Slide 4.

Chapter 4
The effect of profit or loss on
capital and the double entry
system for expenses and
revenues
Frank Wood and Alan Sangster, Frank Woods Business Accounting 1, 12th Edition, Pearson Education Limited 2012

Slide 4.2

Learning objectives
After you have studied this chapter, you
should be able to:
Calculate profit by comparing revenue with
expenses
Explain how the accounting equation is
used to show the effects of changes in
assets and liabilities upon capital after
goods or services have been traded
Explain why separate accounts are used for
each type of expense and revenue

Frank Wood and Alan Sangster, Frank Woods Business Accounting 1, 12th Edition, Pearson Education Limited 2012

Slide 4.3

Learning objectives (Continued)

Explain

why an expense is entered as a

debit in the appropriate expense account
Explain why an item of revenue is entered
as a credit in the appropriate revenue
account
Enter a series of expense and revenue
transactions into the appropriate T-accounts
Explain how the use of business cash and
business goods for the owners own
purposes are dealt with in the accounting
records
Frank Wood and Alan Sangster, Frank Woods Business Accounting 1, 12th Edition, Pearson Education Limited 2012

Slide 4.4

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.

Frank Wood and Alan Sangster, Frank Woods Business Accounting 1, 12th Edition, Pearson Education Limited 2012

Slide 4.5

The Nature of Profit & Loss

Profit

= Revenue Expenses
Profit = the amount by which revenues are
greater than expenses for a set of
transactions
Revenue = the sales value of goods and
services that have been supplied to
customers
Expenses = the cost value of all the assets
that have been used up to obtain those
revenues
Frank Wood and Alan Sangster, Frank Woods Business Accounting 1, 12th Edition, Pearson Education Limited 2012

Slide 4.6

Calculating profit
If 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

Frank Wood and Alan Sangster, Frank Woods Business Accounting 1, 12th Edition, Pearson Education Limited 2012

Slide 4.7

The effect of profit and loss on

capital
The

accounting equation we have used is:

Capital = Assets Liabilities

When

profit has been earned, this

increases capital:
Old capital + Profit = New capital

Or

when a loss has been earned, the

capital figure decreases:
Old capital Loss = New capital

Frank Wood and Alan Sangster, Frank Woods Business Accounting 1, 12th Edition, Pearson Education Limited 2012

Slide 4.8

Recording expenses
In order to calculate profit, expenses must
be entered into appropriate accounts. A
separate account is opened for each type
of expense:
Bank interest account

Subscriptions account

Rent account

Overdraft interest
account

Motor expenses
account

Postages
account

Audit fees account

Telephone account

Stationery
account

Insurance account

General expenses
account

Wages account

Frank Wood and Alan Sangster, Frank Woods Business Accounting 1, 12th Edition, Pearson Education Limited 2012

Slide 4.9

Debit or credit
Assets

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.

Frank Wood and Alan Sangster, Frank Woods Business Accounting 1, 12th Edition, Pearson Education Limited 2012

Slide 4.10

Debit or credit (Continued)

Frank Wood and Alan Sangster, Frank Woods Business Accounting 1, 12th Edition, Pearson Education Limited 2012

Slide 4.11

Double entries for expenses

and revenues
Rent of 200 is paid in cash:
Debit the rent account with 200
Credit the cash account with 200

Frank Wood and Alan Sangster, Frank Woods Business Accounting 1, 12th Edition, Pearson Education Limited 2012

Slide 4.12

Double entries for expenses

and revenues (Continued)
Motor expenses of 355 are paid by cheque:
Debit the motor expenses account with 355
Credit the bank account with 355

Frank Wood and Alan Sangster, Frank Woods Business Accounting 1, 12th Edition, Pearson Education Limited 2012

Slide 4.13

Double entries for expenses

and revenues (Continued)
60 cash is received for commission
earned by the business:
Debit the cash account with 60
Credit the commissions received account with
60

Frank Wood and Alan Sangster, Frank Woods Business Accounting 1, 12th Edition, Pearson Education Limited 2012

Slide 4.14

Activity
June 1 Paid for postage stamps by cash
50
June 2 Paid for electricity by cheque 229
June 3 Received rent in cash 138
June 4 Paid insurance by cheque 142

Frank Wood and Alan Sangster, Frank Woods Business Accounting 1, 12th Edition, Pearson Education Limited 2012

Slide 4.15

Activity (Continued)

Frank Wood and Alan Sangster, Frank Woods Business Accounting 1, 12th Edition, Pearson Education Limited 2012

Slide 4.16

Drawings
Money

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.
Frank Wood and Alan Sangster, Frank Woods Business Accounting 1, 12th Edition, Pearson Education Limited 2012

Slide 4.17

Drawings
Drawings

Expenses of a business
Drawings = cash and physical goods
taken out from the business for the
owners private
Drawing =
Capital

Frank Wood and Alan Sangster, Frank Woods Business Accounting 1, 12th Edition, Pearson Education Limited 2012

Slide 4.18

Accounting Entries

Frank Wood and Alan Sangster, Frank Woods Business Accounting 1, 12th Edition, Pearson Education Limited 2012

Slide 4.19

Recording drawings
On 25 August, the owner takes 50 cash
out of the business for his own use:

Frank Wood and Alan Sangster, Frank Woods Business Accounting 1, 12th Edition, Pearson Education Limited 2012

Slide 4.20

Recording drawings (Continued)

On 28 August, the owner takes 400 of
goods out of the business for his own use:

Frank Wood and Alan Sangster, Frank Woods Business Accounting 1, 12th Edition, Pearson Education Limited 2012

Slide 4.21

Learning outcomes
You should have now learnt:
1.How to calculate profit by comparing
revenue with expenses
2.That the accounting equation is central to
any explanation of the effect of trading
upon capital
3.Why every different type of expense is
shown in a separate expense account
4.Why every different type of revenue is
shown in a separate revenue account

Frank Wood and Alan Sangster, Frank Woods Business Accounting 1, 12th Edition, Pearson Education Limited 2012

Slide 4.22

Learning outcomes (Continued)

5. Why

an expense is shown as a debit entry

in the appropriate expense account
6. Why revenue is shown as a credit entry in
the appropriate revenue account
7. How to enter a series of expense and
revenue transactions into the appropriate
T-accounts
8. What is meant by the term drawings

Frank Wood and Alan Sangster, Frank Woods Business Accounting 1, 12th Edition, Pearson Education Limited 2012

Slide 4.23

Learning outcomes (Continued)

That drawings are always a reduction in
capital and never an expense of a
business
10. How to record drawings of cash in the
accounting books
11. How to record drawings of goods in the
accounting books
9.

Frank Wood and Alan Sangster, Frank Woods Business Accounting 1, 12th Edition, Pearson Education Limited 2012