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Read free for 60 days Cancel anytime. A brief history It’s tricky to explain debit sides and credit sides without a little history which we're going to cover in our accounting tutorials. Initially, debit and credit side refers to the parts on the page in a book called the ledger. And a ledger was a book that had many pages that looked something like this  Everything to the left of the centre was the debit side and everything to the right was called the credit side. Accountants would assign a page in the book to each account (eg. a page for Rent, one for bank charges etc.). Each Ledger Account had a debit side and a credit side. So imagine that you have just made an EFT to pay your landlord. To update your ledger you’ll find the rent page and record the payment you made. Then you would go to the bank account page and also record the same transaction there. We obviously don’t do this anymore. But the software we use today for accounting has largely been built around this paradigm. So this begs the question, on which side would you have put the transaction in the Rent Account? And on which side would you have put the transaction in the Bank Account? A rule to commit to memoryTo be able to answer the question of which side on the ledger we place these transactions, we need to follow the rules of accounting. Here’s the rule: Assets increase on the debit side. Liabilities and Equity increase on the credit side. Memorise this rule and it will help you to figure out it would be helpful. Step by step to understandNow let us walk through a few examples to help you understand how this works. While doing this I will highlight some questions you should be asking that will prove a useful framework for solving debit and credit questions. Here’s our first transaction: The owner deposits R50,000 of his own money into the business’ bank account. This is his contribution to the business. First Question: What are the two accounts involved? The two accounts are Bank Account and Owners Contribution Account. Second Question: What kind of Accounts are these? The Bank Account contains cash so it’s an Asset. And Owners Contribution is an Equity Account. Third Question: What’s the effect on these accounts? (ie. are they increasing or decreasing) Bank increases with R50,000. The business has R50,000 more cash than before this transaction. Since assets increase on the debit side according to accounting rules, the bank account of the business will have a debit of R50,000. Owners Contribution (an Equity account) will also increase. The question we have to ask ourselves is whether Owners Contribution is more or less after the transaction in question. Or, another way of putting it, has the owner contributed more or has he withdrawn his contributions. In this case, the account called Owner's Contribution has increased by R50,000. If we were doing accounting the old way, our ledger would look something like this for the bank account. And like this for the owner's contribution account. Let’s look at another transaction for this business The owner buys Equipment for the business to the value of R5,000. He paid via EFT from the business bank account. Remember that, when analysing these transactions, we will answer those three questions again:
The answer to the first question is Equipment Account and Bank Account. To answer question two, they are both Asset accounts How are these accounts affected? Well, we spent some of the R50,000. Since bank is an asset and assets increase on the debit side, we need to credit the bank account with R5,000 so that the account decreases. Here’s another look at our old ledger account for the bank account. Notice the R50,000 in debit and R5,000 in credit. As a side note. At any given time if you want to know the balance in the account you would subtract debit and credits from each other and this will give you the balance. In the case above it is Dr of 45,000. The second part of this transaction is the effect on the equipment account. Since the equipment is an asset and with this transaction, we’ve increased the value of Equipment the business has, will be a debit the equipment account with R5,000. The most important items to take away from this article is the accounting rules around debits and credits and the also the 3 question framework for dealing with transactions. Master these and you are well on your way to being able to quickly assign debits and credits to accounts. Let’s take it one step further by working through transactions that involve income and expenses. Before we go on, let’s review the two components of the previous article. In order to solve any debit and credit question you need to remember the following:
On to our first example: Income and ExpensesPaid monthly Rent to Landlord via EFT. Let’s run this transaction through the 3 question framework. Q1. What are the accounts involved? Bank Account and Rent Paid Account. Bank because the amount of cash in our account is affected, and the amount we spent on Rent is also affected. Q2. What kind of accounts are they? Bank is the easy one; it is an Asset. Rent Paid? What kind of account is this? Let’s see. It’s not an Asset; we don’t have something that has value in itself, it can’t be sold for cash, nor is it cash itself. It’s not a Liability; we aren’t increasing the amount of cash owed to people outside of the business like banks, suppliers or SARS. By way of elimination, it must then be Equity. As we explained previously: Equity is a combination of money and/or assets that the owner invests into the business, as well as the profits of the business’ activities. A Brief Look at Business Activities: Profits or LossesAll businesses do something to make a profit. Profit is what you have left when you take the money you made in a certain venture and subtract the money you spent to make it. Eg. If you made R10,000 in selling shoes and it cost you R6,500 to make those sales, it means you’ve made a profit of R3,500. Here are a few more examples of business activities: A bakery buys flour, sugar, butter and other ingredients and sells cakes and bread. A property company has properties and spends money on Repairs & Maintenance, rates, security etc. and in return they receive a Rent Income. A plumber has tools, then buys in parts and supplies and uses his expertise to make an income from charging customers to repair and install baths, toilets and showers. Nominal AccountsIf we accept that Rent Paid is an Equity Account we can go on to answer the third question. Q3. How are these accounts affected? Bank decreases because we now have less cash than before. So we credit Bank. Take care as we move along here; there is a common error to avoid: The wrong approachRent Paid belongs to Equity. Equity increases on the credit side. Therefore Rent Paid is credited. But it would be incorrect to simply say Rent Paid is Equity. The right approachRent Paid falls into the category of Equity because forms part of calculating profit or losses made by the business. Think of Profit & Loss as a single ledger account but instead of having a debit and a credit side only, both the debit and credit sides have their own sub-debit and credit sides. (This is, in fact, why accounts like Sales, Interest, Income, Bank Charges, Accounting Fees, Postage Expenses etc are referred to as Nominal Accounts. ie Not a real account.) So all expenses will have debit balances and all income will have credit balances. This makes sense since sales and other income increases profits while expenses decrease it. Expenses increase on the debit side and income on the credit side. Now it’s time to work through a few examples. Example 1 Received interest on bank deposit of R50. Q.1 What are the 2 accounts involved? Bank and Interest Received. Q.2 What type of accounts are these? Bank is an Asset and Interest is an income (Equity). Q.3 How are they affected? Bank is increasing. This means a Dr of R50 in the bank account. Income (Equity) is increasing. This means a Cr of R50 to the Interest Account (Equity). Example 2 Paid R500 cash for materials used in the manufacturing process Q.1 What are the 2 accounts involved? Bank and Cost of Sales. Q.2 What type of accounts are these? Bank is an Asset and Cost of Sales is Equity. Q.3 How are they affected? Bank is decreasing. This means a Cr of R500 in the Bank Account. Cost of Sales (Equity) is increasing. This means a Dr of R500 to the Cost of Sales Account (Equity). Example 3 Sold goods for on credit to a customer, R1,200. The customer will pay us in 30 Days. Q.1 What are the 2 accounts involved? Sales and Debtors. Q.2 What type of accounts are these? Debtors is an Asset and Sales is an income (Equity). Q.3 How are they affected? Debtors are increasing because we are owed more money than before. This means a Dr of R50 in the bank account. Income (Equity) is increasing. This means a Cr of R50 to the income account (Equity). ConclusionUnderstanding that Expenses and Income Accounts are part of Equity is key in being able to deal with debit and credit problems. Again, keep going over the examples in this article and the previous one to make sure that you understand the concepts being taught. What will be the effect of this transaction to owner's equity the owner contributes his her personal truck to the business?Owner's contributions to their own business are considered increases in capital in exchange for increase in the assets contributed by the owner and are recorded in the Owner's Equity account.
What is the effect on owner's equity of transaction?Owner's equity accounts
Owner's equity will increase if you have revenues and gains. Owner's equity decreases if you have expenses and losses. If your liabilities become greater than your assets, you will have a negative owner's equity.
What would be the effect on the accounts if the owner invested cash into the business?When an owner invests cash in a business, owner's equity decreases. The capital account is a liability account. When a business pays cash for insurance, a liability is increased. A balance sheet has two major sections, assets and liabilities.
What contributes to owner's equity?Owner's equity is calculated by adding up all of the business assets and deducting all of its liabilities.
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