Presentation on theme: "Chapter 4 The effect of profit or loss on capital and the double entry system for expenses and revenues."— Presentation transcript:
1 Chapter 4 The effect of profit or loss on capital and the double entry system for expenses and revenues
2 Learning objectivesAfter you have studied this chapter, you should be able to:Calculate profit by comparing revenue with expensesExplain how the accounting equation is used to show the effects of changes in assets and liabilities upon capital after goods or services have been tradedExplain why separate accounts are used for each type of expense and revenue
3 Learning objectives (Continued) Explain why an expense is entered as a debit in the appropriate expense accountExplain why an item of revenue is entered as a credit in the appropriate revenue accountEnter a series of expense and revenue transactions into the appropriate T- accountsExplain how the use of business cash and business goods for the owner’s own purposes are dealt with in the accounting records
4 The nature of profit or loss Profit means the amount by which revenue is greater than expenses for a set of transactions, where:Revenue means the sales value of goods and services that have been supplied to customers.Expenses means the cost value of all the assets that have been used up to obtain these revenues.
5 Calculating profitIf we supplied goods and services valued for sale at £100,000 to customers, and the expenses incurred by us in order to supply those goods and services amounted to £70,000, the result would be a profit of £30,000: Revenue £100,000 Less expenses (£70,000) Profit £30,000
6 The effect of profit and loss on capital The accounting equation we have used is:Capital = Assets − LiabilitiesWhen profit has been earned, this increases capital:Old capital + Profit = New capitalOr when a loss has been earned, the capital figure decreases:Old capital − Loss = New capital
7 Recording expensesIn order to calculate profit, expenses must be entered into appropriate accounts. A separate account is opened for each type of expense:Bank interest accountSubscriptions accountRent accountOverdraft interest accountMotor expenses accountPostages accountAudit fees accountTelephone accountStationery accountInsurance accountGeneral expenses accountWages account
8 Debit or creditAssets and expenses involve expenditure by the business and are shown as debit entries because they must ultimately be paid for.Revenue is the opposite of expenses and therefore revenue entries appear on the credit side of the revenue accounts.
15 DrawingsMoney that the owner takes from the business for private use is called drawings.Drawings reduces capital – they are never an expense of the business.An increase in drawings is a debit entry in the drawings account.The credit entry is against cash or bank if money was taken from the business, or purchases if stock was taken.
16 Recording drawingsOn 25 August, the owner takes £50 cash out of the business for his own use:
17 Recording drawings (Continued) On 28 August, the owner takes £400 of goods out of the business for his own use:
18 Learning outcomes You should have now learnt: How to calculate profit by comparing revenue with expensesThat the accounting equation is central to any explanation of the effect of trading upon capitalWhy every different type of expense is shown in a separate expense accountWhy every different type of revenue is shown in a separate revenue account
19 Learning outcomes (Continued) Why an expense is shown as a debit entry in the appropriate expense accountWhy revenue is shown as a credit entry in the appropriate revenue accountHow to enter a series of expense and revenue transactions into the appropriate T-accountsWhat is meant by the term ‘drawings’
20 Learning outcomes (Continued) That drawings are always a reduction in capital and never an expense of a businessHow to record drawings of cash in the accounting booksHow to record drawings of goods in the accounting books