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Understanding Accounting Entries

To make accounting concepts easy to grasp, let’s use the example of a small tea stall business. This will help in understanding how financial transactions are recorded step by step in accounting.

1. Investment in the Business

Mama, the tea stall owner, decides to start his business with an initial investment of ₹25,000.

📌 What happens in accounting?

  • This money is considered capital, meaning the business owes this amount to Mama. In accounting, capital is recorded as a liability because the business must return it to the owner if it shuts down.
  • The cash received (₹25,000) increases the business’s available money, which is an asset.

✅ Journal Entry:

  • Debit: ₹25,000 to the Cash Account (increasing cash)
  • Credit: ₹25,000 to Mama’s Capital Account (showing the business owes this to Mama)

2. Purchasing Equipment and Raw Materials

To start operations, Mama buys:

  • Equipment (stove, cups, teapot) for ₹2,800
  • Raw materials (tea leaves, milk, sugar) for ₹2,200
  • Total purchase = ₹5,000
  • He pays ₹2,000 in cash and buys the rest on credit from Super Bazaar (a local supplier).

📌 What happens in accounting?

  • Equipment is considered a fixed asset (since it will be used for a long time).
  • Raw materials are current assets (as they will be used daily).
  • The business's cash decreases by ₹2,000.
  • The remaining ₹3,000 is recorded as a liability (since Mama owes this to Super Bazaar).

✅ Journal Entry:

  • Debit: ₹2,800 to Equipment Account (increasing fixed assets)
  • Debit: ₹2,200 to Stock-in-Hand Account (increasing raw materials)
  • Credit: ₹2,000 to Cash Account (reducing cash)
  • Credit: ₹3,000 to Super Bazaar (Creditors) Account (indicating a pending payment)

3. Recording Daily Sales

At the end of the first day, Mama sells 325 cups of tea, earning ₹1,625.

📌 What happens in accounting?

  • Sales income increases, which is recorded as a credit in the sales account.
  • The business receives cash, so the cash account is debited.
  • Making the tea cost ₹800 in raw materials, so this amount is recorded as an expense under the “Cost of Goods Sold” account.

✅ Journal Entry:

  • Debit: ₹1,625 to Cash Account (business receives money)
  • Credit: ₹1,625 to Sales of Tea Account (recording revenue)
  • Debit: ₹800 to Cost of Goods Sold Account (recording expense)
  • Credit: ₹800 to Stock-in-Hand Account (reducing raw materials used)

4. Paying Rent and Employee Salary

At the end of the month, the tea stall pays:

  • ₹5,000 for stall rent
  • ₹8,000 as salary for an employee

📌 What happens in accounting?

  • Rent and salary are business expenses, so they are recorded as debits in the expense accounts.
  • The business pays in cash, so the cash account decreases.

✅ Journal Entry:

  • Debit: ₹5,000 to Rent Expense Account
  • Debit: ₹8,000 to Salary Expense Account
  • Credit: ₹13,000 to Cash Account (reducing available cash)

5. Calculating and Booking Profit

At the end of the month, Mama calculates his business performance:

  • Total Sales Revenue: ₹40,000
  • Total Expenses (including cost of tea, rent, salary, etc.): ₹20,000
  • Net Profit: ₹20,000

📌 What happens in accounting?

  • The profit earned belongs to Mama (the owner), so it is recorded as capital (a liability of the business).
  • The Profit and Loss Account is adjusted to reflect the month’s earnings.

✅ Journal Entry:

  • Debit: ₹20,000 to Profit or Loss Account (closing the profit calculation)
  • Credit: ₹20,000 to Capital Account (Mama’s Account) (showing profit as part of owner’s equity)

Final Business Status

  • Cash on Hand: ₹44,000 (earned through sales)
  • Remaining Stock Value: ₹1,000
  • Profit Earned: ₹20,000
  • Liability to Super Bazaar: ₹3,000 (still to be paid)

Conclusion

Through this simple tea stall example, we can see how different business transactions are recorded in accounting. Every transaction affects the financial records, and keeping track of them ensures that the business can calculate profits, manage expenses, and make informed financial decisions.

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