Chapter 3: The Capital Account

Within accounting, there are two types of accounts: Temporary and Permanent. 

Temporary

Temporary accounts are closed out at the end of the accounting period, and therefore, at the start of each new accounting period, these accounts start out with a zero balance. Temporary accounts transfer their balances into the owner's equity/capital account at the end of the period. These are your revenue, expense and owner's withdrawal accounts. 

Permanent

Permanent accounts, however, accumulate from one period to the next. The beginning balance for each period is the ending balance from the previous period. Assets, Liabilities and Owner's Equity are all permanent accounts. If you think of Cash in Bank, for example, you would not zero out the balance at the end of each month. The balance of cash rolls over, because you do not wipe out your bank account at the end of each month, and then redeposit the funds.

Assets = Liabilities + Owner's Capital (+ Revenue - Expenses - Withdrawals)

This chapter adds to the Owner's Capital account by creating a more detailed picture of the current accounting equation. Three accounts are going to be added: 

• • Revenue

  • Expenses

  • Withdrawals

The explanation of the accounts will be provided below. 

Revenue is the money earned from the sale of goods or services. Other related terms include income or sales. When a business generates revenue, this then increases the balance of the owner's equity account. For a business such as the grocer pictured above, they receive income from the sale of various food products.

Expense - money spent or costs incurred in an effort to generate revenue. Expenses decrease the value of the owner's equity account. In order for this same grocer to sell their products, they have to purchase the food they sell, employ a manager and clerk, pay for the rent and utilities on their building, furnish their store, etc.

Owner's Withdrawal are when an owner takes capital out of the business. This could be in the form of cash, or another asset that they maybe previously invested. As a business becomes more self-sustaining, the owner may decide that the entity now has enough cash flow to function on its own without those original investments made. One instance could be that an owner previously invested their own computer in the business, but now that cash flow is good, the business can afford to buy its own computer. Therefore, the owner withdrawals the invested computer, which then decreases owner's equity, as well as the appropriate asset account.