The business sells services or goods for money and in the
process the business also have to buy services or goods to be able to sell their
services or goods. These business activities can briefly be illustrated in the
following diagram:
The above diagram clearly illustrates the transactions
that occur frequently in a business. There are also a number of parties
involved. The affect of these basic transactions on the accounting equation can
be illustrated as follows:
The owner invests in the business:
- Owner invests cash:
The business receives the cash from the owner and that the
business owes this amount to the owner, which is the owners interest in the
business.
Debit - Bank Account = Credit - Capital
Account
- Owner invests assets:
The business receives an asset e.g. a motor vehicle from the
owner and it increases the business assets. On the other hand it also increases
the owners interest in the business.
Debit - Vehicles Account = Credit - Capital
Account
Purchase of assets:
- Purchase of assets and pay cash:
The business receives an asset e.g. a motor vehicle, stock;
etc. from another party (the supplier) and it increases the business assets.
On the other hand it also decreases the assets (cash in the bank).
Debit - Vehicles, etc. Account = Credit - Bank
Account
- Purchase assets on credit:
The business receives an asset e.g. a motor vehicle, etc. from
another party (the supplier) and it increases the business assets. On the other
hand it also increases the liabilities towards the supplier, which will then be
referred to as the creditor.
Debit - Vehicles, etc. Account = Credit - Creditor’s
Account
Incur expenses:
- Incur expenses and pay cash:
The business receives the value of goods and services, which
the business will consume or use up in the normal business activities, e.g.
placing of an advertisement, fuel for the motor vehicle, etc. and it increases
the business nominal accounts, the expense accounts. On the other hand it also
decreases the assets (cash in the bank).
Debit - Advertisements, Fuel, etc. Account = Credit -
Bank Account
- Incur expenses on credit:
The business receives the value of goods and services, which
the business will consume or use up in the normal business activities, e.g.
placing of an advertisement, fuel for the motor vehicle, etc. and it increases
the business nominal accounts, the expense accounts. On the other hand it also
increases the liabilities towards the supplier, which will then be referred to
as the creditor.
|
+ |
Expenses |
= |
+ |
Liabilities |
Debit - Advertisements, Fuel, etc. Account = Credit -
Creditor’s Account
Purchase of stock or goods for
resale:
- Purchase of stock or goods and pay cash:
The business receives an asset (stock) from another party
(the supplier) and it increases the business assets. On the other hand it also
decreases the assets (cash in the bank).
Debit - Stock Account = Credit - Bank
Account
- Purchase of stock or goods on credit:
The business receives an asset (stock) from another party (the
supplier) and it increases the business assets. On the other hand it also
increases the liabilities towards the supplier, which will then be referred to
as the creditor.
Debit - Stock Account = Credit - Creditor’s
Account
Sell services or goods:
- Sell services for cash:
The business receives an asset (cash) from another party (the
customer) and it increases the business assets. On the other hand it also
increases the nominal accounts (income).
Debit - Bank Account = Credit - Sales
Account
- Sell services on credit:
The business receives an asset (debtor) from another party
(the customer) and it increases the business assets. On the other hand it also
increases the nominal accounts (income).
Debit - Debtor’s Account = Credit - Sales
Account
- Sell stock for cash:
The business gains an asset (cash) from another party (the
customer) and it increases the business assets. On the other hand it also
increases the nominal accounts (income).
The business loses an asset (stock at cost price) and it
decreases the business assets. On the other hand it also decreases the nominal
accounts (cost of sales).
|
+ |
Assets |
= |
+ |
Income |
|
- |
Assets |
= |
- |
Cost of sales |
Debit - Bank Account = Credit - Sales Account with
the Selling Price of the goods sold.
Debit - Cost of Sales Account = Credit - Stock
Account with the Cost Price of the goods sold.
- Sell stock on credit:
The business gains an asset (debtor) from another party (the
customer) and it increases the business assets. On the other hand it also
increases the nominal accounts (income). The business loses an asset (stock at
cost price) and it decreases the business assets. On the other hand it also
decreases the nominal accounts (cost of sales).
|
+ /TD>
|
Assets |
= |
+ |
Income |
|
- |
Assets |
= |
- |
Cost of sales |
Debit - Debtor’s Account = Credit - Sales Account
with the Selling Price of the goods sold.
Debit - Cost of Sales Account = Credit - Stock
Account with the Cost Price of the goods sold.
Receive cash from debtors:
The business gains an asset (cash) from another party (the customer) and it
increases the business assets. On the other hand it also decreases the business
assets (debtors).
Debit - Bank Account = Credit - Debtor’s
Account
Payment of creditors:
The business decreases a liability (creditor) with the money paid to the
other party (the creditor) and it decreases the business assets (cash).
Debit - Creditor’s Account = Credit - Bank
Account
In addition to these transactions, you may also find other
transactions, such as -
-
Returns to creditors (suppliers), which has the opposite
affect on the accounting equation as purchases.
-
Credit notes or goods returned, received from debtors
(customers) has exactly the opposite effect on the accounting equation as
sales.
-
Correction of errors and adjustments, which does not
necessarily involve a third party.
