Free Accounting Tutorials

Class Summary

In this class, you will discover how to manage accounts and financial transactions to operate
successful business. This course includes tons of interactive exercises to help you create accounts.
Make sure to take them.

What should i know?

Nothing! This is an absolute beginner guide to accounting.

Syllabus

1. What is accounting and why do we need it?

2. Assets and Liabilities
3. The Accounting Equation
4. Revenue, Expenses and Drawings
5. Introducing The Complete Accounting Equation
6. Basic transactions
7. Journal Entries
8. Ledgers
9. Fixed assets and depreciation
10. The Trial Balance
11. How to produce a Profit and Loss Statement
12. The Balance Sheet
13. Cash Flow Report
14. Decision Making – How to analyze financial reports to make informed decisions
What is accounting and why do we need it?
If you’re like most people out there, just hearing the word “accounting” probably sends your brain
off to sleep. You probably think accounting is hard. And boring. And for old people.
Well, the good news is, that’s not entirely true. Accounting can actually be extremely interesting. In
fact, a large part of accounting is basically learning about how to make more money. And most
people find making money a lot of fun J.

What is accounting?

Accounting can be defined as the production of financial information.

What this means is accounting allows us to see things like how much money you are earning, how
much you are worth, how much money you spend and where you can improve to make even more
money! The reason we need to know this is so we can make decisions.

Consider this scenario:

You run a bakery and you bake the best cream cake in the country. It is world famous and you
receive orders for your legendary cake from every continent!
However, one night a fanatic customer who believes you have a magic oven breaks into your bakery
and steals it. You go ballistic.

You need $10,000 to buy a new oven. You decide to go to the bank and ask for a loan.

You ask the bank for a $10,000 loan. The thing is, you don’t even have an accountant, so you do not
have any financial information about your bakery.

The loan officer is a pretty lady named Anne.

Anne asks how much profit you made this year. You don’t know so you guess. You say it was maybe
$30,000.

She asks you how much your assets are worth. You have no idea.

She asks how much debt you have. You’re not sure.

She asks what your cash flow is each month. You don’t even know what that means.

Because you have no financial information, Anne says no.

Now let’s say you go and find an accountant, who prepares some financial records for you. You
return to the bank with the following information.You have $5,000 of cash in the bank.

 You have sold $52,000 worth of cakes this year.

 This year you made a profit of $27,000, and profit has been increasing at an average rate of 6%
per year for the last 3 years.
 Your operating expenses are $25,000 this year. The largest is wages at $11,000 per year. The
next largest is advertising at $7,500 per year. The smallest is telephone expenses at $600 per
year.
 Your bakery has net assets of $122,000 and no debt.
 Your bakery had a net positive cash flow of $13,000 this year.
Now you can tell Anne the loan officer exactly how much money you make, how much you spend,
what you spend it on, how much you owe, how much you have in the bank, and how much your
assets are worth.
Because she now has information, she is able to make a decision to loan you the money. This is
because she knows how much money you make each month and can be confident you will be able to
repay the loan.

Now, don’t worry if you don’t understand all the fancy terms up there like “cash flow” and “net
assets”. We’ll be learning what all that means very soon.

So, what does accounting do for us? I’m sure you already know that when you’re in business, you
need to know whether you’re making money or not. Well, accounting helps you determine exactly
that! And remember, it’s important for the people you do business with (like the loan officer) to
know that too.

Even if you’re not in business, chances are you work for somebody that is. Whether you fix the
computers, write advertisements or makes sales over the phone, your role is designed to help your
employer achieve one key objective – making a profit. Your ability to understand financial
information makes you that much more valuable, not only to your employer but to your clients and
customers too. By understanding accounting, you have the ability to understand how a business
makes money, making you a more complete professional and connecting you with your employer,
your clients and their goals.

We also cannot forget the benefits of good personal finance. Accounting is as much a personal tool
as it is a business one. Money is a big problem for many people all over the world. Perhaps you are
finding it difficult to make ends meet, or maybe you’re trying to save for a vacation but can’t seem to
figure out where all your money goes. Accountancy provides you with the skills you need to manage
your money, where you can trace and categorise your expenses and effectively budget your income.
This allows you to determine exactly how much you spend on non-essentials such as movies and
fancy dinners, while also ensuring the important stuff such as rent and food for the family is always
paid on time.

What are Assets and Liabilities in Accounting

The words “asset” and “liability” are two very common words in accounting.
Some people simply say an asset is something you own and a liability is something you owe. In other
words, assets are good and liabilities are bad. That’s not wrong, but there’s a little more to it than
that. Let’s look at a more complete definition.

Assets
Assets are something that your business uses to help generate a profit.

To make your famous cream cake, you need your oven. These two things are examples of assets.

To be an asset it has to satisfy 3 requirements:

 It’s something you have control over

 You have control as a result of a past event
 It has a future economic benefit
Now, let’s say after you got your loan of $10,000, you went out and bought a new oven. But not just
any oven. You bought the latest and greatest model. You bought the Bakemaster X Series 3000.

Let’s see if your new Bakemaster fits the requirements of an asset.

Something you have control over?

You paid for it didn’t you? You can keep it, you can sell it, you can even bake your shoes in it if you
want to! Yep, it’s definitely in your control.

As a result of a past event?

In this case, going to the store and handing over your cash will constitute a past event.
Has a future economic benefit?

With your new Bakemaster, you’re definitely going to be baking some serious cream cakes which
customers are going to pay top dollar for. That’s definitely a future economic benefit.

Because your new oven meets above 3 requirements, it’s definitely an asset.

Now let’s take a look at an example, where something might not fit the definition of an asset.

Example B

A customer calls your store and says he had a dream about your cakes. He says he’s coming in
tomorrow to spend $1,000 in your bakery on every lemonade butter cream flavoured treat he
can find.

You think the $1,000 should be recorded as an asset in your records.

Let’s see if it fits the definition of an asset.

Something you have control over?

Sorry, you don’t have the $1,000 yet. You can’t spend it. You can’t even touch it! Definitely not in
your control.

As a result of a past event?

The event needed for you to gain control of that cash will be when he comes in and hands it to you.
Hasn’t happened yet though! So in this case, no event has taken place.

Has a future economic benefit?

$1,000 can buy a lot of things. Of course it has a future economic benefit.

Sorry, but this time you’re only 1 for 3. The $1,000 holds a future benefit, however you do not
have control of the money and the past events needed for you to gain control have not occurred yet.

Therefore, the $1,000 is not an asset.

Another example:

Your friend lets your borrow his car as a delivery vehicle. However, one night the road is slippery
and your driver crashes into a tree. The car is completely damaged and is no longer drivable. Let’s
see if the car is an asset:

Something you have control over?

The car doesn’t belong to you. It was lent to you by a friend, and you didn’t sign a lease or contract
giving you any rights to the car. Therefore, the car is not in your control.

As a result of a past event?

The event needed for you to gain control of the car is you signing an agreement and paying to
purchase the car or rent it. Sorry, but no such event has taken place.

Has a future economic benefit?

The car is completely damaged and cannot be driven. It won’t be providing a future economic benefit
for anyone.

Sorry, but this time you’re 0 for 3. The car is definitely not an asset.

Hopefully that gives you an understanding of assets and when you recognize them. But what about
liabilities?
Let’s take a look.

Liability
A liability requires 3 things:

 Presents the business with an obligation

 Obligation is a result of past events
 Settling the obligation will require an outflow of valuable resources
Remember when Anne decided to give you that loan? Well, before you walked out of the bank she
said to you, “You’re going to need to pay $1,000 each month until the whole $10,000 is paid back!”

Let’s see if the loan from Anne fits the definition of a liability.

Presents the business with an obligation?

You took the money. Now you’re required to pay it back! Definitely presents an obligation.

As a result of past events?

You signed the loan agreement. The obligation comes as a result of this past event.

Requires an outflow of valuable resources?

Paying back the loan requires the outflow of money. Money is valuable! That’s certainly an outflow
of valuable resources.

Bingo! The loan satisfies all the requirements, so we’ll be recording it in our books as a
liability.

Example B:

The sink in your store is leaking. One of your staff takes a look at it and tells you that you’ll
definitely need a plumber to come in and fix it, which will cost you around $200. You want to
list the $200 as a liability in your records.

Let’s see if the $200 fits the definition of a liability.

Presents the business with an obligation?

You are not obliged to pay anybody at this stage. The leaking sink is simply an inconvenience which
you can either choose to fix or not to fix. Therefore there’s no obligation to the business...yet.

As a result of past events?

You’ll need to actually call the plumber and receive the $200 invoice before any liability can be
recognised. This event hasn’t occurred yet!

Requires an outflow of valuable resources?

With no obligation to pay anybody just yet, no outflow of resources should be expected.

Luckily for you, the $200 doesn’t fit the requirements for a liability. You can keep this one off your
records!

Activity:

Think about the stuff you have in your life. Perhaps you drive a Ferrari, or maybe you simply ride a
bicycle. Maybe you own a mansion or maybe you live at the bottom of the ocean in a submarine.
Either way, you probably needed a mortgage for it. In this case, your Ferrari would be an example of
an asset whereas your mortgage is a liability. Use the worksheet below and list at least 3 assets and 3
liabilities you have in your business or your personal life. Use the checklist to make sure they fit the
definition of an asset.
 Assets Interactivity

Enter name of asset:

Liability Interactivity
Enter name of LIABILITY:

Below is a list of everyday thing you come across. Classify them as Asset, Liability or perhaps
neither

Assets Liability Neither Status

1. Bank
1. 1. 1.

1. Loan
1. 1. 1.

1. Building
1. 1. 1.

1. Hired furniture
1. 1. 1.

1. Rented property
1. 1. 1.

1. Mortgage
1. 1. 1.

1. Car
1. 1. 1.

1. Lawyer’s fees
1. 1. 1.
1. Bank account
1. 1. 1.

1. Credit Debit
Card 1. 1. 1.

1. Investments
1. 1. 1.

1. Bonds
1. 1. 1.

1. Job
1. 1. 1.

1. Unpaid bills
1. 1. 1.

1. House
1. 1. 1.

1. Hire purchase
contracts 1. 1. 1.

1. Future bills
1. 1. 1.

1. Computer
1. 1. 1.

1. Cellphone
1. 1. 1.

1. Past bills
1. 1. 1.
 1. Television
1. 1. 1.

1. Furniture
1. 1. 1.

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What are Assets and Liabilities in Accounting

Details

Last Updated: Saturday, 27 June 2015 16:00

The words “asset” and “liability” are two very common words in accounting.

Some people simply say an asset is something you own and a liability is something you owe. In other
words, assets are good and liabilities are bad. That’s not wrong, but there’s a little more to it than that.
Let’s look at a more complete definition.

Assets

Assets are something that your business uses to help generate a profit.

To make your famous cream cake, you need your oven. These two things are examples of assets.

To be an asset it has to satisfy 3 requirements:

It’s something you have control over

You have control as a result of a past event

It has a future economic benefit

Now, let’s say after you got your loan of $10,000, you went out and bought a new oven. But not just any
oven. You bought the latest and greatest model. You bought the Bakemaster X Series 3000.
Let’s see if your new Bakemaster fits the requirements of an asset.

Something you have control over?

You paid for it didn’t you? You can keep it, you can sell it, you can even bake your shoes in it if you want
to! Yep, it’s definitely in your control.

As a result of a past event?

In this case, going to the store and handing over your cash will constitute a past event.

Has a future economic benefit?

With your new Bakemaster, you’re definitely going to be baking some serious cream cakes which
customers are going to pay top dollar for. That’s definitely a future economic benefit.

Because your new oven meets above 3 requirements, it’s definitely an asset.

Now let’s take a look at an example, where something might not fit the definition of an asset.

Example B

A customer calls your store and says he had a dream about your cakes. He says he’s coming in tomorrow
to spend $1,000 in your bakery on every lemonade butter cream flavoured treat he can find.

You think the $1,000 should be recorded as an asset in your records.

Let’s see if it fits the definition of an asset.

Something you have control over?

Sorry, you don’t have the $1,000 yet. You can’t spend it. You can’t even touch it! Definitely not in your
control.

As a result of a past event?

The event needed for you to gain control of that cash will be when he comes in and hands it to you.
Hasn’t happened yet though! So in this case, no event has taken place.

Has a future economic benefit?

$1,000 can buy a lot of things. Of course it has a future economic benefit.

Sorry, but this time you’re only 1 for 3. The $1,000 holds a future benefit, however you do not have
control of the money and the past events needed for you to gain control have not occurred yet.

Therefore, the $1,000 is not an asset.

Another example:

Your friend lets your borrow his car as a delivery vehicle. However, one night the road is slippery and
your driver crashes into a tree. The car is completely damaged and is no longer drivable. Let’s see if the
car is an asset:

Something you have control over?

The car doesn’t belong to you. It was lent to you by a friend, and you didn’t sign a lease or contract
giving you any rights to the car. Therefore, the car is not in your control.

As a result of a past event?

The event needed for you to gain control of the car is you signing an agreement and paying to purchase
the car or rent it. Sorry, but no such event has taken place.

Has a future economic benefit?

The car is completely damaged and cannot be driven. It won’t be providing a future economic benefit
for anyone.

Sorry, but this time you’re 0 for 3. The car is definitely not an asset.

Hopefully that gives you an understanding of assets and when you recognize them. But what about
liabilities?

Let’s take a look.

Liability

A liability requires 3 things:

Presents the business with an obligation

Obligation is a result of past events

Settling the obligation will require an outflow of valuable resources

Remember when Anne decided to give you that loan? Well, before you walked out of the bank she said
to you, “You’re going to need to pay $1,000 each month until the whole $10,000 is paid back!”

Let’s see if the loan from Anne fits the definition of a liability.
Presents the business with an obligation?

You took the money. Now you’re required to pay it back! Definitely presents an obligation.

As a result of past events?

You signed the loan agreement. The obligation comes as a result of this past event.

Requires an outflow of valuable resources?

Paying back the loan requires the outflow of money. Money is valuable! That’s certainly an outflow of
valuable resources.

Bingo! The loan satisfies all the requirements, so we’ll be recording it in our books as a liability.

Example B:

The sink in your store is leaking. One of your staff takes a look at it and tells you that you’ll definitely
need a plumber to come in and fix it, which will cost you around $200. You want to list the $200 as a
liability in your records.

Let’s see if the $200 fits the definition of a liability.

Presents the business with an obligation?

You are not obliged to pay anybody at this stage. The leaking sink is simply an inconvenience which you
can either choose to fix or not to fix. Therefore there’s no obligation to the business...yet.

As a result of past events?

You’ll need to actually call the plumber and receive the $200 invoice before any liability can be
recognised. This event hasn’t occurred yet!

Requires an outflow of valuable resources?

With no obligation to pay anybody just yet, no outflow of resources should be expected.

Luckily for you, the $200 doesn’t fit the requirements for a liability. You can keep this one off your
records!

Activity:

Think about the stuff you have in your life. Perhaps you drive a Ferrari, or maybe you simply ride a
bicycle. Maybe you own a mansion or maybe you live at the bottom of the ocean in a submarine. Either
way, you probably needed a mortgage for it. In this case, your Ferrari would be an example of an asset
whereas your mortgage is a liability. Use the worksheet below and list at least 3 assets and 3 liabilities
you have in your business or your personal life. Use the checklist to make sure they fit the definition of
an asset.

Assets Interactivity
Enter name of asset:

Is under your control? Yes No

Do you own as a result of past event ? Yes No

Will provide a future economic benifits? Yes No

Sorry! is not an Asset.

Congratulation! is an Asset

Liability Interactivity

Enter name of LIABILITY:

Does impose a present obligation? Yes No

Do you owe as a result of past event ? Yes No

Will result in outflows of resources that have economic value? Yes No

Hi,

Sorry! is not an LIABILITY.

Congratulation! is an LIABILITY

Below is a list of everyday thing you come across. Classify them as Asset, Liability or perhaps neither

Assets Liability Neither Status

Correct.
Bank
Sorry, not correct.

Correct.
Loan
Sorry, not correct.

Correct.
Building
Sorry, not correct.

Hired furniture Correct.

 Sorry, not correct.

Correct.
Rented property
Sorry, not correct.

Correct.
Mortgage
Sorry, not correct.

Correct.
Car
Sorry, not correct.

Correct.
Lawyer’s fees
Sorry, not correct.

Correct.
Bank account
Sorry, not correct.

Correct.
Credit Debit Card
Sorry, not correct.

Correct.
Investments
Sorry, not correct.

Correct.
Bonds
Sorry, not correct.

Correct.
Job
Sorry, not correct.

Correct.
Unpaid bills
Sorry, not correct.

Correct.
House
Sorry, not correct.

Hire purchase Correct.

contracts Sorry, not correct.

Future bills Correct.

 Sorry, not correct.

Correct.
Computer
Sorry, not correct.

Correct.
Cellphone
Sorry, not correct.

Correct.
Past bills
Sorry, not correct.

Correct.
Television
Sorry, not correct.

Correct.
Furniture
Sorry, not correct.

Prev

The Accounting Equation

The accounting equation! Probably sounds intimidating. Don’t worry, it really is as simple as ABC.
Here’s what it looks like.

Assets = Liabilities + Owners Equity

Or

A = L + OE

We already know what the words “Asset” and “Liability” mean from the previous lesson. Let’s
quickly define this new term, “Owners Equity”.
Owner’s Equity

We can define Owners Equity as “the amount of money that you (the owner) have invested in
the business.”

Whenever you contribute any personal assets to your business your owner’s equity will increase.
These contributions can be any asset, such as cash, vehicles or equipment. For example, if you put
your car worth $5,000 into the business, your owner’s equity will increase by $5,000. If you invest
$10,000 of your savings into the business, your owner’s equity will increase by $10,000.

Likewise, if you take money out of the business your owner’s equity will decrease. For example, you
go into your store and take $100 from the cashier to buy yourself a shirt. Because you are taking
$100 out of the business, your owner’s equity will decrease by $100.

Let’s see if you can identify which of the following transactions will result in a change in owner’s
equity:

Activity: For each of these transactions we could simply have a “yes” and “no” button. I’ll write the
correct answer below for you to code.

Transaction 1:
You invest $1,000 of your personal savings into the business.
Change in owner’s equity? Yes No

Incorrect Correct

Transaction 2:
Your new oven breaks. You hire a repairman $50 to fix it.
Change in owner’s equity? Yes No

Correct Incorrect

Transaction 3:
You purchase a computer for the business using the business bank account.
Change in owner’s equity? Yes No

Incorrect Correct

Introduction to the accounting equation

Every single transaction that occurs in your bakery will be recorded using the accounting equation.

Before we go any further, there are 3 very important things to remember about the equation:

1. The left side is referred to as “The Debit Side”

2. The right side is referred to as “The Credit Side”
3. The equation must always be in balance.

The two sides to the equation:

The Debit Side

The left side of the equation is known as the debit side. As you can see, the left side of the equation
consists of Assets.

The Credit Side

The right side of the equation is known as the credit side. As you can see, the right side of the
equation consists of Liabilities and Owners Equity.
Remember, the equation must ALWAYS balance.

Note: Throughout this lesson you will also notice that we refer to different “accounts”. An account
can be thought of as a collection of related entries. For example, every entry that relates to our loan
will be recorded in the “loan account”. Every transaction that relates to our oven will be recorded in
the “oven account”. Might be part of the reason this subject is called “accounting”!

Let’s look at some examples to see the accounting equation in action.

Transaction 1

After making cupcakes in your Grandma’s kitchen your whole life, you decide to open a
bakery. You use your $10,000 in savings to start your business.

Now let’s look at how this fits into the accounting equation.

Accounts affected:

You have just put $10,000 into the bank, which is an asset. This goes on the debit side.
Now that the debit side has gone up, we need to balance this with $10,000 on our credit side.

We know that our $10,000 investment represents an increase in owner’s equity, and owner’s equity
will go on the credit side.

With these two entries, the equation is now balanced.

Let’s fit this into the accounting equation.

We started off with $0 = $0 + $0. Doesn’t get much easier than that!

Now it’s changed a little.

As you can see, we have +$10,000 on the left side (the debit side), and we have +$10,000 on the
right side (the credit side). Because both sides went up by $10,000, we’re still in balance. Phew!

Still don’t get it? Don’t worry, it’ll click soon enough. Let’s look at another example.

Debit side Credit Side

Bank +$10,000 Owner’s Equity +$10,000

Transaction 2

You need an iPhone to take delivery calls from all your crazy customers. You buy one off eBay
for $500.

Accounts affected:
Remember in the first example we put money into the bank? Well, this time we’ll be using the bank
again, only now we’ll be spending money. That means our bank account, an asset, is going to
decrease.

Now that we know the Debit side has decreased, we need to record the second side of the transaction
that will keep the equation in balance.

We’re going to create a new asset account called IPHONE, because we need to record the new phone
as an asset. Remember, it cost $500, so the two sides of the transaction are:

BANK -$500 (Debit side decrease)

IPHONE+$500 (Debit side increase)

Our bank caused the debit side to decrease, but then our new phone caused it to increase. That means
our debit side had no change in the end, and our equation still balances.

You may be wondering, why didn’t the credit side change in this example like it did in the previous
example?

Remember, the credit side is only involved in transactions that relate to liabilities and owner’s equity.
In this particular transaction, only assets were involved: we used an asset (bank) to purchase another
asset (iphone).
We saw above that owner’s equity only relates to investments made personally by the owner. In this
example, we used the business bank account to purchase a business asset. Therefore the owner was
not involved. If we had used the owner’s personal bank account to buy the iPhone, then our
owner’s equity on the credit side would have increased.

Still not getting it? Let’s do a few more examples.

Activity

Have a go at working out the two sides of each transaction. Remember, it needs to balance!

Transaction 3:

It’s time to go oven shopping, but first you need some cash. You visit Anne the loan officer and she
gives you a loan of $10,000.

Drag & Drop the blocks into correct positions in table

 10000$
 -10000$
 10000$
 -10000$
 Bank
 Loan

Debit Side Credit Side

Account Amount Account Amount

1. 1. 1. 1.

Transaction 4:
It’s your lucky day. You just won a lottery prize of $5,000. You decide to invest your $5,000 into the
business.
Drag & Drop the blocks into correct positions in table

 5000$
 -5000$
 5000$
 -5000$
 Bank
 Loan
 Owner's Equity
 Vehicle

Debit Side Credit Side

Account Amount Account Amount

1. 1. 1. 1.

Transaction 5:

We don’t want Anne to get angry. You better pay back some of the loan. You decide to pay back
$1,000.

 1000$
 -1000$
 1000$
 -1000$
 Bank
  Loan
 Owner's Equity
 Vehicle

Debit Side Credit Side

Account Amount Account Amount

1. 1. 1. 1.

Transaction 6:

You need a computer to start taking internet orders and also to watch funny Youtube videos after
work. You purchase a computer for $1,500.

 -1500$
 1500$
 1500$
 -1500$
 Bank
 Loan
 Owner's Equity
 Computer

Debit Side Credit Side

Account Amount Account Amount

 1. 1. 1. 1.

1. 1. 1. 1.

Transaction 7:

Your oven got stolen! Time to purchase the new Bakemaster X Series! It costs you $2,000

 -2000$
 2000$
 2000$
 -2000$
 Bank
 Loan
 Owner's Equity
 Oven

Debit Side Credit Side

Account Amount Account Amount

1. 1. 1. 1.

1. 1. 1. 1.

After recording these 7 transactions, our accounts now look like this. We have all our assets listed on
the debit side and all our liabilities and owner’s equity listed on the credit side.
Take a quick look back and see if you can follow how the numbers have changed.

DEBIT SIDE CREDIT SIDE

Bank $20,000 Loan $9,000

Computer $1,500

Oven $2,000 Owner’s Equity $15,000

Iphone $500

Balance$24,000 Balance$24,000

Still in balance. Perfect!

In case you haven’t figured out how we got to these figures, we’ve broken it down step by step for
you below.

Let’s use our Bank account as an example.

Our bank account started at $0. Then the following happened:

Transaction Running bank balance

We put $10,000 into the business $10,000

We spent $500 on an iPhone $9,500

We got a loan of $10,000 from the bank $19,500

We invested another $5,000 in the business $24,500

We paid back $1,000 of the loan $23,500

We bought a new computer for $1,500 $22,000

We bought a new oven for $2,000 $20,000

As you can see, we added all transactions that related to the bank to arrive at our ending balance of
$20,000. This is the same approach we took for all the accounts.

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What is Revenue, Expense and Drawing

In Lesson 2 we defined the terms Asset and Liability. In this lesson we will complete the last of our
definitions by defining the terms Revenue, Expense and Drawings.

Revenue

Revenue is money your business receives from its normal business activities. When the old man with
a top hat comes in each morning and hands over $5 for his slice of cream cake, that $5 is considered
to be revenue. Sometimes, revenue is referred to as turnover.
Remember, not all money you receive is revenue. Revenue is money received from the sale of goods
or services.

Consider the following:

Your friend Jane meets a handsome boy at the gym. The next day, the boy calls Jane and asks her on
a date. However, Jane has no money to buy a dress!

Jane borrows $100 from the bank so she can buy a dress for her date, which charges her interest of
10%.
A week later, Jane pays the bank back its $100 and the additional $10 in interest. Hence the bank
receives $110.

How much of the $110 is revenue?

Remember revenue is only money received from business activities. Therefore, Jane’s payment of
$100 is not from the sale of goods or services. It is simply repayment of the $100 the bank lent to her
in the first place.

However, the $10 in interest arises as a payment for the service of providing the loan. Hence, of the
$110 paid to the bank, only the $10 interest is actually considered revenue.

Expenses

The basic definition of an expense is money you spend to run your business.

For example, to run your bakery, you need to pay for much more than just cake mix. You need to pay
rent to Arnold the landlord each month. You need to pay for repairs to the delivery car every time
you ding your bumper in the parking lot. And you need to pay for internet so you can check how
many likes you have on the bakery’s Facebook page. All these things you are paying for are
examples of the business’s expenses.

An important characteristic of an expense is that it is a cost which does not result in the acquisition
of an asset.

For example, purchasing a car is not an expense. It is the purchasing of an asset, which we refer to as
capital expenditure. However, purchasing of insurance and gasoline for the car are examples of
expenses, which is known as revenue expenditure. We can loosely define capital expenditure as
purchasing something that lasts for more than one year, while revenue expenditure is the purchase
of something that lasts for less than one year.
Go through the following transactions and see if you can distinguish between capital and revenue
expenditure.

Drawings

As the owner, you will put money into the business from time to time. For example, on the day the
business started you would’ve deposited some of your own money into the business. This means you
can also take money out of the business.

For example, imagine one day you’re running late for dinner with your mother. As you’re running
down the street to the restaurant, you realize in your panic that you’ve forgotten your wallet!
There’s no way you can go back home, it’s an hour away! Then you realize the bakery is just around
the corner. You quickly pop over and take $100 out of the cashier.

This $100 will be recorded as drawings. Drawings is any amount the owner withdraws from the
business for personal use.

Drawings is generally only a factor in smaller, owner operated (proprietor) businesses. Large
companies and corporations will not deal the issue of drawings very often, simply because owners
can be quite detached from day to day running of the business. While it easy to account for drawings
in a small business such as a bakery, it is impossible for a Microsoft shareholder to simply go into a
Microsoft store and take a bundle of cash as drawings! In such cases, owner’s receive money from
the business via dividends or a shareholder’s salary.

Example 1:
You purchase a new oven for $1,000 for your bakery.

Revenue Expenditure Capital Expenditure

Incorrect Correct

Example 2:
Your new oven breaks. You hire a repairman $50 to fix it.
Revenue Expenditure Capital Expenditure
Correct Incorrect

Example 3:
You decide to furnish your store. You purchase 5 sets of tables and chairs at a total cost of $2,000.
Revenue Expenditure Capital Expenditure

Incorrect Correct

Example 4:

The delivery car is out of petrol! You take it to the gas station and fill up the tank for $100.
Revenue Expenditure Capital Expenditure

Correct Incorrect

Example 5:

We need more cream for the cakes! One of your staff heads to the supermarket and picks up a couple
of litres for $25.
Revenue Expenditure Capital Expenditure

Introducing The Complete Accounting Equation

Remember in Lesson 2 we learned the basic form of the accounting equation as:
Assets = Liabilities + Owners Equity

Now that we also understand the terms Revenue, Expense and Drawings, we can finally understand
the accounting equation in its complete form. Let’s take a look.

Assets + Expenses + Drawings = Liabilities + Revenue + Owners Equity

In Lesson 2 we learned that the left side is known as the debit side and the right side is known as the
credit side. The same rules apply here, only now we have some new additions to each side.

The Debit Side

The debit side now consists of not only Assets, but also Expenses and Drawings.

The Credit Side

The credit side now consists not only of Liabilities and Owners Equity, but also Revenue.

Let’s look at some common transactions that might occur in your day to day business, and how they
are recorded in the accounting equation.

Example 1:Purchasing a car with cash

Step 1: Identify the accounts involved in the transaction

Let’s identify the 2 accounts involved in this transaction

1. Bank – an Asset ( you will draw money to pay for car)

2. Car – an Asset (car will give you benefit for more than 1 year and is an asset)

Step 2: Determine where the accounts lie on Debit/ Credit Side

Both the accounts lie on the left hand side of the equation.

Step 3: Determine which accounts will increase or decrease

So in order to balance the equation, one asset must increase (Car) and other must decrease (Bank).

Debit side Credit side

Owner’s
Assets Expenses Drawings = Liabilities Revenue
Equity

Increase

Decrease
Example 2: Receiving revenue for selling Cakes
Step 1: Identify the accounts involved in the transaction

Let’s identify the 2 accounts involved in this transaction

1. Bank – an Asset ( you will deposit your revenue money into Bank)
2. Cake Sales – aRevenue account

Step 2: Determine where the accounts lie on Debit/ Credit Side

In this case, the 2 accounts lie on the opposite sides of the accounting equation.

Step 3: Determine which accounts will increase or decrease

Both the accounts could increase or decrease

But, it will be never be the case that one account is increasing and other decreasing, otherwise the
equation will not balance.

In this scenario, money from cake sale will be deposited in the bank. So Assets will increase.
Likewise, Revenues will increase as well

Debit side Credit side

Owner’s
Assets Expenses Drawings = Liabilities Revenue
Equity

Increase Increase

Example 3: Paying expenses with cash

 Increase
 Decrease

Debit side Credit side

Owner's
Assets Expenses Drawings = Liabilities Revenue
Equity
1. 1.
1. 2. 1. 1. 1.

Example 4 :Owner invests money in the business

 Increase
 Increase

Debit side Credit side

Owner's
Assets Expenses Drawings = Liabilities Revenue
Equity
1. 1.
1. 1. 2. 1. 1.

Example5: Owner withdraws money

 Decrease
 Increase

Debit side Credit side

Owner'
Expense Liabilitie Revenu
Assets Drawings = s
s s e
Equity
1. 1.
1. 2. 1. 1. 1.

Example 6: Pay back loan

 Decrease
 Decrease

Debit side Credit side

Owner's
Assets Expenses Drawings = Liabilities Revenue
Equity
1. 1. 1. 2. 1. 1. 1.
Notice every time the equation balances. If a debit account increases, then another debit account
decreases. There will never be a time when two debit accounts increase, because then the equation
won’t balance!
Similarly, it’s also common to see a debit account increase and then a credit account increase with it.
This also allows the equation to balance. You will never see a debit account increase and a credit
account decrease, because the equation will be left out of balance.

At the end of the day, the equation is just basic maths you learned at school!

1=1

If you add 5 to one side, we have to add 5 to the other side, otherwise it will simply be wrong:

1+5 = 1
Wrong!

Or, we can minus 5 from the same side to keep it balanced.

1+5-5 = 1

Don’t let the debits and credits confuse you. At the end of the day, it’s all just good ol’ pluses and
minuses.

If you’re still not quite getting it, don’t worry. In the following lesson, we’ll look at some examples
of recording transactions to get some practice at using the full accounting equation.

Basic Accounting Transactions

In this lesson, we are going to learn how basic transactions move through the accounting equation.
What we need to remember is that because the accounting equation always balances,every
movement in the equation must be countered by another movement of the same amount.
Now, here’s what the bakery’s accounts look like right now:
ASSETS LIABILITIES

Bank $20,000 Loan $9,000

Computer $1,500

Oven $2,000 OWNERS EQUITY $15,000

iPhone $500

Balance $24,000 Balance $24,000

As you can see, on the left side we have assets of a $20,000 in the bank, a computer which cost
$1,500, our favourite Bakemaster X Series oven worth $2,000, and an iPhone we scored off eBay for
$500. On the right side we have a single liability which is a loan from Anne at the bank for $9,000.
The balance is made up of Owners Equity of $15,000.

Notice how both the debit side and the credit side are in balance with each other, as they both
add up to $24,000.

That’s a good start.

Now it’s time for business. Below are some everyday transactions in the life of your bakery. Let’s
start selling cakes!

Transaction 1: You buy some cake mix for your store for $3,000

Purchasing our famous cake mix is like purchasing inventory. For now, we are going to classify
inventory purchases as an expense. Hence, our expenses are going to increase. Remember, this will
result in an increase in the debit side.

So now that expenses (CAKE MIX) has increased on the debit side, another movement is needed to
keep the equation in balance. The other side of our transaction will need to be either:

 An increase on the credit side

 A decrease on the debit side
In this case, because we are spending cash to buy the cake mix, the movement is obviously a
decrease in our bank account of $3,000.
Hence the transaction will look like:

DEBIT SIDE CREDIT SIDE

Account Amount Account Amount

Bank (asset) -$3,000

Cake mix (expense) +$3,000

Movement $0 Movement $0

Notice how our debit side increased by $3,000 due to an increase in the Cake Mix Expenses. Then,
our debit side decreased by $3,000 because our bank account, an asset, decreased when we paid for
the cake mix. The result is that both entries cancel each other out and our equation stays in balance.
Perfect!

Transaction 2: Anne the loan officer calls. She asks for interest of $1,000 to be paid on the loan.

OK, so we’re dealing with an expense, which is interest. We know that expenses sit on the debit side.
That means we’ll record interest expenses of $1,000.

To pay the interest, we took money out of the bank account, so the other side of the equation will be
a decrease in our bank account of $1,000. Let’s see how it balances.

DEBIT SIDE CREDIT SIDE

Account Amount Account Amount

Bank -$1,000

Interest expense +$1,000

Movement $0 Movement $0
Perfect!

Now it’s your turn. Have a go at dragging the correct accounts and their amounts onto the correct
side.

Transaction 3:

You sell a box of cakes for $5,000.

Hint - SALES is revenue. Revenue sits on the credit side. When you make sales, you receive
money in the BANK.

 -5000
 5000
 -5000
 5000
 BANK
 SALES
 OWNER'S EQUITY
 LOAN

DEBIT SIDE CREDIT SIDE

Account Amount Account Amount

1. 1. 1. 1.

Debit Movement Credit Movement

Transaction 4:

You pay your telephone bill of $300

Hint – TELEPHONE bill is an expense. Expenses sit on the debit side. Paying your telephone
bill will require money to be taken from the BANK.

 -300
 300
 300
 -300
 BANK
 LOAN
 OWNER'S EQUITY
 TELEPHONE EXPENSE

DEBIT SIDE CREDIT SIDE

ACCOUNT AMOUNT ACCOUNT AMOUNT

1. 1. 1. 1.

1. 1. 1. 1.

Debit Movement Credit Movement

Transaction 5:
You sell another box of cakes for $2,000

 -2000
 2000
 -2000
 2000
 BANK
 SALES
 OWNER'S EQUITY
 LOAN

DEBIT SIDE CREDIT SIDE

Account Amount Account Amount

1. 1. 1. 1.

Debit Movement Credit Movement

Transaction 6:

You’ve been playing with your bakery’s Facebook page for too long and the computer overheats.
You pay a repairman $50 to fix it.

Hint – REPAIRS is an expense. Expenses sit on the debit side. Paying expenses requires money
to be taken from the BANK.
  -50
 50
 50
 -50
 BANK
 LOAN
 OWNER'S EQUITY
 REPAIRS

DEBIT SIDE CREDIT SIDE

ACCOUNT AMOUNT ACCOUNT AMOUNT

1. 1. 1. 1.

1. 1. 1. 1.

Debit Movement Credit Movement

Transaction 7:

It’s time to go on holiday. Hawaii maybe? You withdraw $1,000 from the bakery’s bank account to
purchase your ticket.

Hint – When an owner withdraws money for personal reasons, this is considered DRAWINGS.
Drawings sits on the debit side.

 -1000
  1000
 1000
 -1000
 BANK
 LOAN
 OWNER'S EQUITY
 Drawings

DEBIT SIDE CREDIT SIDE

ACCOUNT AMOUNT ACCOUNT AMOUNT

1. 1. 1. 1.

1. 1. 1. 1.

Debit Movement Credit Movement

Transaction 8:

You visit Johns Car Shop to buy a delivery car. You choose the pink beetle with yellow polka dots
and a big flower in the middle. It costs $3,000. You purchase the car on credit, meaning you will pay
for it in full next month.

Hint – CAR is an asset. Assets sit on the debit side. When you purchase something on credit, it
is similar to debt. You owe money, which is a liability. Liabilities sit on the credit side.

 -3000
  3000
 -3000
 3000
 CAR
 JOHNS CAR SHOP
 OWNER'S EQUITY
 BANK

DEBIT SIDE CREDIT SIDE

Account Amount Account Amount

1. 1. 1. 1.

Debit Movement Credit Movement

We’ve just had 8 new transactions run through our business. Let’s have a look at what our accounts
look like now:

The below table is simply an expanded version of our accounting equation. Notice how on the left
side we still have assets, expenses and drawings. On the right side we have revenue, liabilities and
owner’s equity.

Debit side Credit Side

Bank $21,650 Sales $7,000

Computer $1,500

Car $3,000
iPhone $500

Oven $2,000 Loan $9,000

Johns Car Shop $3,000

Cake mix expense $3,000

Interest expense $1,000 Owner’s Equity $15,000

Telephone expense $300

Repairs $50

Drawings $1,000

Balance $34,000 Balance $34,000

It can also be helpful to classify our “accounts” into their respective categories. For example,
“bank” is an asset, hence we can display it in the Assets category. Sales are a form of revenue, and
hence we can place it in the Revenue category.

This allows us to split our debit side up into assets, expenses and drawings, while our credit side is
split up into liabilities, revenue and owner’s equity. This is very helpful when trying to monitor
changes in our accounting equation.

Let’s go ahead and break down our debit and credit side into categories. As long as each account is in
the right place, everything should stay in balance:

Debit side Credit Side

ASSETS REVENUE

Bank $21,650 Sales $7,000

Computer $1,500
Car $3,000

iPhone $500 LIABILITIES

Oven $2,000 Loan $9,000

EXPENSES Johns Car Shop $3,000

Cake mix expense $3,000

Interest expense $1,000 OWNERS EQUITY $15,000

Telephone expense $300

Repairs $50

DRAWINGS $1,000

Balance $34,000 Balance $34,000

Still in balance? Perfect!