1. 3 The Account Learning Objectives
1.   Explain the concept of T-accounts and the accounting method for maintaining account balances using debits and credits
3.   Describe the Chart of Accounts and its’ importance to the firm.
3.    Describe the use of contra accounts.
4.   Describe the separation of the 5 major types of accounts into two main categories, permanent accounts and temporary accounts.
5. Analysis: Explain and calculate a common size balance sheet
Unit 3

2. Objective 3.1: Debits, credits, T-accounts
These are the mechanics of maintaining account balances. They are critical to understanding accounting systems
O3.1

3. Depending on where the account resides, the normal balance
Every account has a left and a right side. Left is the debit and right is the credit side.
Depending on where the account
resides, the normal balance
will be a debit or a credit balance.

4. For Example: Accounts can be visualized as a T, with a left and right side
DEBIT side
CREDIT side
O3.1

5. Blue areas are debit balances red areas are credit balances
The normal balance depends on where the account resides (the account classification)
Blue areas are debit balances red areas are credit balances
O3.1

6. The account classification indicates how an account is increased and decreased
- +
- +
+ -
+ -
- +
Accounts in blue areas are increased with debits accounts in red areas are increased with credits
O3.1

7. What is meant by normal balance?
Answer: A positive balance.
The $8 credit balance in Accounts Payable
tells us that $8 is owed to creditors
for this account
O3.1

8. Why do you need to use left and right, debit and credit?
Answer: Using debits and credits simplifies
accounting entries, reduces errors and most
importantly insures that all changes made
to the accounting system keep the system
in balance.
Total debits must always equal total credits
DEBITS
CREDITS
O3.1

9. How do debits and credits work in an individual account?
Increase accounts by entering a normal balance entry, debit (left) or credit (right).
Decrease accounts by entering the opposite of a normal balance entry debit or credit.
At any point in time, the account balance is determined by whether there is an excess of debits or credits. Debits offset credits and visa versa, dollar for dollar. -See example on the following slide.
O3.1

10. In the transaction below:
The cash account started with a $150 normal balance and accounts payable started with a $60 normal balance
Cash is used to pay the accounts payable owed of $60 with a credit to Cash and a debit to Accounts Payable.
The ending balances resulting in both accounts are shown.
The change made to the accounting system involved equal debits and credits.
O3.1

11. Objective 3.2: Chart of accounts
The Chart of Accounts is the official list of all accounts used by a firm. The Chart of Accounts is specially tailored to the needs of each individual firm. (See sample on next slide)
O3.2

12. Chart of Accounts Chung Supply O3.2
This is the official list of accounts used by this firm.
Chart of Accounts
Chung Supply
Notice the optional logical numbering system
O3.2

13. Can accounts be removed or added to the Chart of Accounts?
Yes, whenever a new account is needed or an
account is no longer needed, changes
can be made to the Chart of Accounts
Controls should be in place within the firm to require proper approval to change the firm’s Chart of Accounts.
O3.2

14. Objective 3.3: Contra accounts
Contra accounts are “backward” accounts –their normal balances (debit or credit) are the opposite of the normal balances of the account(s) to which they are associated
O3.3

15. A typical contra account is the Owner’s Drawing account.
Think of the contra account as a take away bucket hanging under the regular account to which it is attached.
P. Wills, Capital 10
P. Wills, Drawing
(4)
Contra
Account
Net Equity 6
O3.3

16. Why are contra accounts necessary?
At times, it is important to accumulate separately
all the reductions recorded to an account rather
than simply make the reductions directly
This gives us additional information. For example,
“Equity is $4,000” is not as informative as
“Equity started the year at $15,000, however
$11,000 was withdrawn by the owner and
$4,000 remains”.
O3.3

17. What is another contra account?
Accumulated Depreciation is a contra account that
gathers all of the reductions in value recorded for
depreciable assets since their acquisition by the
firm.
O3.3

18. Accumulated Depreciation (150)
The net effect or “weight” on the balance sheet is often called the Book Value.
Equipment
850
Accumulated Depreciation
(150)
Book Value –Equipment
700
Contra
Account
O3.3

19. Objective 3.4: Permanent and Temporary Accounts
In general, Balance Sheet accounts are permanent and Income Statement accounts are temporary
O3.4

20. temporary accumulations of eventual changes to the equity account.
Remember the five broad classes of accounts,–Assets, Liabilities, Equity, Revenue and Expenses.
Also remember that revenue and expenses are
temporary accumulations of
eventual changes to the equity account.
As such, the Income Statement accounts are considered temporary accounts and the Balance Sheet accounts* are considered permanent accounts. The income statement accounts are considered temporary because they are regularly closed (every fiscal period).
Closing an account sets the balances back to zero and causes
the net effect of these accounts to be formally updated (moved)
to the equity accounts.
O3.4

21. PERMANENT ACCOUNTS TEMPORARY ACCOUNTS O3.4
All the activity from income and expenses is summarized in profit or loss. Closing the temporary income statement accounts will formally bring this result to the
equity section.
O3.4

22. Objective 3.5: Common size Balance Sheet
By expressing individual items on a balance sheet in terms of their percentage of total assets, valuable additional information is obtained
O3.5

23. For Example: This is calculated as 75/737 = 10.2%
Balance Sheet
As of 12/31/08
(Common Size)
For Example: This is calculated as 75/737 = 10.2%
With common size percentages, balance sheet items can be compared from one period to the next and from one firm to the next.

24. End of Unit 3