28/01/22

The effects of capital, income, drawings and expenses on the accounting equation

o Capital and drawings are the main accounts for owners’ equity.
o When the owner adds money/assets into the business as capital, the owner gets more
interest (increase in money), but when the owners withdraws money/assets out of the
business, the interest on the owners’ capital decreases.(money decreases)
o Income and expenses affect owners’ equity through profit or loss.
o Profit is income, and an increase in profit increases the owners’ equity.
o Expenses and drawings reduce income and the owners’ equity.

Examples

A. Capital contribution by the owner

1) The owner transferred $ 180 000 into the business’ bank account as his capital.
Effect; Money was deposited into the bank, bank increases. Capital introduction
increases monetary interest in the business, owners’ equity increases. No effect on
liabilities.

Assets = Owners’ Equity + Liabilities

Effect Reason Effect Reason Effect Reason
1) +180 000 Bank increased +180 000 Capital 0 -

B. Receiving money for income

2) Sold goods for cash, $ 12 500.
Effect; cash was received when good were sold, cash increases. Sales is income,
income increases profit, owners’ equity increases. No effect on liabilities.

Assets = Owners’ Equity + Liabilities

Effect Reason Effect Reason Effect Reason
2) + 12 500 Cash increased +12 500 Sales (income) 0 -

C. Paying for expenses

3) Paid cash for stationery, $ 300.
Effect; Cash in the business decreases when stationery is bought. Stationery is an
expense, which decreases profits and owners’ equity. No effect on liabilities.

Assets = Owners’ Equity + Liabilities

Effect Reason Effect Reason Effect Reason
3) - 300 Cash decreased - 300 Stationery (expense) 0 -

D. Withdrawals/drawings by the owner

4) The owner took $ 5 000 cash for personal use.
 Effect; Cash in business decreases. Drawings decrease owners’ equity. No effect on
liabilities.

Assets = Owners’ Equity + Liabilities

Effect Reason Effect Reason Effect Reason
4) - 5 000 Cash decreased - 5 000 Drawings 0 -

E. Buying other assets

5) Bought equipment and paid by debit card $ 30 000.
Effect; Bank decreases, equipment in the business increases. No effect on owners’
equity and liabilities.

Assets = Owners’ Equity + Liabilities

Effect Reason Effect Reason Effect Reason
5) - 30 000 Bank decreased 0 - 0 -
+30 000 Equipment increased

F. Depositing cash into the bank

6) Deposited $ 1 500 cash into the bank
Effect; Cash account decreases, bank account increases. No effect on owners’
equity and liabilities.

Assets = Owners’ Equity + Liabilities

Effect Reason Effect Reason Effect Reason
6) - 1 500 Cash decreased 0 - 0 -
+1 500 Bank increased

G. Withdrawing money for cash float

7) Withdrew $ 400 by debit card for cash float.
Effect; Bank account decreases, Cash float increases. No effect on owners’ equity
and liabilities.

Assets = Owners’ Equity + Liabilities

Effect Reason Effect Reason Effect Reason
7) - 400 Bank decreased 0 - 0 -
+400 Cash float increased

H. Withdrawing money for business use.

8) Withdrew $ 6 000 by debit card for business use.
Effect; Bank account decreases, cash account increases. No effect on owners’
equity and liabilities.
 Assets = Owners’ Equity + Liabilities
Effect Reason Effect Reason Effect Reason
8) - 6 000 Bank decreased 0 - 0 -
+6 000 Cash increased

I. Borrowing a loan (liabilities)

9) Borrowed a loan of $ 50 000 from Bank ABC, received the money by EFT.
Effect; Bank account increases when loan is received. Liabilities increase since it’s a
borrowed loan. No effect on owners’ equity.

Assets = Owners’ Equity + Liabilities

Effect Reason Effect Reason Effect Reason
9) +50 000 Bank increased 0 - +50 000 Liabilities
increase (Loan,
Bank ABC)