Determining Profit & Loss - Revenue & Expense Accounts

Building upon the basics learnt in previous tutorials, the realistic business model requires to know whether the business functions at a profit or loss in day-to-day activity. To determine profit or loss you must find the difference between revenue and expenses. Every sale comprises various hidden costs which is what revenue and expense accounts record uniquely.

Revenue Accounts

A revenue account is of a credit nature which derives from the owners equity account, also being of a credit nature. Revenue items generate profit that belong to the owner, therefore; revenue items have the ultimate effect of increasing owners equity so they have a credit nature.

Business is categorized into three distinct categories for revenue, being:

• Goods,
• Services, or
• Goods & Services.

Some businesses sell only goods (butcher, hardware, supermarket), some only sell a service (solicitor, marketing), and some sell both (mechanic provides parts and a service to fit the parts). The complexity of your business type outlines the exact ledger accounts required (chart of accounts).

The "inventory" account was used in prior tutorials for the basics of learning, however; the inventory account (also known as "stock on hand") is not used for goods purchased for short-term stock with the intent to sell for profit (ie. supermarket). Goods bought for the sale at a profit must be uniquely distinguished from the sale of business assets. This is done through using a "sales" account.

Expense Accounts

An expense account is of a debit nature which derives from the owners equity account. Expense items reduce the profit the business makes, therefore; as expense items have the effect of decreasing owners equity, they have a debit nature.

If your business kept goods in which are turned over on a regular basis, then an expense account called "purchases" would be created to hold the stock on hand. A supermarket buys goods to sell at a profit to the customer, so they would buy the goods and register them into an expense account of purchases, and when sold they become a revenue of sales. If goods where purchased to provide services then an expense account called "supplies expense" would be created. An example of supplies expense would be an electrician purchasing goods to use on a job. An electrician provides a service though requires goods such as power points, light switches, wire and the like to complete the service.

The point being made is that these goods are classified as an expense because they are bought and sold on a short-term basis, so they are kept separate from business asset accounts such as furniture, vehicles, etc. The business outlays money or must pay money on account for the goods at some point, hence why they are an expense and not so much an asset at this point in time. Each business structure is unique in how it handles revenue and expenses, which your bookkeeper or accountant can ascertain for you.

In its broadest terms, an asset is a good which is held by the business for more than 12 months and holds a value of $100 (Ex GST) or more. An expense is a good which is "used up" by the business in the immediate or near future (less than 12 months).

Theory to Practice

Using the following sales and purchases, derive a transaction analysis table as learnt in previous tutorial (remembering, sales are revenue (cr) and purchases are expenses (dr) account types):

• Jan 01 - Sold CD's and DVD's for $3020 cash,
• Jan 02 - Paid wages $1526,
• Jan 02 - Purchased $30,000 of blank media from M-Tek, for resale ($1000 cash - $29,000 30 day account),
• Jan 05 - Paid electricity account $985,
• Jan 07 - Sold $10,000 computers to ABC Pty Ltd on account,
• Jan 10 - Paid wages $1526,
• Jan 11 - Sold $500 computer parts and $1100 in computer services for cash,
• Jan 15 - Paid vehicle lease of $890,
• Jan 16 - Purchased $22,000 stock of computer cables, packaged, paid cash,
• Jan 17 - ABC Pty Ltd paid $5,000,
• Jan 20 - Paid telephone account $2490,
• Jan 30 - Purchased $22,000 Intel processors on account to Intel Co.,
• Jan 30 - Sold $5,349 computers for cash,
• Jan 31 - Paid $15000 to M-Tek.

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Achieving the transaction analysis, transfer to the ledger accounts in columnar format (remembering that ledger accounts are grouped by type).

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Now having your transaction analysis plus having posted to your ledger accounts, present a trial balance as at the last day of Jan to prove your work.

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