- There are three primary financial statements,
the balance sheet, the income statement,
and the statement of cash flows.
The elements of the balance sheet:
assets, liabilities, owner's equity.
The elements of the income statement:
revenues and expenses.
Each of these elements is comprised
of many different accounts.
Now, an account is a specific accounting record
that provides an efficient way
to categorize similar transactions.
Thus, we may designate asset accounts,
liability accounts, and owner's equity accounts.
Examples of asset accounts are cash,
inventory, and equipment.
Liability accounts include accounts payable
and notes payable, for example.
The equity accounts for a corporation
are capital stock, or paid in capital,
and retained earnings.
Now, you can think of an individual account
as a summary of every transaction
affecting a certain item, like cash.
The summary may be recorded on one page in a book
or in one column of a spreadsheet,
as illustrated here.
Using our previous four transactions,
we can easily see how the accounting equation
can be expanded to include specific accounts
under the headings of assets, liabilities,
and owner's equity.
We can also see that after each transaction,
the equality of the accounting equation
can be determined by adding up the balances
of all the asset accounts
and comparing the total to the sum
of all the liability and owner's equity accounts.
Now, when double entry accounting
was formalized over 500 years ago,
all the adding and subtracting, done by hand.
You can imagine the difficulties
of tracking multiple accounts
involving hundreds of transactions,
using the spreadsheet method above,
while doing all the computations by hand.
Mixing pluses and minuses in one column
would provide ample opportunity to make mistakes.
The problem was solved by separating
the pluses and the minuses for each account
into separate columns,
totaling each column and then computing the difference
between the columns to arrive at an ending balance.
The simple, most fundamental format
is the configuration of the letter T.
As luck would have it, this is called a T account.
Note that a T account is an abbreviated representation
of an actual account, which we will illustrate later,
and is used as a teaching and learning tool.
The following segment includes examples of T accounts
representing the transactions we described previously.
The account title, cash, for example,
appears at the top of the T account.
Transaction amounts may be recorded, then,
on both the left and the right side of the T account,
as we're going to see.