Analyzing an Expanded Equation

P. 115-139, Required Reading

Expanding the LedgerUntil now, we have only used one account to

record owner’s equity - Capital . Now, we are adding three new accounts to the equity section:

Revenue – related to the sale of goods and services

Expenses – costs related to or required to earn the revenues

Drawings – owner’s withdrawals for personal use.

CapitalThe only OE account that we have used to

this point is Capital.It represents the owner’s personal claim to

the business.We have used this as a “catch all” account.Now, the Capital account will only contain the

opening equity figure and any new capital (outside investment) made by the owner.

GAAP - Revenue RecognitionRevenue must be recorded at the time the

transaction is completed.This convention helps assure that the

revenue is not overstated or understated.It means that the income statement of a

business will be accurate.

ExpensesExpenses are costs directly related to the

generation of revenue.They represent a decrease in owners’ equity

and therefore represent a DEBIT entry. Many students confuse this, thinking that an

increase in expenses is the same as an increase in capital (therefore CREDITING). EXPENSES ARE NOT INCREASES IN OE.

DrawingsDrawings are personal withdrawals of funds

from a businessThey have nothing to do with the generation

of revenue. Therefore, Drawings do not represent an expense.

Drawings reduce equity, so they will be represented by a DEBIT.