Accounting Entries The concept of accounting is explained with an example given below: We will take a “Tea Stall” as a company and see how to book accounting entries for the business.
Peter (The Tea-stall owner) invests $25,000 to start the business.
Peter invested $25,000 in Company, hoping to get some profit. In other words, the company is liable to pay $25,000 to Peter in the future. So, the account “Peter” is a liability account, and it is credited. The company’s cash balance will be increased due to the investment. “Cash” is an asset to the company, and it will be debited.
The company needs equipment and raw materials immediately. He decides to buy them from the nearest general store, “Super Bazaar” whose owner is a friend so that he gets some credit. Equipment cost him $2,800 and raw materials $2,200. He pays $2,000 out of the total cost which is $5,000. This can be recorded in ERP using a Payment Entry.
Equipment is “Fixed Assets” (because they have a long life) and raw materials are “Current Assets” (since they are used for day-to-day business), of the company. So, “Equipment” and “Stock in Hand” accounts have been debited to increase the value. He pays $2,000, so the “Cash” account will be reduced by that amount, hence credited and he is liable to pay $3,000 to “Super Bazaar” later, so Super Bazaar will be credited by $3,000.
Peter (who takes care of all entries) decides to book sales at the end of every day so that he can analyze daily sales. At the end of the very first day, the tea stall sells 325 cups of tea, which gives net sales of $1,625. The owner happily books his first-day sales.
Income has been booked in the “Sales of Tea” account which has been credited to increase the value and the exact amount will be debited to the “Cash” account. Let’s say, making 325 cups of tea costs $800, so “Stock in Hand” will be reduced (Cr) by $800 and expenses will be booked in the “Cost of goods sold” account by the same amount. At the end of the month, the company paid the rent amount of the stall ($5,000) and the salary of one employee ($8,000), who joined from the very first day.
Booking Profit #
As the month progressed, the company purchased more raw materials for the business. After a month he books profit to balance the “Balance Sheet” and “Profit and Loss Statements” statements. Profit belongs to Peter and not the company hence it’s a liability for the company (it must pay it to Peter). When the Balance Sheet is not balanced i.e., Debit is not equal to Credit, the profit has not yet been booked. To book profit, the profit and loss accounts must be reset. The profit/loss is transferred to the Liability account and the profit/loss statement starts fresh. This is done using a “Period Closing Voucher”.
Explanation: Company’s net sales and expenses are $40,000 and $20,000 respectively. So, the company made a profit of $20,000. To make the profit booking entry, the “Profit or Loss” account has been debited and the “Capital Account” has been credited. The company’s net cash balance is $44,000 and some raw materials are available worth $1,000.