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CHAPTER TWO
The Effect of Revenue
and Expenses
Accounting
Terminology
OBJECTIVES
Upon completion of this chapter, you should be able to:
• Accounts receivable
1.
Analyze business transactions involving revenue and expenses.
2.
Record the effects of revenue and expenses in the accounting equation.
3.
Compute net income or net loss.
• Expenses
• Net income
• Net loss
• Paid on account
INTRODUCTION
• Received on account
Revenue and Expenses play an important role in owner’s equity. The costs of operating the
business decrease the owner’s equity. Revenues increase owner’s equity. ■
• Revenue
■ REVENUE, EXPENSES, AND NET INCOME
The staffing services provided by Rebecca Van Lieu will produce revenue, or income. In
producing this revenue, the employment agency will incur certain business costs, which are
known as expenses.
The revenue remaining after the expenses have been deducted is net income (also
called net profit). When there is a net income, the owner’s equity is increased. On the other
hand, if expenses are greater than revenue, the result is a net loss, which decreases the
owner’s equity.
Transaction (f) At the end of the first week of operations, Rebecca Van Lieu received
$1,000 for résumé preparation and job placements.
1.
2.
Previous totals
1. Cash received
Cash
$11,700
$10,300
a business. Expenses
decrease equity.
Net Income: The amount
remaining when revenue
exceeds expenses.
remaining when expenses
exceed revenue.
Furniture
and
Equipment
Expenses: Costs of operating
Net Loss: The amount
The asset Cash is increased by $1,000.
Owner’s equity is increased by $1,000 in revenue.
Assets
Revenue: Inflow of assets
from business operations,
usually from providing services or selling goods. Revenue increases equity.
Liabilities
Loans
Payable
$1,000
Accounts
Payable
$7,000
Owner’s Equity
Rebecca
Van Lieu,
Capital
$14,000
$
0
1,000
2. Owner’s equity
increased by
revenue
1,000
$10,300
$8,000
$15,000
$1,000
$7,000
$14,000
$1,000
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$23,000
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$12,700
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New totals
Revenue
$23,000
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Transaction (f)
Provided services for cash.
Accounts Receivable:
Amounts customers have
promised to pay in the future
for services or goods bought
on credit.
Transaction (g)
Provided services on credit.
The increase in cash is recorded, as usual, under Assets. Note that a separate column
has been added under Owner’s Equity for recording revenue. This column will make revenue figures easily available when other financial reports are prepared. The total of the assets has increased to $23,000. Owner’s equity has also increased because of the revenue.
The new total of the liabilities and the owner’s equity (including revenue) is $23,000
($8,000 $15,000).
In business, goods are often sold and services are often provided on credit. Customers
who buy on credit do not pay cash immediately. Instead, they promise to pay later. The
amounts that a firm’s customers have promised to pay in the future are an asset known as
accounts receivable. (Remember that the liability incurred by a business when it promises
to pay its creditors is called accounts payable.)
Transaction (g) Van Lieu tests and screens job applicants for a client, Reeta Stern,
and bills her for $800. Revenue is obtained in the form of an account receivable. This
causes changes in the assets and in the owner’s equity.
1.
2.
The asset Accounts Receivable is increased by $800.
Owner’s equity is increased by $800 in revenue.
Assets
Cash
Liabilities
Owner’s Equity
Furniture
Rebecca
Accounts
and
Loans
Accounts
Van Lieu,
Receivable Equipment Payable Payable Capital Revenue
Previous totals $12,700 1. Account
receivable
obtained
$
0
$10,300
$1,000
$7,000
$14,000
800
2. Owner’s equity
increased by
revenue
800
$800
$10,300
WWW Inquiry:
Find the URL address for
General Motors. What was
GM’s consolidated income
from continuing operations in
the last available year?
Transaction (h)
Payment of an expense
(salaries).
$8,000
$15,800
$1,000
$7,000
$14,000
$1,800
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$23,800
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$12,700 
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New totals
$1,000
$23,800
Note that a separate column has been added under Assets to record accounts receivable. The total of the assets has increased to $23,800. Owner’s equity has also increased
through additional revenue. This new total of the liabilities and the owner’s equity (including revenue) is $23,800 ($8,000 $15,800).
Transaction (h) At the end of the first week of operations, Van Lieu pays a salary of
$300 to her assistant. This expense causes changes in the assets and the owner’s equity.
1.
2.
The asset Cash is decreased by $300.
Owner’s equity is decreased by $300 in expenses.
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Chapter 2
Assets
Liabilities
The Effect of Revenue and Expenses
13
Owner’s Equity
Furniture
Rebecca
Accounts
and
Loans
Accounts
Van Lieu,
Cash Receivable Equipment Payable Payable Capital Revenue Expenses
Previous totals $12,700 1. Cash paid out
$800
$10,300
$1,000 $7,000
$14,000 $1,800 300
2. Owner’s equity
decreased by
expense
New totals
300
$800
$10,300
$1,000 $7,000
$14,000 $1,800 $15,500
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$23,500
$23,500
Note that a separate column has now been included under Owner’s Equity for recording expenses. Thus the expense figures will be easily available for financial reports. The total of the assets has decreased to $23,500. Owner’s equity has also decreased because of the
expense for salaries. The new total of liabilities and the owner’s equity accounts (including
expenses) is $23,500 ($8,000 $15,500).
When a business sells on credit, it sends bills or statements to its customers and then
receives payments from the customers. The amounts from these customers are referred to
as money received on account. Similarly, the amounts that the business pays to its creditors
are referred to as the money paid on account.
Transaction (i) Van Lieu receives a check for $400 on account from Reeta Stern, who
owes $800 for testing and screening of applicants. This is a partial payment of her bill.
The asset Cash is increased by $400.
The asset Accounts Receivable is decreased by $400.
Assets
$300
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$12,400 $8,000
1.
2.
$ 0
Liabilities
WWW Inquiry:
Find the URL address for
General Motors. What
amount of interest expense
was incurred by GM in the
last available year?
Transaction (i)
Receipt of partial payment
on account.
Owner’s Equity
Furniture
Rebecca
Accounts
and
Loans
Accounts
Van Lieu,
Cash Receivable Equipment Payable Payable Capital Revenue Expenses
Previous totals $12,400 1. Cash paid out
$10,300
$1,000 $7,000
$14,000 $1,800 $300
$10,300
$1,000 $7,000
$14,000 $1,800 $300
400
2. Amount owed
by a customer
decreased
New totals
$800
400
$400
$8,000
$15,500
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$23,500
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$12,800 $23,500
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The total of the assets remains at $23,500 because there has merely been a substitution
of one asset (cash) for another asset (accounts receivable). No change has occurred in the
liabilities or the owner’s equity.
Transaction (j) Van Lieu pays $100 for repairs to the copier/fax machine. The following financial changes are caused by this expense transaction.
Transaction (j)
Payment of an expense
(equipment repairs).
1.
2.
The asset Cash is decreased by $100.
Owner’s equity is decreased by $100 in expenses.
Assets
Liabilities
Owner’s Equity
Furniture
Rebecca
Accounts
and
Loans
Accounts
Van Lieu,
Cash Receivable Equipment Payable Payable Capital Revenue Expenses
Previous totals $12,800 $400
$10,300
$1,000 $7,000
$14,000 $1,800 100
1. Cash paid out
2. Owner’s equity
decreased by
expense
New totals
$300
100
$400
$10,300
$1,000 $7,000
$8,000
$400
$15,400
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$23,400
$14,000 $1,800 
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$12,700 $23,400
After the transactions involving revenue and expenses have been recorded, the accounting equation is still in balance. Each side now totals $23,400. The owner’s equity is
$15,400, or $1,400 more than Rebecca Van Lieu’s personal investment in the business. The
$1,400 is the net income from business operation (found by subtracting the expenses of
$400 from the revenue of $1,800).
Compare the present balance sheet with the one prepared when the business opened
on July 24. Both these balance sheets follow. Note the overall effects of the ten recorded
transactions.
In the Owner’s Equity section of the July 31 balance sheet, observe that Van Lieu’s
original investment ($12,000) has been increased by the additional cash investment of
$2,000 plus the net income of $1,400 for the one-week period.
VAN LIEU CREATIVE SOLUTIONS
BALANCE SHEET
JULY 24, 20XX
Balance Sheet Start
of Business
Assets
Note:
Assets Liabilities Owner’s Equity.
Cash
Furniture and Equipment
Total Assets
Liabilities and Owner’s Equity
10,000.00
7,000.00
17,000.00
Liabilities
Accounts Payable
Owner’s Equity
Rebecca Van Lieu, Capital
12,000.00
Total Liabilities
and Owner’s Equity
17,000.00
5,000.00
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Chapter 2
The Effect of Revenue and Expenses
VAN LIEU CREATIVE SOLUTIONS
BALANCE SHEET
JULY 31, 20XX
Assets
Cash
Accounts Receivable
Furniture and Equipment
Balance Sheet after
Transactions Have
Occurred
Liabilities and Owner’s Equity
12,700.00
400.00
10,300.00
Liabilities
Loans Payable
Accounts Payable
1,000.00
7,000.00
Total Liabilities
Owner’s Equity
Rebecca Van Lieu, Capital
July 24, 20XX
12,000.00
Additional Investment
2,000.00
Net Income
1,400.00
Rebecca Van Lieu, Capital
July 31, 20XX
Total Assets
23,400.00
Total Liabilities
and Owner’s Equity
C H A P T E R
•
15
The inflow of assets received from business
operations—usually from providing services or
selling goods—is known as revenue. The costs of
business operations are called expenses.
2
S U M M A R Y
•
The difference between revenue and expenses is
net income (net profit) or net loss.
When revenue is greater than expenses, there is a
net income. When expenses are greater than
revenue, there is a net loss.
Net income results in an increase in the owner’s
equity. Additional investments also cause an increase
in the owner’s equity.
Net loss results in a decrease in the owner’s equity.
•
Revenue is usually obtained in the form of cash or
accounts receivable.
•
•
Accounts receivable are amounts that customers
have promised to pay in the future for services or
goods bought on credit.
•
A P P L I C AT I O N S
EXERCISES
Complete the following assignments on the forms
provided in your workbook.
EXERCISE 2-1
Computing net income and owner’s equity.
The accounting records of Elmer Mears’ medical practice
show the following balances on September 30.
Cash
$23,000 Accounts Payable
$ 7,000
Accounts Receivable 7,000 Elmer Mears, Capital 54,000
Office Equipment
20,000 Revenue
18,000
Medical Equipment
24,000 Expenses
5,000
Instructions:
1. Compute the net income.
15,400.00
23,400.00
•
C H A P T E R
8,000.00
2.
3.
Compute the owner’s equity as of September 30.
Complete the accounting equation:
Assets Liabilities Owner’s Equity.
EXERCISE 2-2
Computing a net loss and owner’s equity.
The accounting records of Farrell eBay Sales show these
balances on July 31.
Cash
$16,000
Accounts Receivable 9,000
Supplies
3,000
Equipment
12,000
Accounts Payable $11,000
Kelly Farrell, Capital 32,000
Revenue
4,000
Expenses
7,000
Instructions:
1. Compute the net loss.
2. Compute the owner’s equity as of July 31.
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Introduction to Accounting
Complete the accounting equation:
Assets Liabilities Owner’s Equity.
2.
EXERCISE 2-3
Analyzing transactions.
3.
Instructions:
1. Determine how assets, liabilities, and owner’s equity
are affected by the following transactions.
2. Use plus and minus signs to show the changes.
Example: Cash invested by owner.
Assets, Owner’s Equity
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
Paid cash for office rent.
Provided services for cash.
Issued checks to pay salaries.
Paid cash for equipment repairs.
Performed services on credit.
Purchased equipment on credit.
Received cash on account from credit customers.
Issued a check to a creditor.
Paid the telephone bill.
Borrowed cash from the bank.
EXERCISE 2-4
Preparing a balance sheet that includes net income.
On July 31 of the current year, William Neilson’s
financial records show the following amounts:
Cash
Accounts Receivable
Equipment
Accounts Payable
$15,000
22,000
40,000
20,000
William Neilson,
Capital, July 1 $57,000
Net Income
7,000
Instructions:
1. Prepare a balance sheet for William Neilson,
Psychologist, as of July 31 of the current year. (Refer
to the balance sheet on page 15 to see how net
income is entered in the Owner’s Equity section.)
PROBLEMS
Complete all assigned problems on the forms provided in
your workbook.
PROBLEM 2-1
Analyzing transactions and determining the effect of
a net income. On July 1, the O’Brien Employment
Agency has assets, liabilities, and owner’s equity as
shown in the equation in the workbook.
Instructions:
1. Analyze the following transactions and record the
effects on the equation. (Use plus and minus signs to
show the changes.) Enter new totals after each
transaction.
Compute the net income for July. Then add the net
income to the capital to compute the owner’s equity.
Total the assets and complete the accounting
equation.
Transactions:
a. Paid $1,800 for the month’s rent.
b. Received $700 for providing employment services.
c. Paid $200 for the telephone bill.
d. Received $1,500 for providing employment services.
e. Provided services for $1,400 on credit.
f. Paid $1,000 to creditors on account.
g. Received $500 from customers on account.
PROBLEM 2-2
Analyzing transactions and determining the effect of
a net loss. On June 5, Linda Neeld started Neeld’s Auto
Repair Service.
Instructions:
1. Use the equation form in the workbook to record the
following transactions. (Use plus and minus signs to
show the effects on the equation.) Enter totals after
each transaction.
2. Compute the net loss for June. Then subtract the net
loss from the capital to compute the owner’s equity.
3. Total the assets and complete the accounting
equation.
Transactions:
a. Neeld invested $60,000 in the business.
b. Paid $2,000 for June rent.
c. Purchased a used tow truck for $40,000 on credit.
d. Received $1,400 for repairing automobiles.
e. Received a bill for $600 for advertising; payment is
due in 30 days.
f. Completed repair jobs for customers with charge
accounts and billed the customers $1,000.
g. Issued a check for $2,000 in partial payment of the
amount due for the tow truck.
h. Paid $1,800 for employees’ wages.
i. Received $600 from charge customers on account.
PROBLEM 2-3
Analyzing transactions and determining the results of
operations. Brenda Burg, D.D.S., opened her dental
office on May 1.
Instructions:
1. Use the equation form in the workbook to record the
following transactions. (Use plus and minus signs to
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Chapter 2
2.
3.
4.
show the changes.) Enter totals after each
transaction.
Compute the net income or net loss.
Compute the owner’s equity.
Total the assets and complete the accounting
equation.
Transactions:
a. Burg invested $50,000 in her dental practice.
b. Purchased dental equipment for $60,000 on credit.
c. Received $1,900 for providing dental services.
d. Paid $200 for the telephone bill.
e. Paid $600 for office file cabinets.
f. Provided dental services for $2,000 on credit.
g. Paid $1,700 for office rent.
h. Paid $6,000 to a creditor on account.
i. Received $2,000 on account from patients.
j. Returned a damaged file cabinet and received a
refund of $200.
PROBLEM 2-4
Preparing a balance sheet. Account balances are listed
below for the Global Travel Agency.
Cash
$13,000
Accounts Receivable 15,000
Equipment
18,000
Accounts Payable
11,000
Lynne Russell,
Capital, May 1
28,000
17
Commissions
$14,500
Rent Expense
2,000
Salaries Expense
4,000
Advertising Expense 1,000
Telephone Expense
300
Postage Expense
200
CASE STUDY
Write the answer to the case study on the form provided
in your workbook.
In starting his computer consulting business, Russ Begly
decided to use the following accounts:
Cash
Equipment
Accounts Payable
Russ Begly, Capital
Knowing little about setting up financial records for
a business, he is wondering if these accounts are correct
or if he should change them or include others.
Critical Thinking
What do you think?
Hint: Does the equipment account accurately
reflect his needs for both office equipment and
computer equipment?
■
Instructions:
1. Compute the net income or net loss.
2. Prepare a balance sheet dated May 31 of the
current year.
The Effect of Revenue and Expenses