Welcome, one of the crucial parts of bookkeeping is being able to aggregate like transactions into an account so that we can get an overall sense of what's going on in the firm. In this video, I'm going to discuss T-accounts, my favorite way of doing this. But I'll also show you some other ways that we may aggregate in order to post information into our financial statements. Now, before we do that, I want to remind you of this accounting process. The first step is analyzing the situation. Analyzing the situation is the most interesting part of accounting. That's where we try to figure out, what really was the economic impact on the firm? Remember we don't just think about cash, we think about the overall impact on the firm. Once we figure that out we need to move onto the bookkeeping. That's the way we're going to keep track of what's going on in the firm. So that we can structure and put together financial statements. That's where we journalize, recording that analysis, so that people will have it for the future. And then we post to the accounts, so that we can aggregate all of those items together. And then finally, we're going to take those accounts and we're going to put all those together into Financial Statement Format. Now that last part, it's not actually part of the accounting process, where we're focusing on just an individual transaction, so let's get that out of there. And we've got other videos to talk about analyzing, in fact lots of them, and some videos on journalizing. In this video, we're going to focus on that posting to accounts part, so let's go ahead and get started on that. What do you notice when you look at this slide? Something that looks a lot like a T. Well, that's why accountants decided to get really creative and call that a T-account. Now, it might look simple, but it's actually a brilliant tool for a visual representation of what is going on in any sort of given account. Every T-Account is going to be structured the same way. Everyone you look at is going to have have an Account Title at the top. That Account Title might be accounts receivable, it could be inventory, accounts payable, stockholders' equity, or any other sort of account that you're going to need to aggregate together transactions and track what's gone on in the company. Now, within each T-Account, the debits are going to go on the left and the credits are going to go on the right. It doesn't matter whether it's an Asset T-Account, a Liability T-Account or a Stockholders Equity T-Account, a Revenue Account, an Expense Account, you get the point. It doesn't matter what kind of an account it is. Debits always are on the left and credits always are on the right. If you want to understand why, let's think about how a T-Account fits together with the basic journal entry. You should recall that journal entries have debits on top and to the left and credits on the bottom and to the right. Well, if you think about what a T account does, it just creates space for these debits and credits. It's going to allow us to aggregate a whole bunch of debits and a whole bunch of credits to an individual account. And, in doing so, we can get that aggregation attribute that we need in order to be able to pull together financial statements. Okay, let me show you some examples here, because that might make all of this clearer. Imagine you start a new business and you make the following four transactions. The first thing you do is get the owners to contribute $400 in cash. So that there's an initial capital to run the business with. If we're analyze this, we would say, hey, now the business has cash, $400 worth, and it came from our owners. We then go to a bank and convince them to loan us another $200. Now the company is changed again. We have $200 more in cash and that came from a liability. We're going to have to pay that bank back in the future. The next thing we do is take $300 of that cash we have and purchase a computer. We've now changed from one asset, cash, into another asset, a computer. Our final transaction for this example is going to be purchasing merchandise. In this case, we're able to go to a vendor and convince the vendor, give us $50 worth of your merchandise, maybe it's T-shirts, and we'll pay you for that in the future. So now we have $50 of another asset, T-shirts and we have another liability, $50, that we owe to those vendors. So how would we record this in T-accounts? The first thing we would do is to create a T-account for each one of these categories. That way we can aggregate the transactions that impact a similar account. Let's look at our first transaction now, when we get that $400 in cash, we debit our cash account. That's showing our increase in cash. And we credit our shareholders' equity account. That's showing us that we got something from our shareholders. Notice the little number one by each one of those. We would have done a journal entry to record this transaction and that number one would allow us to reference back to that journal entry. Giving us the history that we're going to want in case we want to figure out this particular transaction at some point in the future. Let's move on to the second transaction. That's where we get that $200 in cash. It's another increase in cash, so it's another debit. And where did we get that from? We borrowed it from the bank. So we credit our loan account, that's showing an increase in that liability. And our third transaction? Well now, we take one asset, cash, and we decrease it. Because we're decreasing the cash asset now, you see that we put that credit on the right-hand side of the account. On the other hand, our equipment asset went up by $300, so we debit that, putting it on the left-hand side of the account. And then we've got our final transaction. We got $50 worth of inventory. And the way that we got that was, we promised to pay somebody in the future. So you can see we debit by putting on the left-hand side $50 in the inventory account. And we represent the credit to our accounts payable by putting that on the right-hand side. Now we would keep going along in these transactions and enter individual transactions in here, until we hit a point in time where somebody says, hey, give me a snapshot, where we are right now? At that point, we could just sum up everything that's happened in this account. And you could look at this and tell people, I now have $300 in cash, $400 that came from my shareholders, $200 in loans that I owe the bank, another $50 that I owe my trade creditors. I also have $50 worth of inventory and $300 worth of equipment. If I want to work backwards and break any of those accounts down, I can use those references back to those journal entries to understand what's going on in those. You can see that this is a very neat and concise way to pull together information. It allows me to understand where I stand right now. It also allows me to look backwards in history and understand what's happened in the company. I like T-accounts, and I would encourage you to practice with them a little bit to see whether they're useful for you in really understanding the company. That said, I also know that lots of students prefer to take a different approach. They like to use a spreadsheet to track this things instead. And most of spreadsheet are based on that balance sheet equation. The equation that says assets equals liabilities plus equity. We can do the same four transaction in using that spreadsheet. >> We do our first transaction, we get money from our shareholders, we increase our assets by $400, and we increase our equity by $400. Then we do our second transaction. In that transaction, we get $200 more in cash. So again, we put a positive in the asset category. And we showed that that came from liabilities by increasing our liabilities. In our third transaction, we reflect the fact that our cash has gone down, but we got another asset that went up. So you can see the negative $300 in our cash and the positive $300 in our computer nets to no impact on assets. Notice that our balance sheet still balances here. Because assets haven't changed, there's no need for liabilities and owners' equity to change. Finally in our fourth transaction, we reflect the fact that we have the $50 worth of inventory. And we reflect that we owe somebody $50, so our liabilities go up by that amount as well. Just like with the T-accounts, we can sum these. Now you do you see some loss in information here. If you asked me, where do we stand right now? I'd say well we have $650 worth of assets. $250 worth of liabilities and $400 in owners' equity. The problem with this though, well I can't tell you exactly what those assets are. I'd have to go back through the transactions and undo that. You can fix this problem. You could create a column for each asset account. That's not too bad when we only have three assets, but imagine if you were a real company, I don't know, say Target. Imagine how many different columns they would have to have. It gets prohibitive pretty quickly, and it's not just assets we'd have to do that with. We'd have to list out every liability account, we'd have to list out all of our equity accounts, etc. It can get overwhelming. That said, I know for a lot of students this balance sheet equation seems easier to them because they're not busy thinking about is this a debit or credit? Which side does it go on, etc. You can try it out and see if this tool works better for you as well. I often recommend to people, try using a spreadsheet and using T-accounts sometimes, and see which one's working better for you in really allowing you to get the answers you want to get. Now, before we leave spreadsheets, I want to talk about one other problem that I've seen with them. My experience is, students who rely entirely on spreadsheet approach, often struggle with the income statement. Let me show you why that's the case. We're going to have to add a fifth transaction to make that work. Let's imagine that that company now sells all of it's merchandise for $100 in cash. Remember that merchandise had cost us $50. I'm going to do the journal entries for you first, so that you can get a look at those and understand the transaction, and then we'll go back to using the spreadsheet. So just like in any journal entry, I'm going to start with the cash. We got $100 in cash, that's an asset so we're going to debit it. That means it goes on the top and to the left. Now, where did that cash come from? Well, it came from revenue. That is, it came from our primary line of business people paid us for selling them something. I think in this case, we said it was T-shirts we're selling. You can look at this journal entry and see that we've got debits and we've got credits and they equal each other. That's an important thing. Remember in double entry book keeping our debits and credits should always equal each other. We haven't fully captured the transaction, though. We've reflected the fact that we got cash and we got it from our customers for making a sale to them. But we haven't reflected the fact yet that we also lost inventory. Since that's an asset that declined, we're going to credit that, putting it on the bottom and to the right. And then to capture the other side of that, we have to say, well, where did that inventory go? We're going to call that Cost of Goods Sold, that's an expense. It's value that we had to use up in order to generate that revenue. So if you look at these journal entries put together, they show you that our asset cash went up. We got that because we made a sale. Our asset inventory went down and it went down because we had to use it up in order to make the sale. That seems pretty straight-forward. Now here is the problem, if we try to use that same sort of spreadsheet to reflect this, well, we've only got a balance sheet here because we used the balance sheet equation to structure our spreadsheet. So what happens? Well, on the assets side we're okay. That first transaction, we get a $100 in cash. Now, we know that assets have gone up, so either liabilities or equity have to go up as well in order to keep our balance sheet balancing. In this case, we know it's not a liability. We don't owe anybody anything. So it must be equity. It must belong to our owners. So we increase equity by $100. Now, we say we've got to reflect the fact that we've also given up $50 worth of inventory. So we can knock that asset down. And again, that means that, with assets having changed, in this case going down, either liabilities or owners' equity needs to have changed. We look at this and think, well, we don't owe anybody anything, so it's not liabilities. So again, I guess we'll put that into equity. That's a $50 decrease in equity and in total that means our equity has gone up by $50, and if we look on the asset side, in total our assets have gone up by $50. The $100 increase in cash and the $50 decrease in inventory. This seems great, but remember we have two big questions we want tp answer in life. This tells us where we stand right now. It gives us that snapshot in time, but how is this going to answer for us what's happened over time, it doesn't. In order to answer that second question, we're going to have to go back into our equity account, and we're going to have to figure out what part of our equity account was really getting at that second question. And what part wasn't? Remember that first $400 had nothing to do with value creation over time. That was actually just a balance sheet transaction. What I found is that, when students do this, they have a difficult time going into that equity account and undoing it and really keeping that second question clear in their mind. If you really want to use a spreadsheet, I recommend you do it this way. Add two more columns, revenues and expenses. Now let's look at how we would do the entries. We reflect the fact that we got that extra $100 in cash, and where did it come from? Well, we made a sale to our customers, we put that in our revenue account. And we also reflect the fact that we no longer have $50 worth of inventory. Where did it go? Well, we had to use that up in order to generate the sales. It's an expense, it went out of the company. Now if I need to answer the question what happen over time, I can look in my revenue and expense columns. And that's going to build my income statement for me. It really helps to build that sort of a thought-process. It's not just mechanical. My experience is that students who do it this way, or who use T-accounts where they have T-accounts for the revenue and expense, really understand what the income statement's doing better. Now, if you've been looking at this for a moment, you're probably looking at it saying great, I got an income statement but you've forgotten, now my balance sheet doesn't balance. I've got that $100 increase in the assets, but nothing's happened on the liabilities and equity side. Then I had that $50 decrease in assets, and again, nothing's happened on the liability or equity side. Well, at the end of the period, we can look at everything that's happened on the income statement, and say the net impact of all of that should come over to my balance sheet. And that's going to come over to my equity. Here I'm showing both of the items coming over. Another way to do it would just be to sum those columns up, and bring the final number over. But, now you'll see our balance sheet does balance. That $100 increase in cash came from revenues of $100. And then when we pull it over at the end of the period, it shows that revenue increased our equity by $100. Again I really encourage you to try the T-accounts and see whether you can get more out of them, but if you are going to use the spreadsheet, please consider using the revenue and expense columns. I really think they're going to make this much easier for you to get the concepts of the income statement, and they certainly lend themselves to answering that second big question in life. What happened over time, a lot better than just using the balance sheet approach. By now, you should be in good shape to post items up into our financial statements.
