- Sometimes you might sell services
and merchandise for cash.
At other times, you might sell them on credit,
and a receivable is established
for collection at a later date.
We will illustrate these possibilities
in the transactions that follow,
and note that the effect of revenues and expenses
on owner's equity is indicated in brackets
for each transaction.
So let's get started.
Now, recall in a previous transaction
that we showed the entry required
when cash was borrowed from the bank.
In that entry, you borrowed $2,000
to be paid over 12 months.
Suppose you're required to make
a monthly loan payment of $178,
with a portion of each payment being attributed to interest
and a portion to reducing the liability,
just like a mortgage on a house.
As the following compound journal entry shows,
a note payable or similar obligation
requires an entry for payment of the principal,
as well as the interest due.
Note that interest is the amount charged
for borrowing money.
Analysis of this transaction reveals that the asset,
cash in this case, has decreased for two reasons.
First, a portion of the liability has been paid with cash,
and liabilities, as we know, decrease with debits.
Second, interest expense at 12%
for one month on the note payable has been paid.
And expenses are recorded as debits, remember?
Expenses reduce owner's equity,
and that happens with a debit.
Since the interest charge is an expense
and decreases owner's equity, the impact of the entry
on the accounting equation looks like this.
Now, recall that you obtained financing
in two ways to start your business,
investors, you, mom, and dad,
and the bank.
In the previous journal entry, we illustrated how the bank
receives a return on its investment.
Well, mom and dad would like a return as well.
Corporations that are profitable
generally pay dividends to their stockholders.
Dividends represent a distribution to the stockholders
of a part of the earnings of the company.
This is reasonable because the earnings belong
to the owners of the company, the stockholders.
The following entry illustrates the payment
of a cash dividend with a debit to the dividend account
and a credit to cash.
Now, as noted earlier, dividends,
like revenues and expenses, affect owner's equity.
But unlike revenues and expenses,
dividends are a distribution of profits
and therefore are not considered in determining net income.
Because dividends reduce the retained earnings accumulated
by a corporation, they decrease owner's equity.
The payment of a $50 dividend
affects the accounting equation as follows.
The grand takeaway from this exercise is that,
because debits equal credits
with each and every journal entry,
the accounting equation balanced with every transaction.