Drawings Debtors Creditors Owned/Loaned Capital

Learning Accounting through an example

Day three

Oberoi, went to the wholesale market, bought vegetables with 260 and then set out on his trip around the locality for selling vegetables.

Expenditure

= 260/

= Cost of Purchase

After buying the vegetables (stock/goods)

Capital
260 Stock/Goods 260

End of day three

By the end of the day, Mr. Oberoi, sold all the vegetables he purchased in the morning. He counted the cash with him and found it to be 300. This 300 would be his sales realisation.

His expenditure on purchase of vegetables at the beginning of the day being 260, the extra realisation can be attributed to the profit he made on day three.

Profit

= Sale proceeds − Cost of purchase

= Income − Expenditure

= 300 − 260

= 40

Capital at the end

= Capital at the beginning + Profit for the day

= 260 + 40

= 300

Capital
300 Cash 300

He then recollected that in the afternoon, he used 40 from the sale proceeds for buying some personal items to take home. The sale proceeds of 300 he had was after using up this amount.

Drawings

  • The amounts relating to the business, used by the owners of business for personal purposes.

Had he not used that 40 for his personal purposes, he would have had 340 with him. This 340 is the actual sale realisation, of which he has used up 40 for own purposes. Thus we can say that his income for the day is 340.

Profit (based on the actual sale realisation)

= Actual Sale proceeds − Cost of purchase

= Income − Expenditure

= 340 − 260

= 80

Based on the actual profit made for the day, his capital at the end of the day should have been 340 and not 300.

Capital at the end

= Capital at the beginning + Profit for the day

= 260 + 80

= 340

We will be able to account for the lesser capital if we take the amount of drawings also into consideration

Capital at the end

= Capital at the beginning + Profit for the day − Drawings during the day

= 260 + 80 − 40

= 300

From this we learn one another fundamental understanding in accounting/business.

Drawings decrease Capital

As we withdraw amounts from business for personal purposes, the amount of capital available for investment in the business would get reduced.

Additional Capital

Drawings represents capital withdrawn (taken away from business). The action that is opposite in nature to this is bringing in capital.

Since the capital brought in would be an addition to the existing capital, it is termed Additional Capital. It represents capital brought in during the course of the business.

Drawings : Additional Capital :: Losses : Profits

For day four

Cash available for investment in goods/stock is 300.

Capital
300 Cash 300

Day four

Mr. Oberoi went to the wholesale market and selected the vegetables he wanted to buy. The total amount he had to pay for the purchase amounted to 350.

Because he only had 300, he asked the wholesale vendor for a credit of 50 with a promise to repay by that evening or next day morning. Since he had been purchasing stock from him for the past few days, the wholesale vendor did not mind extending him the credit.

Expenditure

= 350/

= Cost of Purchase

Mr. Oberoi has paid 300 and has to pay up the remainig 50, whether or not he sells the vegetables. The value of goods he purchased is 350 and his expenditure or cost of purchase is 350.

Capital
?
300
50
Stock/Goods 350

We say that he has purchased stock using 300 from his own sources and 50 from outside sources. The 50 credit he obtained for the stock is a loan to be repaid later on.

After buying the vegetables (stock/goods)

Capital
Creditors
300
50
Stock/Goods 350

Creditors

  • The persons or organisations to whom/which the business organisation owes money or anything of value.
  • lender
  • debtee
  • debtor

Eg : The wholesale vendor who gave vegetables on credit, is Mr. Oberoi's creditor or to be more specific a creditor to/of Mr. Oberoi's business.

Owned Capital

  • Amounts and other resources invested in the business that belongs to the owners of the business.

It includes the capital that has been brought in as well as the capital that has been accumulated through profits.

Loaned Capital

  • Amounts and other resources invested in the business by borrowing from outsiders is called loaned capital.

Loaned capital also forms capital for the business. It is also called debts of or debts owed by the business.

The business is reponsible for the borrowed amounts. In most cases the owner(s) are also collectively repsonsible for the debt.

Total Capital = Owned Capital + Loaned Capital

The capital employed in the business is a sum total of the capital from own sources and capital from loaned sources.

Thus on day four, after buying vegetables from the wholesale market,

Investment in stock/goods

= 350

= Total Capital employed

= Oberoi's Capital (300) + Loan/Credit from the Vendor (50)

Own Loaned Capital is Owned Capital

The owners of the business may invest in the business by taking loans personally and investing that in their name as capital contribution. The responsibility for this amount lies with the person who is borrowing the amount and not the business. This should not be misunderstood as loaned capital for the business.

End of day four

By the end of the day, Mr. Oberoi, sold all the vegetables he purchased. He counted the cash with him and found the sale realisation with him to be 400 which indicates that he made a profit.

What would his profit be? Would it be

  • 100 (400 − 300) since his capital is 300 only or
  • 50 (400 − 350) since the investment or total capital employed is 350?

Since the goods/stock he sold for a total of 400 had been purchased for 350, it would be appropriate to consider the profit to be 50.

Capital at the end of day four

= Captial at the start of day four + Profit for day four

= 300 + 50

= 350

Capital
Creditors
350
50
Cash 400

Using the sale proceeds, Mr. Oberoi cleared the debt of 50 to the wholesale vendor and used up 20 as drawings.

Capital at the end of day four

= Captial at the start of day four + Profit for day four − Drawings during day four

= 300 + 50 − 20

= 330

Cash remaining

= Cash from sale proceeds − Amount paid to clear Creditors − Amount of Drawings

= 400 − 50 − 20

= 330

Capital 330 Cash 330

For day five

Amount available for investment in goods or stock is 330.

Day five

Mr. Oberoi, went to the wholesale market, bought vegetables with 330 he had and then set out on his trip around the locality for selling vegetables.

Expenditure

= 3350/

= Cost of Purchase

Capital 330 Stock/Goods 330

End of day five

Mr. Oberoi, counted the cash with him at the end of the day and found it to be 330. There is no surplus or shortage, which implies that he has made neither profit nor loss.

He then recollected that he had to collect an amount of 20 from one of his customers, Mrs. Vimla. She only had a 1,000 bill and he did not have the money to give her the change. Since she was a regular customer, he offered to take the amount the next day.

Had he collected that amount from her, he would have had 350 in hand which is the actual sale realisation.

Total Sale proceeds/realisation (received and receivable)

= Collected in Cash + Due from Mrs. Vimla

= 330 + 20

= 350

His profit or loss on day five should be assessed based on this actual sale proceeds and not just the cash collected.

Profit for day five

= Total Income − Expenditure

= Total realisation − Cost of purchase

= 350 − 330

= 20

Capital at the end of day five

= Captial at the start of day five + Profit for day five

= 330 + 20

= 350

Capital 350 Cash
Debtors (Vimla)
330
20

Debtors

  • The persons or organisations who/which owe money or anything of value to the business organisation.
  • borrower
  • creditor

Eg : Mrs. Vimla who owes an amount to Mr. Oberoi is his debtor or to be more specific a debtor to/of Mr. Oberoi's business.

From the sale proceeds at the end of the day, Mr. Oberoi used up 30 as drawings.

Capital at the end of day five

= Captial at the start of day five + Profit for day five − Drawings during day five

= 330 + 20 − 30

= 320

Cash remaining

= Cash from sale proceeds − Amount of Drawings

= 330 − 30

= 300

Capital 320 Cash
Debtors
300
20

For day six

Mr. Oberoi would be able to invest only the amount available with him for buying his vegetable stock. All of his capital is not available to him in cash. Some of it is struck up in Debtors which only when collected in cash can be used as investment.

Amount available for investment = 320

Influence of Debtors/Creditors on Capital

Debotrs and Creditors do not increase the capital that indicates the amount that belongs to the ownership. They neither increase nor decrease owned capital. When we just say capital we always mean owned capital.

Creditors increase loaned Capital

Capital
Creditors
300
50
Cash 350

Creditors increase loaned capital. This will result in an increase in the total capital employed. This makes greater investment available for being used in business activities like buying stock or for purchases.

Debtors reduce available investment

Capital 320 Cash
Debtors
300
20

Debtors block up some of the total capital from being used as investment. They can be understood as an avenue where some of the total capital has been invested. This will result in a decrease in the investment available for being used in business activities like buying stock or for purchases.