Double-entry bookkeeping: Keeping the balance
The accounting equation is the fundamental principle of double-entry bookkeeping: Assets = Liabilities + Owner's Equity. Every single business transaction affects at least two accounts and must always keep this equation in balance. Here are common business scenarios and how to record them using the accounting equation.
1. Owner's Investment
Scenario: The owner invests $10,000 of personal cash into the business.
Analysis: The business receives cash, which is an Asset. The owner's claim on the business increases, which is Owner's Equity.
Recording: Increase Cash (Asset) by $10,000. Increase Owner's Capital (Equity) by $10,000.
Equation: Assets ($10,000) = Liabilities ($0) + Owner's Equity ($10,000). The equation remains in balance.
2. Purchase of Equipment with Cash
Scenario: The business buys a computer for $1,500 cash.
Analysis: The business exchanges one asset (Cash) for another asset (Equipment).
Recording: Increase Equipment (Asset) by $1,500. Decrease Cash (Asset) by $1,500.
Equation: Assets (+$1,500 - $1,500) = Liabilities ($0) + Owner's Equity ($0). Assets stay the same, keeping the equation balanced.
3. Purchase of Supplies on Credit
Scenario: The business buys $500 of office supplies on credit, to be paid later.
Analysis: The business receives a new Asset (Supplies) and incurs a new debt, which is a Liability (Accounts Payable).
Recording: Increase Supplies (Asset) by $500. Increase Accounts Payable (Liability) by $500.
Equation: Assets ($500) = Liabilities ($500) + Owner's Equity ($0). The equation remains in balance.
4. Paying Off a Liability
Scenario: The business pays $300 of the debt owed for the office supplies.
Analysis: The business pays out a portion of its Cash (Asset) to reduce its debt (Liability).
Recording: Decrease Accounts Payable (Liability) by $300. Decrease Cash (Asset) by $300.
Equation: Assets (-$300) = Liabilities (-$300) + Owner's Equity ($0). The equation remains in balance.
5. Services Rendered for Cash
Scenario: The business provides a service and receives $2,000 in cash.
Analysis: The business receives a new asset (Cash) and earns revenue, which increases Owner's Equity.
Recording: Increase Cash (Asset) by $2,000. Increase Service Revenue (Equity) by $2,000.
Equation: Assets ($2,000) = Liabilities ($0) + Owner's Equity ($2,000). The equation remains in balance.
6. Services Rendered on Account
Scenario: The business provides a service for $700 and invoices the client, who will pay later.
Analysis: The business earns revenue, which increases Owner's Equity. It gains a new asset in the form of a promise to pay (Accounts Receivable).
Recording: Increase Accounts Receivable (Asset) by $700. Increase Service Revenue (Equity) by $700.
Equation: Assets ($700) = Liabilities ($0) + Owner's Equity ($700). The equation remains in balance.
7. Collection of Accounts Receivable
Scenario: The client from the previous scenario pays the $700 owed.
Analysis: The business receives Cash (Asset), and the promise to pay (Accounts Receivable) is fulfilled and eliminated.
Recording: Increase Cash (Asset) by $700. Decrease Accounts Receivable (Asset) by $700.
Equation: Assets (+$700 - $700) = Liabilities ($0) + Owner's Equity ($0). Assets stay the same, keeping the equation balanced.
8. Paying a Business Expense
Scenario: The business pays a $200 utility bill with cash.
Analysis: The business pays out an asset (Cash) to cover an expense. Expenses decrease Owner's Equity.
Recording: Decrease Cash (Asset) by $200. Increase Utilities Expense (which decreases Equity) by $200.
Equation: Assets (-$200) = Liabilities ($0) + Owner's Equity (-$200). The equation remains in balance.
9. Owner's Withdrawal (Draw)
Scenario: The owner takes $500 cash from the business for personal use.
Analysis: The business's asset (Cash) decreases. The owner's claim on the business (Owner's Equity) also decreases.
Recording: Decrease Cash (Asset) by $500. Increase Owner's Draw (which decreases Equity) by $500.
Equation: Assets (-$500) = Liabilities ($0) + Owner's Equity (-$500). The equation remains in balance.
10. Purchase of Equipment with a Loan
Scenario: The business buys a new piece of equipment for $2,500 by taking out a loan.
Analysis: The business receives a new Asset (Equipment) but also incurs a new Liability (Loan Payable).
Recording: Increase Equipment (Asset) by $2,500. Increase Loan Payable (Liability) by $2,500.
Equation: Assets ($2,500) = Liabilities ($2,500) + Owner's Equity ($0). The equation remains in balance.
11. Purchase of Inventory
Scenario: A retail business buys $5,000 worth of clothing inventory on credit.
Analysis: The business receives a new Asset (Inventory). It also incurs a new debt, which is a Liability (Accounts Payable).
Recording: Increase Inventory (Asset) by $5,000. Increase Accounts Payable (Liability) by $5,000.
Equation: Assets ($5,000) = Liabilities ($5,000) + Owner's Equity ($0). The equation remains in balance.
12. Sale of Inventory
Scenario: The retail business sells all of the clothing inventory for $8,000 cash. The clothing originally cost the business $5,000.
Analysis: This transaction involves two parts that need to be recorded.
Revenue Recognition: The business receives cash and recognizes revenue. This increases Assets (Cash) and Owner's Equity (Revenue).
Cost of Goods Sold: The inventory leaves the business. The cost of that inventory becomes an expense. This decreases Assets (Inventory) and Owner's Equity (through the COGS expense).
Recording:
Increase Cash (Asset) by $8,000. Increase Revenue (Equity) by $8,000.
Increase Cost of Goods Sold (which decreases Equity) by $5,000. Decrease Inventory (Asset) by $5,000.
Equation:
Assets (+$8,000 - $5,000) = Liabilities ($0) + Owner's Equity (+$8,000 - $5,000).
The net change is +$3,000 on both sides of the equation, which is the business's gross profit from the sale. The equation remains in balance.
Navigating these common issues is part of the journey. If you have a bookkeeping challenge of your own or specific scenario that you need help with? Feel free to share your questions in the comments below! We will discover a solution and answer any other questions that develop.
