THE DOUBLE ENTRY SYSTEM FOR EXPENSES AND REVENUES. The effect of Profit or Loss on Capital
The buying and selling of goods and services will give rise to a profit or loss. The purchase of goods and services will either decrease the cash (asset) or increase a creditor (liability). The sale will either increase the cash (asset) or increase a debtor (asset). By following the same double entry principles, the resultant profit or loss must either increase or decrease the capital respectively:
Capital = Assets – Liabilities
To achieve this all of the expenses and revenue accounts for the period are closed by way of transfer to the Profit and Loss Account. This account is then part of the Capital of the business.