As previously discussed, double-entry accounting tracks transactions in at least two accounts using the T-account. This account remains fundamental for double-entry accounting, in which the left side represents debit and the right, credit. As a rule of thumb, the net debit must equal the net credit. Sequel to Double-Entry Accounting Part 1, this article provides insight into the remaining three of five key accounts. They are Owner Equity, Revenue, and Expenses accounts. It would also highlight the proper entry of transactions in a T account.
Owner equity refers to resources contributed by the owners. Based on the fundamental accounting equation, equity is what is left after all liabilities have been offset. In which case, owner equity would equal assets. This follows the principle that each side of the equation must balance every time. Another name for owner equity is owner financing or stockholders’ equity. Resources contributed by other people other than the owners are referred to as non-owner financing.
The owner’s equity account commonly consists of retained earnings, contributed capital, dividends, common stock, and non-controlling interest. It also includes the two accounts found in the income statement which are revenue and expense.
Revenue refers to the value of all products and services rendered over a period. It is also referred to as Income or Sales and can therefore be found in the Income statement or Profit/Loss statement. Usually, when accomplishments exceed efforts in a company, profits are declared. On the other hand, losses are declared when efforts outweigh the accomplishments.
A fundamental note is that revenue impacts owner’s equity positively. Thus, once revenue increases, equity increases, and vice versa.
This type of account contains all money spent or costs incurred by a business to generate income. This simply implies that all cost of doing the business is accounted for in the expense account. It can be found in the income statement as well. It is expected that when these costs are deducted from the revenue the net income is positive, that is, a profit is made. Examples of transactions found in the expense account are the cost of goods sold, travel expenses, wages, and utility expenses.
Expenses impact on owner’s equity negatively.
Correctly recording a transaction
Before proceeding with the correct way to record transactions, a few basic rules should be re-emphasized. They are.
- A debit increases an asset
- A credit decreases an asset
- A debit decreases liability or equity
- A credit increases liability or equity
However, dividends and expenses are equity accounts with an exception to the above rule. In this case, they are increased by debit and decreased by credit.
In Accounting, transactions are recorded in a journal using a chronological three-step method.
Three Step Method
- Determining which key account is impacted by the transaction i.e., asset, liability, equity, revenue, or expense.
- Specifying whether the account is increased or decreased by the transaction
- Recording the transaction in the journal as appropriate. This is known as journalising the transaction.
Following these three steps is the gateway to the correct recording of transactions. It is always helpful to identify any impact on cash first.
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