Accounting 10
Module 1
Lesson 5
Accounting 10
1
Lesson 5
Accounting 10
2
Lesson 5
Lesson Five -Using Accounts For Owner's
Equity
Read pages 94 to 102 in the textbook.
Topics:
•
Recording Owner's Equity in T-Accounts
•
Remember These Important Points
•
Conclusion
•
Self Test
•
Answers for Self Test
•
Assignment 5
After studying Lesson 5, you should be able to
•
open a T-account for each owner's equity element found on the opening balance
sheet of a service firm that is owned and operated as a single proprietorship.
•
explain and use the rules for recording increases and decreases in the owner's
equity account.
•
identify the four parts which make up the owner's equity element in the accounting
equation.
•
explain and record in T-accounts the debits and credits resulting from given capital
transactions, revenue and expense transactions, and owner's withdrawal
transactions.
Accounting 10
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Lesson 5
•
record transactions affecting all parts of the equation by date in a T-Account ledger;
calculate accurately and show the balance on the correct side of the account;
prepare a summary of ledger account balances; and from the data in that summary,
prepare an income statement and a related balance sheet.
Recording Owner's Equity Changes in T-Accounts
Previously you learned that Owner's Equity in the accounting equation may be changed as
a result of four types of business transactions:
•
additional investment by the owner of the business
•
revenue
•
expense
•
a withdrawal of assets for the owner's personal use
An account called "Owner's Equity" as such does not exist in accounting. This account is
simply the claim of the owner against the total assets as shown in the accounting
equation, and as reported by the balance sheet at the end of the financial period.
The complete accounting equation shows four separate sections under owner's equity:
Owner's Equity
OE
Assets = Liabilities + Capital + Revenue - Expenses - Drawing
A
=
L
+
C
+
R
-
E
-
D
•
Capital: the owner's investment. These cause an increase to owner's equity in the
accounting equation, so there is a plus sign in front of C.
•
Revenue: the inflow of cash and accounts receivable resulting from sales. These
cause an increase to OE, so there is a plus sign in front of R.
Accounting 10
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Lesson 5
•
Expenses: the operating costs incurred in bringing revenue to the business. These
cause a decrease to OE, so there is a minus sign in front of E.
•
Drawing: the withdrawal of assets for the owner's personal use. These cause a
decrease to OE., so there is a minus sign in front of D in the equation.
Separate accounts will be needed to record each of these transactions.
Applying Debit and Credit Rules to Record Changes to Owner's Equity
Rules for increasing and decreasing asset and liability accounts can also be used for
recording changes in owner's equity.
Rule for Recording an Increase to Owner's Equity - an increase to owner's equity is
recorded in the account that causes an increase to OE in the accounting equation, and
on the side on which owner's equity is placed in the accounting equation--the credit side.
The item which causes the increase to owner's equity must be first identified. Example an additional investment by the owner would be recorded on the credit side of the Capital
account.
Rule for Recording a Decrease to Owner's Equity - a decrease to owner’s equity is
recorded in the account that decreases OE, and on the side opposite to the one on which
owner's equity appears in the accounting equation--the debit side.
Recording Capital Transactions
The most fundamental business transaction is the initial investment of the owner in
her/his business. In this case, Cash is debited and Capital is credited for the opening
entry. An additional investment is recorded as an increase in Cash and Capital.
Transactions explained in Lesson 4 continue.
Accounting 10
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Lesson 5
Transaction 6 - October 8 – Rob Ireland makes an additional investment of $3 000 cash
in his business.
Debit entry:
What Happens: The asset Cash increases by $3 000.
Accounting Rule: To increase an asset, debit the account. Assets increase on the side
where they appear in the accounting equation (the debit side).
Accounting Entry: Debit: Cash $3 000
Credit entry:
What Happens: Owner's Equity in the equation increases by $3 000.
Accounting Rule: To increase Owner's Equity, credit the account which caused the
increase. Owner's Equity can increase on the same side where it appears in the
accounting equation (the credit side).
Accounting Entry: Credit: Rob Ireland, Capital $3 000
Cash
20__
Sept. 30 28 000
Oct. 1
1 000
8
3 000
Rob Ireland, Capital
20__
Oct. 2 1 000
5 4 000
20__
20__
Sept. 30 30 000
Oct. 8 3 000
Analysis: The asset Cash is debited for $3 000 because increases are shown on the left
side. Under owner's equity, investment is recorded under Capital--on the right or credit
side.
Accounting 10
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Lesson 5
Transaction 7: October 31 - StacomTravel has received $2 000 cash for the sale of
services during October.
Debit entry:
What Happens: The asset Cash increases by $2 000 in the equation.
Accounting Rule: To increase an asset, debit the account. Assets increase on the side
where they appear in the accounting equation (the debit side).
Accounting Entry: Debit: Cash $2 000
Credit entry:
What Happens: Revenue causes an increase to Owner's Equity in the accounting
equation.
Accounting Rule: To increase Owner's Equity, credit the account which caused the
increase. Owner's Equity appears on the credit (right) side of the equation. To increase
OE, record the amount in the account that caused the increase on this side (credit side).
Accounting Entry: Credit: Sales $2 000
Cash
20__
Sept. 30 28 000
Oct. 1 1 000
8 3 000
31 2 000
Sales
20__
Oct. 2 1 000
5 4 000
20__
20__
Oct. 31
2 000
Analysis: In this lesson, the account name Sales will be used to describe the revenue
earned for Stacom Travel.
Accounting 10
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Lesson 5
Transaction 8: October 31 - Stacom Travel sells services on credit to Terry Thompson
for $600, to Janet Brown for $1 000, to Black’s Shoe Co. for $2 000, and to J. McCain for
$400. All customers were given 30 days in which to make payment to the firm.
Debit entry:
What Happens: Four assets increase as follows: Accts. Rec./ Terry Thompson by $600;
Accts. Rec./Janet Brown by $1 000; Accts. Rec./Black’s Shoe Co. by $2 000; and Accts.
Rec./J. McCain by $400.
Accounting Rule: To increase assets, debit the separate accounts involved.
Accounting Entry: Debit:
Accts. Rec./Terry Thompson, $600
Accts. Rec./Janet Brown, $1 000
Accts. Rec./Black’s Shoe Co.,$2 000
Accts. Rec./J. McCain, $400
Credit entry:
What Happens: A second inflow of revenue causes an increase to OE in the accounting
equation by $4 000.
Accounting Rule: To increase OE, credit the account which caused the increase.
Accounting 10
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Lesson 5
Accounting Entry: Credit: Sales $4 000
Accts. Rec./Terry Thompson
20__
Oct. 31
Sales
20__
Oct. 31
31
600
2 000
4 000
Accts. Rec./Janet Brown
20__
Oct. 31
1 000
Accts. Rec./Black’s Shoe Co.
20__
Oct. 31
2 000
Accts. Rec./J. McCain
20__
Oct. 31
400
Analysis: The four assets--Accounts Receivable--are increased; and are, therefore, debited.
Revenue causes an increase in OE; and is, therefore, credited.
Recording Expense Transactions
Lesson 3 explained how an expense results in a decrease to Owner's Equity in the
accounting equation. Therefore, the debit side records any expense transaction.
As you will see in the next two transactions, an expense may be incurred as a result of an
immediate cash payment or as a result of owing a sum through a liability.
Accounting 10
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Lesson 5
Transaction 9: October 31 - Stacom pays expenses of $500 cash for rent, $2 750 cash
for salaries, $110 cash for utilities and $40 cash for the telephone bill.
Debit entry:
What Happens: Four expenses are incurred. These cause Owner's Equity in the
accounting equation to decrease by each individual expense.
Accounting Rule: To decrease Owner's Equity, record the amount in the account that
caused the decrease on the opposite side where OE in placed in the accounting equation.
Accounting Entry: Debit:
Rent Expense, $500
Salaries Expense, $2 750
Utilities Expense, $110
Telephone Expense, $40
Credit entry:
What Happens: The asset Cash decreases by the total amount of expenses, $3 400.
Accounting Rule: To decrease an asset, credit the account.
Accounting 10
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Lesson 5
Accounting Entry: Credit: Cash $3 400
Rent Expense
20__
Oct. 31
Cash
20__
Sept. 30
Oct. 1
8
1
500
28 000
1 000
3 000
2 000
20__
Oct. 2 1 000
5 4 000
31
3 400
Salaries Expense
20__
Oct. 31
2 750
Utilities Expense
20__
Oct. 31
110
Telephone Expense
20__
Oct. 31
40
Analysis: A separate expense account describing the expense used up is shown. A
separate expense account gives better information to the owner, who makes sure s/he
controls those costs of operating the business. Of course, the total debits equal the total
credits for that transaction.
Transaction 10: October 31 - StacomTravel receives a bill for $600 from The City
Record, a local newspaper, for running three large advertisements during October. The
bill allows Stacom Travel a credit period of 30 days in which to pay for the advertising.
Accounting 10
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Lesson 5
Debit entry:
What Happens: An expense for advertising is incurred. This expense decreases Owner's
Equity by $600 in the accounting equation.
Accounting Rule: To decrease Owner's Equity, debit the account which caused the
decrease. Owner's Equity can decrease only on the opposite side where OE appears in the
accounting equation (the debit side).
Accounting Entry: Debit: Advertising Expense $600
Credit entry:
What Happens: The liability Accts. Pay./The City Record increases by $600 in the
accounting equation.
Accounting Rule: To increase a liability, credit the account. Liabilities appear on the
right (credit) side of the equation. The credit side is the increase side.
Accounting Entry: Credit: Accts. Pay./The City Record $600
Advertising Expense
20__
Oct. 31
Accts. Pay./The City Record
20__
600
20__
Oct. 31
600
Analysis: The debit to Advertising Expense has the effect of recording the decrease to
Owner's Equity; it describes the amount used up. The credit to Acct.Pay/The City Record
shows an increase in the liability account.
Accounting 10
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Lesson 5
Recording Drawing Transactions
When the owner withdraws cash from the business for her/his personal use, a separate
drawing account is debited to record all amounts withdrawn. This gives a clear record of
owner's investments (capital) and owner's withdrawals (drawings) in separate accounts.
Transaction 11: October 31 – Rob Ireland withdraws $1 200 cash from Stacom
Travel's bank account for his personal use.
Debit entry:
What Happens: Owner's Equity in the equation decreases by $1 200.
Accounting Rule: To decrease Owner's Equity, debit the account which caused the
decrease.
Accounting Entry: Debit: Rob Ireland, Drawing $1 200
Credit entry:
What Happens: The asset Cash decreases by $1 200 in the equation.
Accounting Rule: To decrease an asset, credit the account.
Accounting Entry: Credit: Cash $1 200
Assets
=
Liabilities
+
Owner's Equity
Accts.
Bk Loan
Accts.
R. Ireland
Cash
Rec.
Equip.
Furn.
Payable
Payable
Capital
Revenue Expense Drawing
$25 600 + $4 000 + $12 000 + $11 000 = $10 000 + $7 600 + $33 000 + $6 000 - $4 000
-1 200
- $1 200
$24 400 + $4 000 + $12 000 + $11 000 = $10 000 + $7 600 + $33 000 + $6 000 - $4 000 - $1 200
$51 400
A
Accounting 10
=
$17 600
+
=
L
+
13
$33 800
OE
Lesson 5
Analysis: The Drawing account is used to record the decrease to owner's equity. This
decrease must be recorded on the debit side-- opposite to the one on which the element is
located in the equation. Cash is the credit entry because it is decreased.
Here are four basic rules that will help you to analyze business transactions.
•
Each transaction affects at least two accounts.
•
If only two accounts are affected by a transaction, the debit entry in one
account must be equal to the credit entry in the other account.
•
If more than two accounts are affected by a transaction, the total debits must
equal the total credits.
•
The debit part of an entry always comes before the credit part.
Remember These Important Points
•
An increase in Owner's Equity is recorded in the account that caused the increase
on the same side as OE is found in the accounting equation.
•
An additional investment by the owner increases OE in the accounting
equation. Therefore, it is credited.
•
Revenue causes an increase to OE in the accounting equation. Therefore,
it is credited.
•
A decrease to Owner's Equity is recorded in the account that caused the decrease on
the opposite side where OE is found in the accounting equation.
•
All expense transactions cause decreases to Owner's Equity in the equation.
Therefore, the dollar amount of expense is placed on the debit side of the
appropriate expense account.
Accounting 10
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Lesson 5
•
A personal withdrawal of cash by the owner decreases OE in the equation. To make
an accounting record of this withdrawal, a separate Drawing account is
used and the dollar amount is placed on the debit side.
•
Every business transaction will have at least one debit entry and one credit entry.
•
Debits must always equal credits for every business transaction.
Conclusion
In this section, you have seen how business transactions (that is, the operation of the
business) can be recorded by increasing and decreasing the items in the Accounting
Equation.
Self Test
1.
P 3-7, page 103, text
(Problem 2-5 was done in the self test, lesson 3)
2.
MC 3-7, page 105, text
3.
Problem 3 which follows immediately on the next page
Accounting 10
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Lesson 5
Problem 3
Ms. Stacey Burns operates an insurance agency. The business' accounts are:
Cash
Office Supplies
Expense
Automobile
Office Furniture
Office Equipment/
Machines
Accts. Pay./Will's Garage
Accts. Pay./Dolan's Stationery
Sales
Accts. Pay./Jane's Equipment Co.
Stacey Burns, Capital
Stacey Burns, Drawing
Miscellaneous Expense
Rent Expense
Utilities Expense
Advertising
The following are selected transactions completed by Ms Burns insurance agency:
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
11.
12.
13.
14.
15.
Received cash from the sale of an old typewriter, $50.00.
Paid cash for a new business equipment, $640.00.
Paid cash for the telephone bill, $36.00.
Received cash from day's sales, $780.00.
Paid cash for office supplies, $30.00.
Paid cash to Dolan's Stationery Store for part of amount owed, $100.00.
Received cash from the sale of an old desk, $45.00.
Received cash from day's sales, $275.00.
Paid cash for repairs to tiles on the office floor, $21.00.
Paid cash for the utility bill, $60.00.
Paid cash to the owner for personal use, $100.00.
Paid cash for newspaper advertising, $85.00.
Paid cash for a new office chair, $65.00.
Received cash from Ms. Burns as an additional investment, $1 000.00.
Paid cash to Jane's Equipment Company for part of amount owed, $250.00.
Instructions: Use a pair of T-accounts for each transaction. Complete steps a, b and c for
each transaction. (a) Write the account titles affected on the T- accounts.
The first T-account is done as an example. (b) Write the debit amount in the account to be
debited. (c) Write the credit amount in the account to be credited.
Accounting 10
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Lesson 5
P 3-7
(i)
(ii)
(iii)
(iv)
(v)
(vi)
(vii)
(viii)
(ix)
Accounting 10
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Lesson 5
P 3-7 continued
(x)
(xi)
Accounting 10
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Lesson 5
Problem 3
Analyzing transactions into debit and credit parts.
1.
Cash
6.
11.
2.
7.
12.
3.
8.
13.
4.
9.
14.
5.
10.
15.
50.00
Office Equipment/Machines
50.00
Accounting 10
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Lesson 5
Answers for Self Test
P 3-7
(i)
Cash
Tree Service Revenue
1 000
1 000
(ii) Accounts Receivable
Tree Service Revenue
3 500
(iii)
3 500
Equipment
Cash
900
(iv)
900
Cash
Tree Service Revenue
400
(v)
400
Accounts Payable
Cash
250
(vi)
250
Advertising Expense
Cash
120
(vii)
120
Equipment
Accounts Payable
300
(viii)
300
Utilities Expense
Cash
130
Accounting 10
130
20
Lesson 5
(ix)
Cash
Accounts Receivable
250
(x)
250
Wages Expense
Cash
3 600
(xi)
3 600
Cash
Accounts Receivable
1 000
1 000
MC 3-7a
Both students are partially correct and also in error with the response that they
have given. Jordan is correct in assuming that one business cheque could be used
to pay both bills, but he is incorrect in recording the owner's personal telephone
invoice amount to the business telephone account. On the other hand, Martin
realizes that there is a complication if a business cheque is used to pay both the
business telephone invoice and the personal telephone invoice.
MC 3-7b
Accounting theory and Canadian Income Tax laws does not allow the owner of a
business to record a personal expense in a business account. The entity concept
requires that business and personal transactions be kept separate. Similarly, the
tax laws of Canada will not allow personal expenses to be recorded as business
expenses since this would increase total expenses, thus decreasing net income and
subsequently decreasing the amount of tax that the owner would have to pay on his
business income.
MC 3-7c
First, it is important to establish the accounts that are affected in this transaction.
Cash, an asset, is decreasing and, according to the rules of debiting and crediting,
the entry must be found on the opposite side from where the element is found in the
equation. The entry must be on the right or credit side in the Cash account.
The second account would be Telephone Expense. An expense account causes the
Owner's Equity to decrease in the accounting equation. To reflect this decrease, the
rule states the amount should be recorded on the opposite or left (debit) side of the
account.
Accounting 10
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Lesson 5
Finally, you must deal with the owner's personal telephone bill. Since the
government and the entity concept will not allow this to be recorded as a business
expense, the owner has two ways of handling the personal amount. The owner
could write a business cheque for the business telephone invoice and a personal
cheque for the personal telephone invoice. Or, the owner could write one business
cheque for both of the invoices, but J. Grassi would be required to record the
business invoice as a Telephone Expense and the personal invoice amount to J.
Grassi, Drawing. The Drawing account must be used because the personal
telephone amount must not be included in the business expenses, but rather the
amount must be analyzed as a withdrawal of personal funds in anticipation of the
business earning future net income.
MC 3-7d
The correct entry, in T-account form, is as follows:
Telephone Expense
20__
Date
45
J. Grassi, Drawing
20__
Date
Cash
20__
Date
18
MC 3-8a
Same as MC 3-7 a.
Accounting 10
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Lesson 5
63
Problem 3
1.
Cash
50.00
6.
Dolan's Sationery
100.00
100.00
Office Equipment/Machines
Cash
7.
640.00
Cash
Office Furniture
Cash
8.
Cash
85.00
13.
275.00
Cash
37.00
Cash
275.00
9.
780.00
Misc. Expense
65.00
14.
21.00
Sales
780.00
Stacey Burns, Capital
21.00
10.
30.00
Utilities Expense
1 000.00
15.
60.00
Cash
Cash
1 000.00
Cash
Office Supplies
Office Furniture
65.00
Sales
Cash
Advertising Expense
45.00
37.00
Jane's Equip. Co.
250.00
Cash
30.00
Accounting 10
12.
85.00
640.00
5.
100.00
45.00
Cash
4.
Cash
100.00
2. Office Equipment/Machines
Utilities Expense
Stacey Burns, Drawing
100.00
50.00
3.
11.
Cash
60.00
23
250.00
Lesson 5