Navigating the Basics of Accounting: A Step-by-Step Example

To demonstrate how accounting works, let’s walk through a simple example:

Suppose you have started a small business called “ABC Consulting Services” on January 1, 2023. Here are the transactions for the month of January:

1. Invested $10,000 of your personal savings into the business bank account.
2. Purchased office equipment for $2,000, paying $500 in cash and the rest on credit.
3. Provided consulting services to a client and received $3,000 in cash.
4. Paid $500 for office rent.
5. Paid $300 for office supplies.
6. Received an invoice for $800 for utility bills (to be paid later).

Now, let’s go step by step and see how each transaction is recorded:

1. Invested $10,000 of your personal savings into the business bank account.
   Transaction:
   Debit: Cash (Asset) $10,000
   Credit: Owner’s Equity (Capital) $10,000
2. Purchased office equipment for $2,000, paying $500 in cash and the rest on credit.
   Transaction:
   Debit: Office Equipment (Asset) $2,000
   Credit: Cash (Asset) $500
   Credit: Accounts Payable (Liability) $1,500
3. Provided consulting services to a client and received $3,000 in cash.
   Transaction:
   Debit: Cash (Asset) $3,000
   Credit: Consulting Revenue (Income) $3,000
4. Paid $500 for office rent.
   Transaction:
   Debit: Rent Expense (Expense) $500
   Credit: Cash (Asset) $500
5. Paid $300 for office supplies.
   Transaction:
   Debit: Office Supplies (Asset) $300
   Credit: Cash (Asset) $300
6. Received an invoice for $800 for utility bills (to be paid later).
   Transaction:
   Debit: Utility Expense (Expense) $800
   Credit: Accounts Payable (Liability) $800

At the end of the month, you would summarize all the transactions and prepare the financial statements:

• Balance Sheet (as of January 31, 2023):
  Assets:
• Cash: $12,700 ($10,000 + $3,000 – $500 – $300)
• Office Equipment: $2,000
• Office Supplies: $300
  Total Assets: $15,000 Liabilities:
• Accounts Payable: $2,300 ($1,500 + $800)
  Total Liabilities: $2,300 Owner’s Equity:
• Capital: $12,700 ($10,000 + $3,000 – $500 – $300)
  Total Owner’s Equity: $12,700 Total Liabilities and Owner’s Equity: $15,000
• Income Statement (for the month of January 2023):
• Consulting Revenue: $3,000
• Rent Expense: $500
• Utility Expense: $800
  Total Expenses: $1,300 Net Income: $1,700 ($3,000 – $1,300)

This example illustrates how transactions are recorded using debits and credits to maintain the balance in the accounting equation (Assets = Liabilities + Owner’s Equity). By keeping track of these transactions, you can prepare accurate financial statements that provide insights into the financial health of the business.