Chapter 5

The Expanded
Ledger:
Revenue, Expense,
and Drawings
1
Expanding the
Ledger

2
 Expanding the Ledger
Through the first four chapters we have
looked at the fundamental accounting
equation …
Assets = Liabilities + Owner’s Equity
This resulted in a single account for
owner’s equity.
By “default”, what types of entries have
you charged to owner’s equity?
3
 Types of OE Entries?
1. Owner’s investment in the company.
2. Revenues from the sale of goods or
by providing a service.
3. Expenses related to the operation of
the business and the generation of
revenues.
4. Drawings or owner’s withdrawals
from the business for personal use.
4
 Expanding the Ledger
 The focus of Chapter 5 is the
specific identification and use of
accounts to track …

REVENUES
EXPENSES
DRAWINGS 5
 Expanding the Ledger
 The purpose of expanding the ledger
is to provide essential information
about the progress of the business.
 This information is needed to assess
the ongoing profitability of the
company.
 What do we mean when we say a
company is profitable or making a
profit?
profit
 What is meant by loss? 6
Example of Expanding the Ledger

What do we know about profitability of

this firm in the month of January?
Did they make a profit or a loss?7
Example of Expanding the Ledger
How much was spent

on advertising?
Are the wages fair?

Is the rent too high?

How much did the

owner withdraw from
the business?

What types of economic events can

we “speculate” impacted the owner’s
equity account?
8
Example of Expanding the Ledger

Now … what can we determine

Owner’s Equity
about the profitability of this firm?
$26,137
9
 Income Statement
 Some of the information from these
REVENUES
new accounts will be used to
prepare an Income Statement.
&
Statement
EXPENSES
 What do you think an Income
Statement is?
An Income Statement
 What accounts doshows,
you think we
in detail, whether
the business
would use to prepare is profitable
in Income
or not … it shows if the
Statement?
Statement company made a
profit or loss.
10
 Note the
What does
Sample
this show?
formatting Income Statement

11
 Revenue
 What is revenue?
revenue
 Selling goods or services
produces revenue.
revenue
 What impact does revenue have
on equity?
 Revenue is an increase in equity
resulting from the sale of goods or
services in the usual course of
business. 12
 Revenue
 A company is paid $500 for
services rendered.
 Before using revenue accounts:
Dr. Cash $500
Cr. Owner’s Equity $500
 Using revenue accounts:
Dr. Cash $500
Cr. Revenue $500
13
 Revenue
How do revenue accounts “behave”?
Assets = Liabilities + Owner’s Equity
Debit Credit Debit Credit Debit Credit
(DR) (CR) (DR) (CR) (DR) (CR)
Normal Normal Normal
Balance Balance Balance

Revenue
Revenue represents an increase Debit Credit
Does
Is the
(DR)Revenue
“Normal
(CR)
in equity.
An increase in equity requires a Balance”
typicallyof a
Normal
Balance
credit entry. Revenue
increase aorDR
decrease
or CR?
Therefore, to book revenue, credit Owner’s Equity?
the revenue account.
14
GAAP - Revenue Recognition
The revenue recognition convention
states that revenue must be recorded
in the accounts (i.e. recognized)
at the time the transaction is
completed.
What does this mean?
Revenue is recorded when the bill is
sent to the customer.
For a cash transaction, revenue is
recorded when the sale is complete and
the cash is received. 15
 Expenses
 What is expenses?
expenses
 The costs associated with
producing revenue.
 What impact do expenses have
on equity?
 Expenses represent a decrease in
equity resulting from the cost of
producing revenue.
 Examples????
16
 Expenses
 A company pays wages of $250.
 Before using expense accounts:
Dr. Owner’s Equity $250
Cr. Cash $250
 Using expense accounts:
Dr. Wages Expense $250
Cr. Cash $250

17
 Expenses
How do expense accounts “behave”?
Assets = Liabilities + Owner’s Equity
Debit Credit Debit Credit Debit Credit
(DR) (CR) (DR) (CR) (DR) (CR)
Normal Normal Normal
Balance Balance Balance

Expenses
Expenses represent a decrease Debit Credit
Is
DotheExpenses
(DR) “Normal
(CR)
in equity.
A decrease in equity requires a Balance”
typically
Normal of an
Balance
debit entry. Expense
increase aorDR
decrease
or CR?
Therefore, expense accounts are Owner’s Equity?
typically debited.
18
 Net Income or Net Loss
 Using the revenue and expense
accounts, a business can determine
if they have earned a net income
(profit) or a net loss.
 Net Income is the difference between
the total revenues and total
expenses, where the revenues are
greater than the expenses.
 A Net Loss is created if expenses are
greater than the revenues. 19
 Drawings
 The owner usually looks to the
profits of the business to provide a
livelihood.
 In a healthy business, the owner is
able to take funds (generated by
profits) out of the business.
 These withdrawals of funds, by the
owner, are known as Drawings and
decrease equity. 20
 Drawings
 Drawings are NOT expenses.
 They are not associated with
producing revenue.
 Drawings have nothing to do with
the determination of the net income
or net loss.
 Cash is the most common item
withdrawn by an owner for personal
use. 21
 Expanding the Ledger
There are four types of accounts in the
equity section:
1. Capital – this account will now contain
only the equity figure at the beginning
of the fiscal period plus new capital
from the owner.
2. Revenues – increases in equity
resulting from the sale of goods or
services. A revenue account normally
has a credit balance. 22
 Expanding the Ledger
3. Expenses – decreases in equity
resulting from the costs of the materials
or services used to produce the
revenue. An expense account normally
has a debit balance.
4. Drawings – decreases in equity
resulting from the owner’s personal
withdrawals. A drawings account
normally has a debit balance. Drawings
are NOT a factor in calculating net
23
income or loss.
• The Income Statement
• Fiscal Periods
• GAAP – Time Period
Concept, The Matching
Principle
• Chart of Accounts
24
 The Income Statement
 The income statement tells the
owners and the managers how the
business is doing.
 By definition, an income statement
is a financial statement that
summarizes the items of revenue
and expense, and shows the net
income or net loss of a business for
a given period of time.
25
 The word
“expense” is not
always required.
Why?
In whatDate?
order are
The accounting
expenses listed?
period for which
the figures have
been accumulated
A company can
have more than
one source of
Net Income
revenue. is not
cash. It is the
difference
between total
revenues and total
expenses.
26
 The Income Statement
 Who uses the Income Statement?
1. Owners and Managers
 Shows if the business is making profit.
 Used for setting goals and policy.
 When compared to previous years, it
provides a trend … highlighting potential
problems.
2. Bankers
 Supports loan decisions.
 Past profitability is one indicator of future
27
potential.
 The Income Statement
 Who uses the Income Statement?
3. Income Tax Authorities
 Every business is required by law to
prepare an income statement.
 The net income figure of a proprietorship
must be included on the owner’s income
tax return.
 Corporations must file their own tax
returns.
 The income statement must be sent to the
government along with the tax returns.28
 Fiscal Period
 Net income is measured over a
specific length of time, known as the
fiscal period.
period
 The formal fiscal period is typically
one year.
 The fiscal year does not have to be
the calendar year … it just has to
run for 12 consecutive months (or in
some cases, 52 consecutive weeks) 29
 Accounting Period
 The text indicates that the fiscal period is
sometimes referred to as the accounting
period.
period
 Companies prepare financial statements
periodically in order to assess their
financial condition and operating results.
Accounting periods are typically one
month, one quarter, or one year.
 If a company uses a one year accounting
period (i.e. they only prepare financial
statements at year end) it is referred to
as their fiscal period or fiscal year.
year 30
 GAAP
The Time Period Concept
The time period concept provides
that accounting will take place over
specific time periods known as fiscal
periods.
What does this mean?
Companies must use fiscal periods of
equal length when measuring financial
progress.

31
 GAAP
The Matching Principle
The matching principle states that
each expense item related to revenue
earned must be recorded in the same
period as the revenue it helped earn.
What does this mean?
Expenses must be recorded in the
period in which the revenue is
recognized.
To do this, accountants make a
number of mathematical adjustments in
the accounts at the end of a fiscal year.
32
(we cover this in detail in Chapter 9)
 Chart of Accounts
 To help organize the expanded ledger, it
is customary to number the accounts in
the ledger. These numbers are used for
identification and reference, particularly
in computer systems.
 Three digits Four digits
 Assets 100 1000
 Liabilities 200 2000
 Capital & Drawings 300 3000
 Revenue 400 4000
 Expenses 500 5000

You can tell what type of account you are

working with by the first digit of its 33
account number.
 Expanded Basis Equation and
Debit / Credit Rules
Assets = Liabilities + Owner’s Equity

Owner’s Owner’s
Assets
= Liabilities
+ Capital - Drawings
Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr.

+ Revenues
- Expenses

Dr. Cr. Dr. Cr.

34
 Equity
Relationship
and the Balance
Sheet
35
 Beginning
Capital
$21,878

Drawings
$3,950 Ending
Capital
$26,137
(Beg + Inc)
Total
Income Increase
$23,660 in Equity
$4,259
(NI – Drawings)

Net
Income
$8,209
(Rev – Exp)

Total
Expenses
$15,451

Beginning Net Net Ending

Capital + Income -- Loss -- Drawings = Capital
36
$21,878 $8,209 $n/a $8,209 $26,137
 The
Forequity
this balance
section clearly
sheet,
describesthe ASSETS
what happened
section
during
is placed
the month
on of
January.
top ofEvethe Boa started
the
LIABILITIES
month with anda $21,878
EQUITY
claim onsections
the assets.
… Since
theinstead
Net Income
of beside
was greater
them.
than This
her drawings
format by
is$4,259,
referred her
to claim
as theon the
report
assets
formincreased
of the to
balance$26,137.
sheet.

37