Boston University School of Management

Accounting 2:
The Balance Sheet,
T-accounts, Debits, and Credits

Professor Robb Dixon

Based on a lecture by
Professor Eng Wu
 Quiz 1

Stockholders’ equity is

A. The fair market value of a company

B. Liabilities minus assets

C. Contributed capital plus retained earnings

D. Revenue minus expenses

Boston University School of Management

 Recap
SMG Corporation
Financing
Operating Balance Sheet
Activities
Activities 26 January 2010

Current Assets Current Liabilities

Long term assets Long term Liabilities

Owners Equity

Investing A = L + OE
Activities
Boston University School of Management
 Balance Sheet

Some items commonly found in the balance sheet:

Current Assets Current Liabilities
Cash Accounts payable
Accounts receivable Wages Payable
Inventories Accrued liabilities
Prepaid expenses Unearned revenues

PPE Notes Payable

Intangibles Bonds Payable

Others Contributed capital

Retained Earnings
Boston University School of Management
 Transaction Analysis
Once a company is formed and starts to do business, there will
be many accountable activities. Some are:
Explicit:
Activities that are observable. Example: You buy a book from
Barnes and Noble – B&N gives you the book and in return
you pay for it with cash (or credit card).
Some observable activities are not recorded because they have
no immediate impact on Assets, Liabilities, or Owners Equity.
Also, we cannot reasonably assign a $ amount to such events.
***Apple announces a new iPhone.***
*** Lehman Bros. fails. ***
Implicit:
These are unobservable activities that must be recorded.
Boston University School of Management
 The Balance Sheet Equation

Accountable transactions have an impact on two or more

accounts. We need to examine each transaction and
determine:

1. The accounts that are affected

2. Whether the impact is positive (increasing the value
of the account) or negative (decreasing the value of the
account).

With the BS equation A=L+OE we can see the impact of

the transaction on the balance sheet.

Boston University School of Management

 Example of transaction
The company borrowed $50,000 from a bank, signing
a note agreeing to repay the amount in two years.
The two accounts affected are:
Cash Cash is increased because Co. received
$50,000 from a bank.
Note Note Payable, a liability is increased
Payable because the company has committed to
repay the loan.

A = L + OE
Cash N/P

Boston University School of Management

 Example 2
The Company bought $5,000 worth of inventories (goods
for resale) paying the supplier 20% cash and the rest to
be paid in 60 days.
Here, 3 accounts are involved:
Inventories Co. has more goods - assets increase
Cash Cash is paid out – assets decrease
Accounts Commitment to repay – liabilities
Payable increase
A = L + OE
Inventories Cash A/P
5,000 - 1,000 4,000
Boston University School of Management
 Example 3
The Company signed a contract with Ms. Smart to
employ her as the Company’s CFO beginning February
2013. The annual salary is agreed at $200,000 a year.
This is not an accountable transaction – no impact on
assets, liabilities, or owners’ equity.

Once Ms. Smart starts working, company will have to

pay her – the accounting starts then.

Note also, when analyzing a transaction – always

take it from the Company’s point of view – unless
otherwise stated.

Boston University School of Management

 Quiz 2

American Corp installed $25,000 of equipment, paying

$5,000 in cash and promising to pay $20,000 in 90 days.
As a result of this transaction

A. Total assets will increase by $5,000

B. Total assets will increase by $20,000
C. Total assets will increase by $25,000
D. Total assets will increase by $30,000

Boston University School of Management

 Recording of Transactions

We are now familiar with how transactions can affect

the balance sheet. Do companies analyze each event
and adjust the Balance Sheet as necessary?

No. Events are first recorded in books (journals),

summarized, adjusted, and checked for accuracy
before the balance sheet is prepared.

Accounting attempts to record the transactions in a

precise, concise manner – using a system known as
“double-entry” bookkeeping.

Boston University School of Management

 The Language of Business
•Accounting is commonly known as the language of business
because it adopts a common method to communicate with
stakeholders.
•It is termed double-entry because companies not only record
what they have, but also, how they are financed.
•Transactions are first recorded in “Journals” and subsequently
posted to “Ledgers”.
•To keep the recording simple and yet meaningful, accounting
employs a system of “Debits” and “Credits”.
•The terms Debits and Credits must not be confused with the
meaning of the words in English. They are simply words employed
in accounting. You may think of:
Debit as left hand side and Credit as right hand side.
Boston University School of Management
 Debits and Credits
The balance sheet is organized in the debit/credit format:
Balance Sheet

Liabilities
Assets
Owners’ Equity

Debit side Credit side

All asset accounts All liabilities and OE

are “debit” items accounts are “credit” items

Boston University School of Management

 Increase or Decrease
•Assets are debit items – so, when we “debit” an asset
we increase its value
•Conversely, when we “credit” an asset, we decrease
its value.
•Liabilities and OE items are on the “credit” side, so
they work in the reverse way.
•When we “credit” a liability or OE item, we increase its
value and if we “debit” one, we decrease its value.
•It’s not good English, but it’s kind of logical:
The value of the account will increase when you
“Debit” a debit item or “Credit” a credit item.
Boston University School of Management
 Journal Entries
Transactions are recorded in Journals in a concise
manner. The recordings are called “Journal Entries”
and they are written in a specific form.
Example: A company paid $25,000 cash for a car.
Using the balance sheet equation, we would say cash
decreased by $25,000 and another asset (equipment)
increased by $25,000.
Both items involved in this transaction are assets or
“debit” items.
The rule: “debit” a debit item - increase
“credit” a debit item - decrease
Boston University School of Management
 J.E. - continued

We need to “debit” equipment and “credit” cash to recognize

that the company is using cash to purchase new equipment.
The journal entry for this is: NB:
Eqpt 25,000
Cash 25,000 is
Equipment (car) 25,000 not a JE
Cash 25,000

By convention: the “debit” entry is written first.

The “credit” entry follows and is indented right.
Each entry has an account name and the relevant $ amount.
Sometimes there are multiple debit and/or credit items. In
such cases, total $ of debits must equal total $ credits.
Boston University School of Management
 Examples of J.E.’s
Using the same examples that were used when we
examined the balance sheet equation:
1. Co. borrowed $50,000 from a bank, signing note.
2. Co. purchased inventories for $5,000 paying 20%
cash and the rest in 60 days.
Journal entries:
1. Cash 50,000
Notes Payable 50,000
Note:
2. Inventories 5,000 Debit =
Cash 1,000 sum of
Accounts Payable 4,000 credits
Boston University School of Management
 Examples of J.E.’s

Suppose you sell products for which you paid

$60,000 for $100,000 (buy low, sell high). Of
the $100,000 in sales, half is for cash and half
on credit.
Cash $50,000
Accounts Receivable $50,000
Expenses $60,000
Inventory $60,000
Revenues
$100,000
Boston University School of Management
 T-Accounts
All accountable transactions are first recorded in “Journals” –
using the journal entry format and subsequently posted (or
transferred) to “Ledgers” or T-Accounts. Every account in the
balance sheet has its summary in a T-account.
BS accounts are permanent in that the reported balances for
each account are carried over to the next accounting period.
If a company reported, say, $10,000 cash in its year end BS, then
this amount is the beginning balance for the cash T-account in
the following accounting period. Cash
Using the above and the BB: 10,000
previous examples, the Cash 1,000 (2)
T-account would look like: (1) 50,000
Boston University School of Management
EB: 59,000
 T-Accounts
Note that the same Debit/Credit convention is used here:

Debits Credits

1. Cash 50,000
Notes Payable 50,000

2. Inventories 5,000
Cash 1,000
Accounts Payable 4,000
Boston University School of Management
 Postings

Except for the Cash a/c other T-accounts are affected by very few
types of activities.
Accounts Receivable:
1. Debited (increased) by credit sales
2. Credited (decreased) by collections
3. Credited (decreased) by write-offs
Accounts Payable:
1. Credited (increased) by purchases
2. Debited (decreased) by payments
Equipment:
1. Debited by purchases new equipment
2. Credited by sales of old equipment
What about depreciation?
1. It’s an expense
2. Accumulated Depreciation is a contra-asset
Boston University School of Management
 Preparation of BS
Once all T-accounts are completed, the ending balance of
each T-account forms the final value on the new BS.
T-a/cs
Old BS
Journal
Beginning entries
balances
(assets) EB EB (Liab. OE)
New BS

Boston University School of Management

 Complete example
Consider a Co. reported in last year BS: $30,000 cash, $15,000 accounts
receivable, $40,000 inventories, and $12,000 accounts payable.
Current year transactions are:
1. Purchased $30,000 inventories, paying 20% cash, the rest to be paid in
60 days.
2. Sold $60,000 worth of inventories for $100,000 collecting 20% cash and
the rest on credit.
3. Paid $25,000 to suppliers for the purchase of inventories.
4. Collected $70,000 from clients
JE2: Cash 20,000
JE1: Inventories 30,000 A/R 80,000
Cash 6,000 Revenue 100,000
A/P 24,000 Costs of Goods sold 60,000
Inventory 60,000
JE3: A/P 25,000
Cash 25,000 JE4: Cash 70,000
Boston University School of Management A/R 70,000
 T-a/c’s for Example

Cash A/R

BB: 30,000 6,000 (1) BB: 15,000

70,000 (4)
(2): 20,000 (2): 80,000
(4): 70,000 25,000 (3)
EB: 25,000
EB: 89,000 Inventories A/P

BB: 40,000 (3): 25,000 BB: 12,000

(1): 30,000 (2): 60,000 (1): 24,000

EB: 10,000 EB: 11,000

Revenues COGS

(2): 100,000 (2): 60,000

Boston University School of Management

 Quiz 3
Which of the following requires a credit?

A. Decreases in liabilities
B. Decreases in stockholders’ equity
C. Increases to assets
D. Increases to liabilities

Boston University School of Management

 Have a Nice Day!

Boston University School of Management