Accounting for a Service Business - Unit 1.6

Owner’s Equity

Revenue

Debit Credit

Owner’s Equity

Debit Credit

Expenses

Debit Credit

Increase Increase

Decrease Increase

Expenses are recorded as debits because expenses decrease equity

Revenue is recorded as a credit because revenue increases equity

Introducing the Owner’s Drawings Account The drawings account records the withdrawal of assets

from the business by the owner The owner of a business may make a regular practice of

withdrawing money or other assets for personal use This withdrawal of assets decreases the value of the

owner’s equity (this event is similar to an expense transaction since owner’s equity is reduced)

However, expenses are recognized only if the cost was incurred to produce revenue. So withdrawal of assets by the owner is not an expense so………….

A withdrawal of assets is recorded in an account called DRAWINGS – an equity account

Drawings Account Has a debit balance since withdrawals decrease owner’s

equity The owners drawings account is debited whenever assets

are withdrawn by the owner for personal use: Withdrawing cash Removing merchandise for personal use Taking equipment from the business for personal use

and Using company funds for personal expenses of the

owner or the owner’s family Owners salary – income tax rules state that the business

may not record the payment in an expense such as salaries expense. The payment of wages or salaries to an owner must be recorded in the Drawings account.

The General Ledger - Review

There is one account for each asset, liability and for the owner’s equity.

There is an account for each type of revenue, expense and for Drawings

As transactions occur, the changes caused by them are recorded in these accounts

Then a trial balance is prepared……

Equity Accounts on the Balance Sheet

The income statement is prepared first because the result, the net income or net loss affects the balance sheet….

The owners capital account and drawings account appear in the owner’s equity section of the balance sheet The capital account increases if there is net income earned or if the

owner increases the assets of the business by further investment The capital account decreases if there is a net loss or if the owner

withdraws assets from the business for personal use The owner’s drawings account is used to record all withdrawals The result of increases or decreases in the capital account are

shown in the equity section of the balance sheet

Account Form vs. Report Form Balance Sheets The account form balance sheet lists the assets on the left

side and the liabilities and owners equity on the right side The report form balance sheet lists the assets, liabilities

and owner’s equity VERTICALLY For the report form balance sheet, dollar signs should be

placed as follows: Beside the first figure in each column in both sections of the

statement Beside the final total in both sections of the statement

The balance sheet equation still appliesA = L + OE

Preparing Financial Statements From the Trial Balance

Income StatementStatement of Owner’s EquityBalance Sheet