry for transaction 05 is:-

Transaction + Assets - + Liabilities - + Equity -
Cash Loan to DEF Ltd 1000
Cash at Bank [Paid] -1000
The "T" account entries for transaction 05 are:-
Cash at Bank (BS) Drs - DEF Loan (BS)
01 6000
2000 02
500 03
500 04 05 1000
1000 05

The accounting equation entry for transaction 06 is:-

Transaction + Assets - + Liabilities - + Equity -
Rent Paid in Advance (pia) 500
Cash at Bank [Paid] -500
The "T" account entries for transaction 06 are:-
Cash at Bank (BS) Rent [pia] (BS)
01 6000
2000 02 06 500
500 03
500 04
1000 05
500 06

The accounting equation entry for transaction 07 is:-

Transaction + Assets - + Liabilities - + Equity -
Cash at Bank [Rec'd] 4250
Debtors 4000
Sales of Stock 8250
Stock -250
Cost of Sales -250

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The "T" account entries for transaction 07 are:-

Cash at Bank (BS) Drs - Credit Sale (BS)
01 6000
07a 4250 2000 02
500 03
500 04 07a 4000
1000 05
500 06

Stock of Pies (BS) Sales - Income (PL) (see note (c) below)
03 500
250 07b 8250 07a

Cost of Sales - Exes (PL) (see note (c) below)

[Exes = Expenses]
07b 250

The accounting equation entry for transaction 08 is:-

Transaction + Assets - + Liabilities - + Equity -
Rent Paid in Advance (pia) -500
Rent Expense -500
The "T" account entries for transaction 08 are:-

Rent [pia] (BS) Rent - Exes (PL) (see note (c) below)

06 500 08 500
500 08

The accounting equation entries for transactions 09 & 10 are:-

Transaction + Assets - + Liabilities - + Equity -
Telephone Expenses (accrued) -300
Legal Expenses (accrued) -1000
Expenses Accrual 1300
The "T" account entries for transactions 09 & 10 are:-

Tel - Exes (PL) (see note (c) below) Crs - Accruals (BS)

09 300 300 09
1000 10

Legal - Exes (PL) (see note (c) below)

10 1000

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The accounting equation entries for transactions 11 & 12 are:-

Transaction + Assets - + Liabilities - + Equity -
Leasehold Premises -400
Gas Oven -200
L/hold Amortisation Charge -400
Gas Oven Depreciation Charge -200
The "T" account entries for transactions 11 & 12 are:-

L/hold Premise (BS) L/H Amort - Exes (PL) (see note (c) below)

02 2000 400 11
400 11

Gas Oven (BS) Oven - Dep'n Exes (PL) (see note (c) below)

04 2000 200 12
200 12

Once the transactions have been posted to the accounts we must evaluate the balance on each
account; this is achieved by adding up both sides of the "T" account and determining whether the
balance is a plus or minus balance, or in this terminology, a debit or credit balance.

Consider the cash "T" account:- Cash at Bank (BS)

01 6000
07a 4250 2000 02
500 03
500 04
1000 05
500 06

total debits ---> 10250 4500 <--- total credits

Balance = 10250 Dr - 4500 Cr = 5750 Dr

The cash account (after 'casting' the numbers - adding up to you and me) had debit entries of
10250, and credit entries amounting to 4500; ie 10250 - 4500 = 5750;
Thus, the 'B'alance is shown on the 'B'iggest side, in this case a debit balance of 5750, simply
written as 5750Dr.

Consider the Creditors for accrued tel/legal expenses:-

Crs - Accruals (BS)
300 09
1000 10

total debits ---> 0 1300 <--- total credits

Balance = 0 Dr - 1300 Cr = 1300 Cr

Again, by inspection, we can see that the 'B'alance will lie on the 'B'iggest side, in this case a
credit balance of 1300, simply written as 1300Cr.

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Adding and listing of all such account balances produces a list called the "Trial Balance". This is
the starting point for the preparation of the accounts:-

Account Trial Balance of Geo ppv Debit Credit

Balances Balances
Leasehold Premises 1600
Gas Oven 1800
Owner Equity 6000
Closing Stock 250
Debtors - Loan 1000
Debtors - Sales 4000
Creditors - Oven 1500
Creditors - Accruals 1300
Cash at Bank 5750
Sales 8250
Cost of Sales 250
Telephone Expenses 300
Legal Expenses 1000
Rent Expenses 500
Depreciation Charges 200
Amortisation Charges 400

Totals 17050 17050

We are not altogether surprised to find that the sum of the debit balances equals the sum of the
credit balances; we have captured both sides of the transactions [debits and credits] at every stage;

Historically, the above process of extracting the trial balance was undertaken manually, and this
could constitute very labour intensive work for large companies. These days, however, the whole
process is computerised, and trial balances may be produced at will, daily, even hourly, and
certainly effortlessly at the flick of a switch.

Journal entries are a form of accounting shorthand instruction itemising which accounts to
debit, and which to credit. Such adjustments to the accounts were kept in a journal book with an
accompanying legend describing the transactions. Thus the instruction to accrue outstanding but
due telephone and legal expenses would be written thus:
DR CR
Description:- Accruals 1300
Telephone expenses 300
"Accrual for telephone and Legal expenses 1000
legal expenses for year
ending dd/mm/yy...."
1300 1300

Two final points to note (a) the "T" account has been referred to as an "account schema." This is
because in the real world, ledger accounts vary in page layout format from system to system and
are only represented in working papers as a "T" for illustrative and training purposes.

(b) The trial balance is not part of the double entry (books of account) of the business. It is merely
a listing of all the balances extracted from the books of account (the T accounts) of Geo ppv at a
certain point in time.

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Note (c)
The rationale for positioning expenses on the left hand (or debit) side, and income or revenues on
the right hand (or credit) side is as follows:-

Owner Equity is an obligation of the business to the owners, and as an (undated) obligation of the
business it is a liability and thus is entered on the right hand side. Since increasing profits increase
owner interests in the business, increasing profits increase owner equity, and therefore increase
the obligations of the business. Thus we would expect profit (per se) to be a right hand side entry,
and this is correct.

Since profit is the sum of income less expense, by positioning expense on the left hand side it will
reduce owner equity (since expense reduces profit), and by positioning income on the right hand
side it will increase owner equity (since income increases profit). In this way, the schema can be
made to fit five classifications, viz, assets, liabilities, equity, expenses and income, as follows:-

Account Name
Assets Liabilities
Expenses Equity
Income

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