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Hult International Business School - London

International Accounting

Handout 2 – Debits & Credits, T Accounts, Trial Balance Module A - 2015 / 2016

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Debits & Credits (I)Regardless of the type/name of the account ... • The Left hand side is the Debit side;• The Right hand side is the Credit side;

Depending on the type/name of the account ... • Increases / decreases are recorded on one or the other side of the

account.

Image source: http://blog.protectmyid.com/2010/06/07/credit-vs-debit/; http://allisaccounting.blogspot.com/2012/02/important-to-know-about-debit-and.html

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Debits & Credits (II)Following these Debit and Credit rules will insure

that:• Debit balances are equal the Credit balances;• Sum total of all Debits used to record each transaction will

equal the sum total of all Credits used;

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Debits & Credits Practice (I)

Image source: http://paceprep.wikispaces.com/Debits+and+Credit; http://basicaccountingconcepts.wordpress.com/2012/03/31/making-sense-of-debits-and-credits-in-accounting/

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Debits & Credits Practice (II)The Owner’s Equity account below can be further

separated into:• Common Stock, • Retained Earnings (which is the summary account for Revenues,

Expenses and Dividends).

Image source: http://www.learn-accounting.com/business_accounting/L1_2_double_entry_bookkeeping.php

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Permanent & Temporary Accounts

• Accounts that remain open (do not close at the end of the fiscal year.

• All balance sheet accounts (asset accounts, liability accounts, owner's equity accounts) except for the dividends or owner's drawing accounts.

• Accounts that must be closed at the end of each fiscal year (they don't carry any balance into the following year).

• All income statement accounts (revenues, expenses) as well as the dividends or owner's drawing accounts.

Image source: http://hotelmule.com/html/77/n-2777-6.html

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Temporary Accounts (II)Why are temporary accounts

used ?• Temporary accounts are subdivisions

of the Shareholder’s Equity account .• Recording all (thousands of)

transactions directly into Shareholder’s Equity account would cause a mess at the end of the fiscal year when time comes to prepare the Income Statement.

• On the debit (left) side there are expenses and dividends, but which is which ?

• On the credit (right) side there are revenues and investments (common stock), but which is which ?

Shareholder's Equity

Winston Wolfe Capital

+21,000 3,000 21,000+2,000 200 2,000+500 250 500+700 300 700

‐3,000 3,750 24,200‐200 20,450‐250‐300

20,450

Shareholder's Equity

Winston Wolfe Capital

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Temporary Accounts ClosingTemporary accounts are kept for the duration of the fiscal year and

are closed at the end of the fiscal year.• Temporary accounts are closed by transferring their balances into

Retained Earnings account (one of two subdivisions of the permanent Shareholder’s Equity account).

Accounts normally have positive balances.• Asset, Expense and Dividend accounts normally have a Debit

balance.• Liability, Revenue as well as Retained Earnings and Common Stock

accounts normally have a Credit balance.

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Transactions (I) in T AccountsTransaction impacting Shareholder’s Equity:1. Shareholder (Winston Wolfe) starts a consulting business by contributing

$20,000 of cash and $1,000 office supplies to the business;

2. WW contributes his workstation computer (worth $2,000) to the business;

+ =

Debit Credit Debit Credit Debit Credit+ ‐ + ‐ ‐ +20,000 1,000 21,000

Cash Office Supplies Common Stock

=

Debit Credit Debit Credit+ ‐ ‐ +2,000 2,000

Computer Workstation

Common Stock

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Transactions (I) in T AccountsTransaction impacting Shareholder’s Equity:3. WW performs a service job for a Customer A and receives $500 from him.

4. WW performs another service job for a Customer B and is promised to be paid $700 in the near future (no payment received yet).

=

Debit Credit Debit Credit+ ‐ ‐ +500 500

Cash Revenue(s)

=

Debit Credit Debit Credit+ ‐ ‐ +700 700

Revenue(s)A/R

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Transactions (II) in T AccountsTransaction impacting Shareholder’s Equity:5. Shareholder (Winston Wolfe) takes $3,000 out of the business to use for home

improvement work around his house.

6. WW pays the $200 monthly business internet bill.

=

Debit Credit Debit Credit+ ‐ + ‐3,000 3,000

Dividends Cash

=

Debit Credit Debit Credit+ ‐ + ‐200 200

Expense(s) Cash

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Transactions (II) in T AccountsTransaction impacting Shareholder’s Equity:7. WW receives a $250 council tax bill for the month just ended and is payable in

two weeks time (no payment made yet).

8. $300 of office supplies are used up (portion of an asset has become an expense).

=

Debit Credit Debit Credit+ ‐ ‐ +250 250

Expense(s) A/P

=

Debit Credit Debit Credit+ ‐ + ‐300 300

Office SuppliesExpense(s)

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Transactions (III) in T AccountsTransaction impacting Assets only:9. WW purchases office supplies for $1,500 of company cash.

10.WW sells $200 worth of office supplies to another party.• These office supplies originally cost $200.

=

Debit Credit Debit Credit+ ‐ + ‐1,500 1,500

Office Supplies Cash

=

Debit Credit Debit Credit+ ‐ + ‐200 200

Cash Office Supplies

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Transactions (III) in T AccountsTransaction impacting Assets only:11.WW collects $500 worth of A/R balance from the transaction when services

were performed on account.

=

Debit Credit Debit Credit+ ‐ + ‐500 500

Cash A/R

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Transactions (IV) in T AccountsTransaction impacting Liabilities:12.WW purchases another computer workstation for $2,000 and agrees to pay at

a later date (on account).

13.$3,000 is borrowed from a bank.

=

Debit Credit Debit Credit+ ‐ ‐ +2,000 2,000

Computer Workstation

A/P

=

Debit Credit Debit Credit+ ‐ ‐ +3,000 3,000

Cash Debt

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Transactions (IV) in T AccountsTransaction impacting Liabilities:14.WW pays off the council tax bill received earlier.

=

Debit Credit Debit Credit‐ + + ‐250 250

CashA/P

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Summarizing Account BalancesSummary of Cash account for Winston Wolfe:• $24.2K subtotal on the Debit side;• $4.95K subtotal on the Credit side;• $19.25K balance on the Debit side; Debit Credit

+ ‐20,000 3,000

500 200200 1,500500 2503000

24,200 4,95019,250

Cash

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Summary of All AccountsDebit Credit Debit Credit Debit Credit Debit Credit+ ‐ + ‐ + ‐ + ‐

Tr. 1 20,000 3,000 Tr. 5 Tr. 4 700 500 Tr. 11 Tr. 1 1,000 300 Tr. 8 Tr. 2 2,000Tr. 3 500 200 Tr. 6 200 Tr. 9 1,500 200 Tr. 10 Tr. 12 2,000Tr. 10 200 1,500 Tr. 9 2,500 500 4,000 0Tr. 11 500 250 Tr. 14 2,000Tr. 13 3,000

24,200 4,95019,250 Debit Credit

‐ + Debit Credit Debit CreditTr. 14 250 250 Tr. 7 ‐ + ‐ +

2,000 Tr. 12 3,000 Tr. 13 21000 Tr. 1250 2,250 0 3,000 2,000 Tr. 2

2,000 0 23,000

Debit Credit Debit Credit+ ‐ ‐ + Debit Credit

Tr. 6 200 500 Tr. 3 + ‐Tr. 7 250 700 Tr. 4 Tr. 5 3,000Tr. 8 300 0 1,200 3,000

750 0

Cash Computer Workstation

A/PDebt Common Stock

Expense(s) Revenue(s)

Dividends

A/R Office Supplies

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Summary of All Accounts – Comments• Debit balances are equal the Credit balances;• Sum total of all Debits must equal the sum

total of all Credits;• It applies to every recorded transaction.

A list(ing) of balances for all accounts is called a TRIAL BALANCE.

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Trial BalanceA trial balance is NOT a financial statement.• It is prepared in order to prove that account balance DO balance (that

Debits = Credits) before financial statements are prepared.1. List the accounts that have balances in the ledger.2. Separate Debit balances from Credit balances (by using separate columns).3. List the amounts & add the balances.4. Verify that Debits = Credits.

• If they do not ... Find the mistakes.

Debit Credit

Cash 19,250A/R 200Office Supplies 2,000Computer Workstation 4,000A/P 2,000Debt 3,000Common Stock 23,000Dividends 3,000Revenue(s) 1,200Expense(s) 750   Total 29,200 29,200