- Okay, now one of your customers asks
if you'll plant some shrubs in her backyard.
She's thrilled that you have just the shrubs that she wants,
thereby saving her a trip to the greenhouse.
You use one half of your inventory of shrubs
in this customer's yard
and it takes you three hours to complete the job.
She pays you in cash.
In this instance we are dealing with
two different types of revenue,
profit from the sale of the shrubs
and revenue from your labors.
Let's deal with each type of revenue separately.
First, the sale of the shrubs.
Sales, whether made on account or for cash,
require entries that reflect not only the sale,
but also the cost of the inventory that's sold.
The cost of goods sold is an expense
and as such, is offset with the sales revenue
to determine to the profitability of the sales transactions.
While accounting for inventory can get quite complicated.
For our purposes, we're just trying to illustrate
the effects of these transactions
on the accounting equation.
Now, in this example you charged your customer $90
for one half of the shrubs your purchased earlier.
The journal entries to record this transaction
are as follows.
Now in this example, inventory costing you $75
is being sold for $90 in cash.
Note that the cash account goes up again.
Cash, an asset, goes up with a debit.
Sales revenue increases with a credit.
Both the debit and the credit are in the amount of $90.
Now to the second entry associated with this transaction,
the cost of the goods that were sold.
What should we call the cost of goods that are sold?
Well accountants tend to call things what they are.
The cost of the goods sold is recorded in an account
that's called exactly that, cost of good sold.
It's an expense
and we know that expenses decrease owner's equity
and they do that through retained earnings.
Cost of goods sold, our expense, is debited for $75.
In addition, inventory went down
and inventory being an asset goes down with a credit.
Debit cost of goods sold, credit inventory for $75.
The effect on the accounting equation
for each transaction is as follows.
With the first journal entry,
assets, cash, increases as a result of earning revenue.
In the second journal, assets, inventory,
decrease as a result of using the asset
to generate revenues.
This is called an expense.
The label expenses is used to explain
how assets have been used.
Sometimes assets are consumed as part of doing business.
In this transaction,
the shrubs now belong to your customer
and they are gone from your business.
Expense is the label we give to the amount of assets
consumed in doing business.
Hopefully, the revenues, the amount of assets generated,
will be more than the expenses,
the amount of assets consumed.
Now, in addition to making a profit
on the sale of the shrubs,
you also generated revenue by planting them.
The journal entry to record this revenue is as follows.
We work, someone pays us cash.
Cash increases and cash increases with a debit
and the source of the increased cash
is landscaping revenue
and as we know, revenues increase with credits.
The effect of this transaction on the accounting equation
is that our assets increase by $45
and our owner's equity, through revenues,
increase by $45 as well.
Thank heavens the accounting equation balances,
but we knew it would.
Why?
Because our debits always equaled our credits.