Revenue, Expense, and Drawings
Remember the following before proceeding to the next slide!!
Up until now, we have been recording transactions to the Capital account in the Owner s Equity section. Here are a few examples of how the Capital account has been affected by these transactions:
The company performs a service ($3000) for a customer who pays cash. In this case, the accounts affected in the ledger would look like: Debits = Credits
The company performs a service ($1000) for a customer on credit. In this case, the accounts affected in the ledger would look like: Debits = Credits
The company pays the workers salaries (wages) with the use of cash (these salaries total $2200). In this case, the accounts affected in the ledger would look like: Debits = Credits
The company receives a phone bill ($150) that hasn t been paid yet. In this case, the accounts affected in the ledger would look like: Debits = Credits
The owner withdraws cash ($1000) from the company for personal use. In this case, the accounts affected in the ledger would look like: Debits = Credits
At the end of these transactions, the Capital account would look like the following: Looking at the Capital account above, one would have a good idea what occurred in the account, but could not be certain as to what transactions specifically happened without going back to the actual transaction details.
In order to explain the Capital account, we will introduce different accounts that better explain the transactions that affect the capital account. Each of the new accounts reflects a particular kind of transaction that affects Owner s Equity (or Capital). These accounts are called: I. Revenues II. Expenses III. Drawings
Revenues: related to the sale of goods and services. Examples: Service Revenue, Fees Earned, Commissions Earned, Interest Revenue, Royalties Earned, etc. Since revenues increase the Capital account, their balance will be of a credit (CR) nature. Rules to follow when working with revenues: Revenue represents an increase in equity (or capital). An increase in capital requires a credit entry. Therefore, the Revenue account is credited.
Revenues The Expanded Ledger: The Revenue Recognition Convention The revenue recognition convention states that revenue must be recorded in the accounts (recognized) at the time the transaction is completed.
Expenses: costs related to the revenues. Examples: Advertising Expense, Utilities Expense, Wages Expense, Telephone Expense, Property Tax Expense, etc. Since expenses decrease the Capital account, their balance will be of a debit (DR) nature. Rules to follow when working with expenses: Expense represents a decrease in equity. A decrease in equity requires a debit entry. Therefore, the Expense account is debited.
Drawings: the owner s withdrawals of assets from the business for his/her own personal use. Since drawings decrease the Capital account, their balance will be of a debit (DR) nature. Rules to follow when working with drawings: Drawings represent a decrease in equity. A decrease in equity requires a debit entry. Therefore, the Drawings account is debited.
Purpose of expanding the system: The accounts mentioned are created for one main purpose: to provide information for the equity section. The information is needed by owners and managers to make sure the business is run profitably and to make sound business decisions.
Here s how the transactions from the beginning of this activity would have been analyzed with the use of the expanded ledger.
The company performs a service ($3000) for a customer who pays cash. In this case, the accounts affected in the ledger would look like: Debits = Credits
The company performs a service ($1000) for a customer on credit. In this case, the accounts affected in the ledger would look like: Debits = Credits
The company pays the workers salaries (wages) with the use of cash (these salaries total $2200). In this case, the accounts affected in the ledger would look like: Debits = Credits
The company receives a phone bill ($150) that hasn t been paid yet. In this case, the accounts affected in the ledger would look like: Debits = Credits
The owner withdraws $1000 cash from the company for personal use. In this case, the accounts affected in the ledger would look like: Debits = Credits
Here s a comparison of the two methods: one without the expanded ledger, one with the expanded ledger.
The debit and credit theory with the expanded ledger. Note: The only time that the Capital account will be used in transactions with the expanded ledger will be in the event that an investment is made by the owner.
Chart of Accounts A chart of accounts is a list of the ledger accounts and their numbers arranged in ledger order. Each ledger account is given a number that corresponds to its category. Here is an example of a list of accounts and their numbers. The reason why there is an interval of five (5) units between each account is in the event of a new account needing to be placed in the chart of accounts. Notice the assets are placed in order of liquidity, the liabilities in order of payment and the revenues and expenses in alphabetical order. Assets are numbered between 100-199 Equity accounts are numbered between 300-399 Revenues are numbered between 400-499 Liabilities are numbered between 200-299 Expenses are numbered between 500-599