Frank Wood’s

Business Accounting 1

Chapter 4
The effect of profit or loss on
capital and the double entry
system for expenses and revenues

1
 Learning objectives
After finishing this chapter, you will 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.

2
 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 owner’s own purposes
are dealt with in the accounting records.

3
The nature of profit or loss
 Profitmeans 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.

4
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

5
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

 Orwhen a loss has been earned, the capital

figure decreases:
Old capital − Loss = New capital

6
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 Rent account
account
Overdraft interest Motor expenses Postages
account account account
Audit fees account Telephone account Stationery
account
Insurance account General expenses Wages account
account

7
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.

8
Debit or credit (Continued)

9
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

10
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

11
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

12
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

13
Activity (Continued)

14
Drawings
 Money or inventory 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.

15
Recording drawings
On 25 August, the owner takes £50 cash
out of the business for his own use:

16
Recording drawings
(Continued)
On 28 August, the owner takes £400 of
goods out of the business for his own use:

17