This chapter discusses calculating profit and loss, and the double entry system for recording expenses and revenues. It explains that profit is calculated as revenue minus expenses, and how profit or loss affects the accounting equation and capital. Separate accounts are used for each type of expense and revenue, with expenses recorded as debits and revenues as credits. The chapter also covers how drawings by the business owner are recorded, decreasing capital rather than being an expense.

1. Chapter 4
The effect of profit or loss on
capital and the double entry
system for expenses and revenues
Frank Wood’s
Business Accounting 1
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2. 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.
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3. 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.
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4. The nature of profit or loss
 Profit means 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.
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5. 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
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6. 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
 Or when a loss has been earned, the capital
figure decreases:
Old capital − Loss = New capital
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7. 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
account
Rent account
Overdraft interest
account
Motor expenses
account
Postages
account
Audit fees account Telephone account Stationery
account
Insurance account General expenses
account
Wages account
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8. 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.
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9. Debit or credit (Continued)
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10. 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
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11. 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
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12. 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
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13. 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
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14. Activity (Continued)
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15. 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.
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16. Recording drawings
On 25 August, the owner takes £50 cash
out of the business for his own use:
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17. Recording drawings (Continued)
On 28 August, the owner takes £400 of
goods out of the business for his own use:
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