Tips for identifying the account type:

 Remember your account types: Account types include Assets, Liabilities, Expense, Revenue, and Capital/Owner Equity accounts. All journal entries in
accounting have to fall into one of these categories. For instance, the office supplies account is an expense, while the cash account is an asset.
 Use standard accounting rules to determine which account is debited and which account is credited: When recording the above transaction in the office
supplies example, you will be increasing your expenses because you purchased office supplies, which is an expense account, while decreasing
your assets because you used your cash account, which is an asset, to purchase those supplies.

INCREASES DECREASES
ACCOUNT TYPE
BALANCE BALANCE

Assets: things of value such as cash, accounts receivable, bank accounts, computers,

Debit Credit
and furniture

Liabilities: things you owe including accounts payable and loans Credit Debit

Revenue: monies received for products or services during the course of doing business Credit Debit

Expenses: the cost of doing business including supplies, rent, payroll expenses, etc. Debit Credit

Capital / Owner Equity: represents your ownership or financial interest in the business Credit Debit
 The nature of each movement is explained below:

  DEBIT SIDE (Assets, Expenses, Drawings) CREDIT SIDE (Liabilities, Revenue, Owner’s Equity)

  Increase     Debit movement     Credit movement  
  Decrease     Credit movement     Debit movement  

Let’s apply this to our example:

When we pay expenses that means our expenses have increased. Also, when we pay expenses, our bank account is obviously going to go down.

So, in summary, we need to record a transaction that will increase expenses and decrease bank.

Referring back to our matrix, we can see that to increase expenses we require a debit movement.

  DEBIT SIDE (Assets, Expenses, Drawings) CREDIT SIDE (Liabilities, Revenue, Owner’s Equity)
  Increase   Debit movement   Credit movement  
  Decrease     Credit movement     Debit movement  

We can also see that decreasing our bank requires a credit movement:

DEBIT SIDE CREDIT SIDE

(Assets, Expenses, Drawings) (Liabilities, Revenue, Owner’s Equity)
Increase Debit movement Credit movement
Decrease Credit movement Debit movement
Debit Side Vs Credit Side
Debit side Credit Side

The debit side is the left side of the accounting equation. The credit side is the right side of the accounting equation.

The accounts of the debit side are ASSETS, EXPENSES, AND The accounts of the credit side are LIABILITIES, REVENUE AND OWNER’S
DRAWINGS. These are known as debit accounts. EQUITY. These are known as credit accounts.
Debit movements Vs Credit movements

For every transaction that occurs, two accounts will change. These two changes are known as a debit movement and a credit movement. The effects of
these movements are shown below.

Debit movements Credit movements

Increase the debit side Increase the credit side

Decrease the credit side Decrease the debit side

It is important you do not think of debit movements and credit movements as “pluses and minuses” or “good and bad”. This line of thinking is incorrect.
Using the above chart, you can see that a debit movement has the ability to both increase and decrease an account, as does a credit movement.
 BANK LEDGER

Details DEBIT CREDIT

Opening balance $0  

Owner’s Equity $10,000  

Loan $10,000  

iPhone   $500

Oven   $2,000

Owner’s Equity $5,000  

Loan   $1,000

Computer   $1,500

Cake mix $3,000

Interest $1,000

Sales $5,000

Telephone $300

Sales $2,000

Repairs $50

Drawings $1,000

TOTAL $32,000 $10,350

Minus credits -$10,350

BALANCE $21,650
Trial Balance Sheet
Debit Side Credit Side
Assets Liabilities

1. Bank  $21,650 1. Loan    $9,000

1. Computer    $1,500 1. John’s Car Shop    $3,000

1. Car   $3,000 1. Accumulated depreciation $400

1. iPhone $500 1. Add your items here

1. Oven $2000 1. Add your items here

Expenses Revenue

1. Cake mix  $3,000 1. Sales   $7,000

1. Interest expense   $1,000 1. Add your items here

1. Telephone expense   $300 1. Add your items here

1. Repairs expense  $50 1. Add your items here

1. Depreciation $400 1. Add your items here

Drawings Owners’ Equity

1. Drawings   $1,000 1. Owner’s Equity     $15,000

Assets 28650 Liabilities 12400

Expenses 4750 Revenue 7000
Drawings 1000 Owner’s Equity 15000
Total Balance 34400 Total Balance 34400
BALANCED!
TRIAL BALANCE FOR (NAME)’S BAKERY AS AT (TODAY’S DATE)  

DEBIT SIDE CREDIT SIDE

   

Assets Liabilities

Bank $21,650 Loan $9,000

Computer $1,500 John’s Car Shop $3,000

Car $3,000 Accumulated depreciation $400

iPhone $500  

Oven $500  

   

Expenses Revenue

Cake mix $3,000 Sales $7,000

Interest expense $1,000  

Telephone expense $300  

Repairs expense $50  

Depreciation $400  

   

Drawings Owners’ Equity

Drawings $1,000 Owner’s Equity $15,000

   

   

Balance $34,400 Balance $34,400

   

To check our Profit and Loss, we’re going to have the figures from two of these sections – Revenue and Expenses.

Let’s have a look at these numbers:

Revenue:

Sales $7,000

Expenses:

 Cake Mix $3,000

 Telephone $300
 Repairs $50
  Interest $1,000
 Depreciation $400

This is all the information that we need to produce for our Profit and Loss Statement. Let’s get started.

The basic format of a Profit and Loss Statement is simply:

Revenue - Expenses = Profit

Using the figures from our trial balance, simply fill in the figures in the Profit and Loss Statement below to work out your profit!

PROFIT AND LOSS STATEMENT FOR (NAME)’S BAKERY FOR THE PERIOD ENDED (TODAYS DATE)    

Revenue    

Sales $7,000  

     

Total Revenue   $7,000 (A)

     

Less: Expenses    

     

Cake mix expense $3,000  

Telephone expense $300  

Repairs expense $50  

Interest expense $1,000  

Depreciation expense $400  

     

Total Expenses   $4,750 (B)

     

Net Profit   $2,250 (C)

Congratulations. You made a profit! As we can see in our Profit and Loss Statement, your bakery made a profit of $2250

Now, before you get too excited, you need to remember that you don’t get to keep all that profit for yourself! There’s a very
important man known as the taxman who takes his cut each year:

How to Calculate Tax

Now that we’ve worked out our profit, we can work out how much tax we need to pay.

Your profit is $2,250. Assuming 30% tax rate, you need to pay a tax of $675

Remember, this is just an example - every country has its tax rate!

Let’s go ahead and do one last journal entry to record our tax expense:

Dr Tax Expense $675

Cr Accounts Payable $675

Tax Expense is an expense, so this causes our debit side to increase. The other side of the equation is accounts payable, which is
a liability.

It’s a liability because it is still owing; it’s a bit like a bill that’s waiting to be paid. This liability will be carried forward on our balance
sheet until we pay our tax the following year. At the time we finally pay it, we will credit our bank account by $675 and debit our
accounts payable by $675. By now, you should be able to see that this will reduce our accounts payable to zero, and the liability will
be eliminated from our accounts.

Tax is interesting because it is a journal entry that we do AFTER our profit and loss have been prepared. This means we have to go
‘backwards’ in the accounting process, so to speak.

After that, we prepare our tax ledgers as per usual and add the balances to the trial balance.
TAX EXPENSE LEDGER

Details DEBIT CREDIT

Opening balance $0  

Tax Payable $675  

BALANCE $675  

TAXATION PAYABLE LEDGER

Details DEBIT CREDIT

Opening balance   $0

Tax expense   $675

BALANCE   $675

Profit and Loss Statement Example

PROFIT AND LOSS STATEMENT FOR (NAME)’S BAKERY FOR THE PERIOD ENDED (TODAYS DATE)    

Revenue    

Sales $7,000  

     
Total Revenue   $7,000 (A)

     

Less: Expenses    

     

Cake mix expense $3,000  

Telephone expense $300  

Repairs expense $50  

Interest expense $1,000  

Depreciation expense $400  

     

Total Expenses   $4,750 (B)

     

Net Profit   $2,250 (C)

Less taxation (30%)   $675

Net profit after tax   $1,575

Revenue
   
 

1. Sales 1. 7000  
1. Calculate Revenue
  Your Total Revenue is 7000

Less: Expenses
   
 

1. Cake mix expense 1. $3,000  

1. Telephone expense 1. $300  
1. Repairs expense 1. $50  
1. Interest expense 1. $1,000  
1. Depreciation expense 1. $400  
1. Calculate Expenses
  Your Total Expenses is 4750

1. Calculate Net Profit

  Your Total Profit is 2250
Why P&L Statement is Importance?
The Profit and Loss Statement is a very important report. It’s the report you’ll submit to the bank next time you apply for a loan.
They’ll use it to see whether or not your business makes enough money to pay it back.

It’s the report you’ll submit to investors who want to invest in your bakery. They’ll use it to determine whether your business is
profitable and will give them a good return on their investment.

It’s the report you’ll submit to the government. They’ll use it to work out how much money you made and how much tax you need to
pay.

Anyone who needs information about your business’s profitability will use this report. Good job! Now let’s take care of the Profit and
Loss Statement’s big brother – the Balance Sheet.

To create our balance sheet, we’re going to need the remaining sections of our Trial Balance – Assets, Liabilities, Owners Equity,
and Drawings. Take a quick look at those.

TRIAL BALANCE FOR (NAME)’S BAKERY AS AT (TODAY’S DATE)

DEBIT SIDE CREDIT SIDE

   

Assets Liabilities

Bank $21,650 Loan $9,000

Computer $1,500 John’s Car Shop $3,000

Car $3,000 Accumulated depreciation $400

iPhone $500 Taxation Payable $675

Oven $500  

   

Expenses Revenue

Cake mix $3,000 Sales $7,000

Interest expense $1,000  

Telephone expense $300  

Repairs expense $50  

Depreciation $400  

Tax Expense $675  

Drawings Owners’ Equity

Drawings $1,000 Owner’s Equity $15,000

   

   

Balance $34,400 Balance $34,400

Let’s take a look at these numbers:

4

Assets

 Bank $24,150
 Computer $1,500
 Car $3,000

Liabilities

 Loan $9,000
 Johns Car Shop $3,000
  Taxation Payable $675
 Accumulated Depreciation $400

Owners’ Equity

 Owners Equity $15,000

 Drawings $1,000

We’ll also need to know our net profit for the year, which we know from our Profit and Loss statement, which is$1,575. Alright,
that’s all the information we need. Let’s get started. The basic format of a Balance Sheet is:

Assets – Liabilities = Owners Equity (Net Assets)

Using the figures from our Trial Balance, simply fill in the blanks on the Balance Sheet below. Note that there are two formats, a “T”
format and a list format. Both formats are commonly used, and are simply different methods of displaying the same information.

BALANCE SHEET FOR (NAME)’S BAKERY AS AT (TODAYS DATE)

Assets     Liabilities    

Bank $21,650   Loan $9,000  

Computer $1,500   John’s Car Shop $3,000  

Oven $2,000   Taxation Payable $675  

iPhone $500        

Car less accumulated depreciation $2,600        

Total Assets   $28,250 Total Liabilities   $12,675

           

      Owner’s Equity    

      Owner’s Equity at start of year $15,000  

      Minus: Drawings $1,000  

      Plus: Net Profit After Tax $1,575  

      Owner’s Equity at year end   $15,575

           

Total   $28,250 Total   $28,250

BALANCE SHEET FOR (NAME)’S BAKERY AS AT (TODAYS DATE)

     

Owner’s Equity    

Owner’s Equity at start of year $15,000  

Minus: Drawings $1,000  

Plus: Net Profit After Tax $1,575  

Owner’s Equity at year end   $15,575

     

Represented by:    

Assets    

Bank $21,650  

Computer $1,500  

Oven $2,000  

iPhone $500  

Car less accumulated depreciation $2,600  

Total Assets   $28,250

     

Less: Liabilities    
Loan $9,000  

John’s Car Shop $3,000  

Taxation Payable $675  

Total Liabilities   $12,675

     

NET ASSETS (Total Assets minus Total Liabilities)   $15,575

     

GREAT! We’ve just completed our Balance Sheet.

How to Read a Balance Sheet

Let me point out a few interesting things about it.

1. Notice how the Owner’s Equity at the top of the statement balances with the Net Assets at the bottom of the statement. They’re
both $15,575. This is where the term Balance Sheet comes from. If your Balance Sheet doesn’t balance, you’ve got a problem!

2. Notice how your Owner’s Equity changed. It’s now $15,575, even though you’ve only put $15,000 into the business, which was
the original amount. This is because you made a profit. As the owner, this profit is yours! Each year, any profit you make will carry
over to the Owner’s Equity section of the Balance Sheet. If you’ve been in business for ten years, then ten years of profit will have
been accumulated in your Owner’s Equity. Think of Owner’s Equity as the amount the business owes to you, so whenever you
make a profit, it’s yours! Oh, the joys of being a business owner!
3. Your Owner’s Equity only increased by $575, even though you made $1,575 in profit. Why is that? It’s because you took $1,000
of drawings during the year. That means although the $2,250 profit is yours, you already took $1,000 of it. Owners need to be
careful not to withdraw so much in drawings that their Owner’s Equity falls below zero.

That’s it friends! We’ve started our business, recorded all our transactions, prepared a list of journal entries, entered them into our
ledgers, taken our ledger balances into a trial balance, and finally produced a Profit and Loss Statement and a Balance Sheet!

This is the accounting process in action, and we now have two key reports that provide valuable information and will allow us to
make good financial decisions.