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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.

 

DEBIT SIDE

Account

  1.  
     

Amount

  1.  
     

CREDIT SIDE

Account

  1.  
     

Amount

  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.

 

DEBIT SIDE

ACCOUNT

  1.  
     

AMOUNT

  1.  
     
  1.  
     
  1.  
     

CREDIT SIDE

ACCOUNT

  1.  
     

AMOUNT

  1.  
     
  1.  
     
  1.  
     
Debit Movement
 
Credit Movement
 
 

 

Transaction 5:

You sell another box of cakes for $2,000

 

DEBIT SIDE

Account

  1.  
     

Amount

  1.  
     

CREDIT SIDE

Account

  1.  
     

Amount

  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.

 

DEBIT SIDE

ACCOUNT

  1.  
     

AMOUNT

  1.  
     
  1.  
     
  1.  
     

CREDIT SIDE

ACCOUNT

  1.  
     

AMOUNT

  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.

 

DEBIT SIDE

ACCOUNT

  1.  
     

AMOUNT

  1.  
     
  1.  
     
  1.  
     

CREDIT SIDE

ACCOUNT

  1.  
     

AMOUNT

  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.

 

DEBIT SIDE

Account

  1.  
     

Amount

  1.  
     

CREDIT SIDE

Account

  1.  
     

Amount

  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!

 

 

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