Guided Readings for Financial Accounting, Lesson 4.2 – Mastery Level

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SUGGESTION: Read the third section of Chapter Four (“Double-Entry Bookkeeping”). It introduces you to an ancient system of recording known as double-entry bookkeeping that has existed for more than 500 years. It is a short-hand type of system to maintain account balances in an efficient and easily understandable manner. To this day, some form of double-entry bookkeeping continues to be utilized by organizations around the world. It does not alter the reporting but is fundamental to understanding the recording of financial events.

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(4Q22) – What is a T-account?

(4A22) – A T-account is a structure used to record the increases and decreases of one specific account so that the current balance can be determined. One side of the T-account is used to record increases. The other side of the T-account is used to record decreases. By netting the increases and decreases, the current balance can be calculated.

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(4Q23) – Where are a company’s T-accounts maintained?

(4A23) – All T-accounts are gathered together for convenience. This grouping is referred to as a ledger (or, in some cases, as a general ledger). If a company official needs to know an account balance such as Cash, the person finds the company’s general ledger (often a computer printout) and looks through it to locate the Cash T-account. For ease of use, T-accounts are usually in a prearranged order and are identified by account or index numbers.

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(4Q24) – What term is used to refer to the left side a T-account? What term is used to refer to the right side of a T-account?

(4A24) – The left side of a T-account is known as the debit side. The right side of a T-account is known as the credit side. Those two terms have been used for hundreds of years. Probably no terms in accounting are better known around the world than debit and credit.

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(4Q25) – Which types of T-accounts show increases by means of an addition to the debit side?

(4A25) – Only three types of basic accounts increase with a debit: expenses, assets, and dividend distributions. They each reflect the use of financial resources—resources are used to obtain expenses (rent, for example), assets (equipment), and to pay dividends. All changes in expenses, assets, and dividend distributions are recorded in the same way. Any increase in one of these accounts appears on the debit side of the appropriate T-account. (Thus, decreases are reflected on the credit side of these T-accounts.)

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(4Q26) – Which types of T-accounts show increases with an addition to the credit side?

(4A26) – Liabilities, revenues, and capital stock (or contributed capital) all refer to inflows of financial resources. They all bring resources into the company—from a lender, from a sale, or from an owner. Increases in these accounts are all recorded in the same way. They show increases on the credit side of the appropriate T-account. Therefore, decreases in these same three account types are reflected using the debit side of the T-account.

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(4Q27) – Are increases in gains and losses reported as debits or as credits?

(4A27) – Gains and losses are created by an event that is not part of normal business activities. They do not happen as part of daily operations but only occasionally. A donut shop might sell a delivery truck at a loss, for example, or a refrigerator at a gain. A gain is similar to a revenue. Hence, a gain account increases with a credit. A loss is the opposite of a gain. A loss is recorded on the debit side of its T-account.

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INCREASE ON THE DEBIT SIDE OF T-ACCOUNT

--Expenses

--Assets

--Dividends distributed

--Losses

INCREASE ON THE CREDIT SIDE OF T-ACCOUNT

--Liabilities

--Revenues

--Capital stock (or contributed capital)

--Gains

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There are only 8 account groups in the previous slide. Four increase as debits and four increase as credits. That is not much to learn. The sooner you learn those the easier the course will become. The more you practice the quicker the learning will become.

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(4Q28) – Is the retained earnings T-account balance usually a debit or credit?

(4A28) – A retained earnings balance is created by the netting of all net income (revenues less expenses) that has been earned over the years less all dividends that have been distributed to owners. If net income has been higher in the past than dividends, retained earnings has a credit balance. If dividends have been higher, retained earnings has a debit balance. Most companies earn more income than is distributed as dividends so the retained earnings balance is most often a credit.

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SUGGESTION: Work the Test Yourself question in Section 4.3 of Chapter Four (“A company incurs a transaction that is…”) and the One Step Further question. These questions are designed to help you learn to see the information that is conveyed by use of debits and credits. Each set of debits and credits describes an event. You want to learn to look at the debits and credits and understand the transaction they are recording?

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