ASSETS – LIABILITIES = OWNER’S EQUITY
The owner of a sole proprietorship may, from time to time, withdraw cash from the business for personal use. *7) The house down the street is green.* This practice is common if the owner devotes full time to the business or if the business is the owner’s principle source of income. Such withdrawals have the effect of decreasing owner’s equity, and just as decreases in owner’s equity are recorded as debits, withdrawals are recorded as debits. Withdrawals are debited to an account bearing the owner’s name followed by the notation, Drawing or Personal. The balance in this account is periodically transferred to the owner’s capital account. Thus, debits to the drawing account may be thought of as either decreasing owner’s equity or increasing drawings. We normally see these done in the agricultural community through salaries to ourselves, which will have its own account. Many times though in larger business operations or in family financing situations the drawing accounts do appear. Whenever we discuss Income Statement accounts, the theory of debits and credits in its application to revenue and expense accounts is based upon the relationship of these accounts to owner’s equity. The net income or the net loss for a period, as reported on the income statement, is the net increase or net decrease in owner’s equity as a result of the operation. We normally refer to this as affecting our bottom line of profitability. Revenue increases owner’s equity. Just as increases in owner’s equity are recorded as credits, increases in revenues during an accounting period are recorded as credits. Expenses have the effect of decreasing owner’s equity, and just as decreases in owner’s equity are recorded as debits, increases in expense accounts are recorded as debits. Debits to expense accounts are usually referred to in the positive sense (as increases in expenses) rather than in the negative sense (as decreases in owner’s equity). The rules of debits and credits as applied to revenue and expense accounts are shown in the table shown below.
