Drawings Debtors Creditors Owned/Loaned Capital

Learning Accounting through an example

During the course of day three : Oberoi, went to the wholesale market, bought vegetables with 260 and then set out on his trip around the locality selling vegetables.

After buying vegetables from the wholesale market,

Oberoi's investment = 260 in stock/goods i.e. vegetables.

End of day three : Oberoi, counted the cash with him at the end of the day. It was 300. The extra 40 (300 − 260) is on account of the profit he made on day three.

Profit made on day three

= Realisation on day three - Investment for day three
= 300 - 260
= 40

He then recollected that he used 40 from the sale proceeds for buying sweets to take home. Had he not used that 40 for his personal purposes, he would have had 340 with him, whereby his profit would have been 80 (340 − 260).

Profit made on day three

= Actual Realisation on day three - Investment for day three
= 340 - 260
= 80

Drawings

The amounts relating to the business, used by the owners of business for personal purposes, is termed drawings.

Influence of drawings on capital

Had Oberoi not used up the 40 as drawings he would have been left with a capital of 340 for starting his business affairs on day four. Since he used up 40 as drawings his capital is now less by 40 i.e. 300 on day four.

Oberoi's capital for day four

= Capital at the beginning of day three + Actual Profit made on day three - Amount used up for personal purposes
= 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 business would get reduced.

Additional Capital

Is there a term that indicates an action (opposite in nature to drawings) that would result in an increase in capital, just like saying profits increase capital as opposed to losses decrease capital.

Drawings amount to taking away capital. Thus the action that is opposite in nature to drawings is bringing in capital. Since the capital brought in would be an addition to the existing capital, it is just termed Additional Capital. There is no special term to identify this action.

Losses : Profits :: Drawings : Additional Capital

Beginning of day four : Oberoi starts the day with the amount he is left with at the end of day three.

Oberoi's Capital for investment = 300.

During day four : He went to the wholesale market, bought vegetables for 350. He bought 300 worth of vegetables on cash and 50 worth of vegetables on credit, by promising to repay by the evening or the next day morning i.e. as a loan from the wholesale vendor. He then set out on his trip around the locality selling vegetables.

After buying vegetables from the wholesale market,

  • Oberoi's capital = 300
  • Loan = 50
  • Total Capital for investment

    = 350 (Mr. Oberoi's capital + Loan)
  • Investment

    = 350 in stock/goods i.e. vegetables

End of day four : Oberoi, counted the cash with him at the end of the day. It was 400, indicating he made a profit. What would be his profit now? Is it 100 (400 − 300) since his capital is 300 only or 50 (400 − 350) since his total capital or investment is 350.

It would be appropriate to think that the profit is 50 and not 100. The capital that Oberoi invested from his own sources is 300. He also invested 50 additionally by taking credit from the wholesaler. Both 300 from his own sources and 50 from loaned sources are termed and treated as capital for the business.

This brings us to understanding two other important terms in accounting.

Owned Capital

Amounts and other resources invested in the business by the owners of the business as their contribution towards Capital is called owned capital.

This represents the value/amount that really belongs to the owners of the business.

Loaned Capital

Amounts and other resources borrowed by/for the business from outsiders also forms capital for the business which we call loaned capital. The business is responsible for the borrowed amounts. In most cases, the owner/owners of the business are also collectively responsible.

These are also called debts or debts owed by the business.

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,

Capital for the business

= Oberoi's Capital + Loaned Capital
= 300 + 50
= 350
We should be able to see the business and Mr. Oberoi as two distinct entities.

That is the reason profit should be calculated by comparing the realisation with the businesse's capital 350 and not just Mr. Oberoi's capital 300.

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.

Creditors

The persons or organisations to whom/which the business organisation owes money (or others of value) are identified as its creditors.

Eg : In the illustration above, the wholesale vendor who gave vegetables on credit to Mr. Oberoi, is a creditor to Mr. Oberoi or to be more specific to Mr. Oberoi's business.

End of day four : Oberoi counted his realisation to be 400 from which he repaid the amount due (cleared the debt) to the wholesale vendor i.e. 50 and used 20 towards drawings.

Profit on day four

= Realisation at the end of day four - Investment for day four
= 400 - 350
= 50

Beginning of day five :

Capital at the beginning of day five

= Capital at the beginning of day four + Profit made on day four - Drawings on day four
= 300 + 50 - 20
= 330
Even based on the realisation he has, we arrive at the same figure

Realisation at the end of day four

= Total Realisation on day four - Creditor's Loan repaid - Drawings on day four
= 400 - 50 - 20
= 330

During day five : Oberoi, went to the wholesale market, bought vegetables with 330 and then set out on his trip around the locality selling vegetables.

End of day five : Oberoi, counted the cash with him at the end of the day. It was 330. There is no surplus or shortage, which implies he has made neither profit nor loss.

He then recollected that one of the customers, Mrs. Vimla, did not give him the amount she had to (20) since she was not having change. Since she was a regular customer, he offered to take the amount the next day. Had she given that amount also he would have been left with 350 which would have resulted in a profit of 20 (350 − 330).

Total realisation

= Cash Collected + Due from Mrs. Vimla
= 330 + 20
= 350

Profit for day five

= Total realisation at the end of day five - Investment at the beginning of day five
= 350 - 330
= 20

He also recollected that he used up 20 for personal purposes.

Debtors

The persons or organisations who/which owe us (to the business here), money (or others of value), are called our/its debtors.

Eg : In the illustration above, Mrs. Vimla who owes an amount to Mr. Oberoi is a debtor to Mr. Oberoi or to be more specific to Mr. Oberoi's business.

Do Debtors/Creditors Increase/Decrease Capital ?

By increase or decrease in capital that we have learned earlier, we mean increase or decrease in owned capital. When we just say capital we always mean owned capital.

Creditors no doubt would increase loaned capital and that should be seen as a different entity. For now, please do not consider the idea of increase/decrease in capital in relation to Debtors/Creditors.