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Accounting equation
Assets= Liabilities + Equity
Equity consists of 4 accounts. They are:
Owner’s Capital
Owner’s Withdrawals
Revenues
Expenses
Owner’s Withdrawals
The owner makes withdrawals for his personal use. This is not for his business use. These are deductions and so it is a minus. Therefore, it reduces the Equity account.
Revenues
These are your sales from operating your business. This is not profit. The revenue account is positive, so it increases Equity.
Expenses
These expenses are incurred in the course of generating sales, like for example advertising expense, selling expense, utility expense, supplies expense etc. These are deductions and they are a minus. Also, they reduce Equity
how do you find Net Income or net profit.
Revenues- Expenses
The expanded accounting equation
Assets= Liabilities + Equity Assets=Liabilities+ (Owner’s Capital- Owner’s Withdrawal+ Revenue- Expenses)
Assets= Liabilities+ Equity or
Own= Owe+ Equity. Therefore, equity can also be written as = Assets- Liabilities + Equity
what happens if you have more liabilities than assets?
bankruptcy
Assets
Assets are on the Left side of the equation= So assets would be Debits by their inherent classification. when you increase assets, then you would debit them, or write them on the left side. When you decrease assets, then you can only show this by crediting them or writing them on the right side.
A debit memorandum
bank debited, or reduced, the depositor’s account balance. (Recall that the depositor’s account is a liability on the bank’s books and debits are used to decrease liability accounts.) The bank records a deposit to a depositor’s account
When you make a sale, two accounts are getting affected. It is either then Cash account, or the A/R account(if the sale is on credit) and of course the Sales account, which is a revenue account.
Sale with cash terms:
Cash is being increased. It is an asset account and since it is being increased, it would be debited.
Sales is a revenue account. It is being increased and so it would be credited.
a) Cash 20
Sales 20
b) Take it out of inventory and apply the cost of that item that is sold to costs of goods sold.
Cost of goods sold 10
Inventory 10
2) Sale on Credit: Cash is not received. Instead, a promise to be paid later is made by the customer. So it’s going to be A/R. Its an asset account. Increases in A/R are shown as debits.
You have to take the item out of your inventory as well as it is no longer on your shelf. So you have to reduce inventory. Inventory is an asset and decreases in assets are shown by crediting them. The cost of the item that is sold has to be charged to cost of goods sold.
A/R 20
Sale 20
Cost of goods sold 10
Inventory 10
3) When the customer actually pays with cash. This means the company has to reduce the A/R and show Cash coming in. We cannot have two accounts open for the same account as it would be overstating assets, which is inaccurate and misleading. Since A/R is being reduced, we have to credit that account.
Cash 20
A/R 20
