One of the main goals of doing business is to generate income. At the same time, expenses also occur concurrently. A simple example is a food stall or restaurant, where the expense includes the cost of raw materials used to prepare food for sale. Income is generated from the food served. The owner’s cash and capital will increase when the business makes a profit.

Now, let’s look at how income and expenses affect the owner’s equity. We’ll explore the relationship between expenses and income with assets and owner’s equity within the financial management concept.

Business Profit

Besides generating revenue, we also aim for profit! Profit (or net income) happens when income exceeds expenses.

Income will increase the owner’s equity, while expenses will reduce it.

The Relationship Between Assets, Equity, Income, and Expenses

Let’s say our restaurant prepares Salmon Fish Head Curry priced at RM 60 and sells it for cash. The cost of raw materials, including other expenses to prepare the dish, is RM 20.

So, the net income from the sale of the Salmon Fish Head Curry is RM 60 – RM 20 = RM 40. This sale will increase the owner’s equity by RM 40.

This sales transaction will also increase cash and owner’s equity by RM 60. Meanwhile, expenses will reduce cash and owner’s equity by RM 20.

Let’s now look at the accounting equation involved:

Aset               =  Liability         +    Equity
Cash     RM 1,900  +    Notes                Capital
Sale     RM    60  -    payable RM 4,000     Kak Ya   RM 5,000 +   
Expenses RM    20                            Sale     RM    60 -
         --------                            Expenses RM    20 
         RM 1,940
         --------
Rental   RM 2,100
Kitchen  RM 5,000
         --------
Total RM 9,040    =            RM 4,000 +             RM 5,040
         ========                 ========            ========

Let’s see how assets increase by RM 40. Similarly, the owner’s equity increases by the same amount.

When the Salmon Fish Head Curry is sold for RM 60, the business receives cash, which increases the assets (cash) by RM 60. However, since the expenses for preparing the dish are RM 20, these expenses reduce cash by RM 20.

Therefore, the net effect on assets is:

• Cash Inflow (Revenue): RM 60
• Cash Outflow (Expenses): RM 20
• Net Increase in Assets (Cash): RM 60 – RM 20 = RM 40

At the same time, because the business made a profit (net income) of RM 40, the owner’s equity also increases by RM 40. This is a result of the profit being retained within the business, thereby increasing both the asset (cash) and the equity by the same amount.

In summary:

• Assets (Cash): +RM 40
• Owner’s Equity: +RM 40

This reflects the core principle of the accounting equation:

Assets = Liabilities + Owner’s Equity

In this case, since there are no liabilities involved, the increase in assets directly translates to an increase in the owner’s equity.