2015-08-21
375
Suppose that John Thompson and Mark Martin each invest $25,000 in cash to start a new business. Before they make these investments, both sides of accounting equation are equal to zero. The firm has no assets no liabilities, and no owners’ equity. The results of their investments are shown as transaction A in Illustration 2-1. Cash (an asset) is increased by $50,000; owners’ equity is also increased by a total of $50,000 to balance the increase in assets.
Note that the entries for this transaction are not lumped together as one asset increase and the owners’ equity increase. Instead the entries are placed in separate accounts, which show exactly what is being increased. Here the investments are cash, so the Cash account is increased. Similarly, under owners’ equity, there is one account for Thompson and one for Martin.
Three additional transactions are shown in Illustration 2-1:
In transaction B, A bank loan of $10,000 was used to purchase equipment. The loan is a liability, and the equipment is an asset.
In transaction C, inventory worth $5,000 was purchased on credit. The inventory is an asset, and the amount owed is a liability.
In transaction D, $5,000 in cash was used to pay off part of the bank loan. The payoff decreases cash, an asset; the reduction of the loan amount decreases a liability.
 Assets
| Liabilities | Owrner's Equity | |||||
| Cash | Equipment | Inventory | Bank Loans | Suppliers | Tompson | Martin | |
| Transaction A (cash investment) | +50000$ | +25000$ | +25000$ | ||||
| 50000$ | +25000$ | +25000$ | |||||
| Transaction B (equipment purchase via bank loan) | +10000$ | +10000 | |||||
| 50000$ | 10000$ | 10000$ | +25000$ | +25000$ | |||
| Transaction C (credit purchase of inventory) | +5000 | +5000$ | |||||
| 50000$ | 10000$ | +5000$ | 10000$ | 5000$ | +25000$ | +25000$ | |
| Transaction D (partial payoff of loan) | 50000$ | -5000$ | |||||
| 45000$ | 10000$ | 5000$ | 5000$ | 5000$ | +25000$ | +25000$ |
Four Business transactions are recorded using the double-entry system.
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Double-entry bookkeeping is used to balance the accounting equation:
Assets = Liabilities + Owner's Equity
Follow through each of these transactions in Illustration 2-1 to make sure you understand why each entry is recorded as shown. Also note that, after all four transactions, assets total $60,000 and liabilities and owners’ equity total $60,000. Thus the books are still balanced. That is assets are indeed equal to liabilities plus owners’ equity.
