Chapter 4

In this presentation...

1. describe the characteristics of business transactions2. differentiate between a business transaction, a personal transaction and a

business event3. explain the accounting equation process of the double-entry system of recording 4. identify the impact of business transactions on the accounting equation5. prepare an accounting worksheet and a simplified income statement and

balance sheet6. identify errors in the accounting worksheet and investigate the origin of the

errorsNote: The following topics discussed in Chapter 4 of the textbook are NOT taught in

unit 200101 AIM:1. discuss how journals and ledger accounts can help in capturing accounting

information efficiently and effectively2. apply debit and credit rules, and record simple transactions in the journals and

ledgers of the business3. explain the purpose of a trial balance

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Business Transactions

• Business transactions are occurrences that affect the assets, liabilities and equity items in an entity

• A business transaction is recorded when – It can be reliably measured in monetary terms– It occurs at arm’s length

• Under the entity concept, every entity must keep records of its business transactions separate from any personal transactions of the owners

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Examples of business transactions

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• contribution of capital by owners

• payment of salaries

• receipt of bank interest

• receipt of GST refund

• purchase of laptop on credit

• payment of accounts payable

• depreciating office equipment

• purchase of accounting software

• charging interest on overdue accounts receivable

• payment of advertising

• withdrawal of capital

• cash purchases

• cash sales

Personal Transactions and Business Events

• Personal transactions are transactions of the owners, partners or shareholders that are unrelated to the operation of the business

• Business events are occurrences that will probably affect the entity in some way, but are not recorded as business transactions until an exchange of goods occurs between the entity and an outside entity

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Accounting Equation

• Assets = resources controlled by entity

• Liabilities = External sources of funds

• Equity = Internal sources of funds (from owners)

• Assets need to be funded by owners and lenders.

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ASSETS = LIABILITIES + EQUITY

A = L + E

(Own) = (Owe) + (Owner)

Accounting Equation (cont)

Example

• Steven’s Seagulls needs $350,000 of assets to do business. Steven only has $200,000 to contribute as equity; his business needs to borrow additional funds of $150,000 from a bank which will become a liability of the business.

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A = L + E

$350 000 = $150 000 + $200 000

The concept of duality

• The accounting equation must be kept in balance after a transaction is entered.– i.e., Assets MUST = Liabilities + Equity

• In order to keep the equation in balance, a transaction must be recorded twice.

• A transaction has a dual effect on the equation– Cash movement effect

– Category of transaction effect

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Duality (cont)

• Cash Movement

– Money paid or received (Cash account)

– Money going to be paid or received (Accounts Payable/Receivable)

• Category of the transaction

– What is the nature of the transaction?

• Purchase an asset = asset account

• Receipt of money from sale – Revenue account

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Duality Example

• The purchase of a motor vehicle via a loan

– Cash effect Loan Payable (liability)

• Payment will be made in the future

– Category Effect Motor Vehicle (Asset)

• This is the purchase of a motor vehicle to support the business whilst the business generates revenue

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A = L + E

Truck = Loan

The ExpandedAccounting Equation

• Recall Chapter 1

– Income produces an increase in equity

– Expenses result in decreases in equity

• Therefore

– Profit (loss) is added to (subtracted from) opening equity on the balance sheet

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ASSETS = LIABILITIES + EQUITY + INCOME – EXPENSES

Relationship between ‘Income Statement’ and the ‘Balance Sheet’

Balance Sheet Income Statement

(accounting equation) R Profits Equity

A = L + E

Less: E Profits Equity

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Profit or Loss

Prepared by Simon LenthenUniversity of Western Sydney

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Transaction Analysis

1. Read the transaction

2. Identify the cash effect

3. Identify the nature of the transaction

4. Check the equation balances.

• Three Examples follow

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Transaction AnalysisExample 1

• Capital contribution

– Owner contributes $100,000 in cash to start a business

1. Key words “Cash”, “Owner”

2. Cash increases $100,000 (Asset)

3. Owner increases Capital (Equity)

4.

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Assets (A) = Liabilities (L) + Equity (E)Cash $100 000 = 0 + Capital $100 000

Transaction AnalysisExample 2

• Purchase of an Asset with cash

– Firm purchases new laptop computer for $3,500 and pays by cash

1. Key words “Cash”, “Computer”

2. Cash decreases $3,500 (Asset)

3. New computer purchased $3,500 (Asset)

4.

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A = L + ECash -$3 500 = 0 + 0Computer +$3 500

Transaction AnalysisExample 3

• Income Earned– CCS sends an invoice to Aussie Wallabies for providing

tennis coaching services totalling $30,000

1. Key words “Invoice”, “Services”

2. Accounts Receivables (AR) increases $30,000 (Asset)

3. Fees Revenue increases $30,000 (Income)

4.

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A = L + EAR+$30 000 = 0 + Fees Revenue $30 000

The Accounting Worksheet

• Summarises the duality associated with each business transaction

• All business transactions of the entity can be entered into the worksheet

• Then the individual columns of the worksheet can be totalled and used as the basis for preparing financial statements

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The accounting worksheet

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Errors in recording business transactions

1. Single entry error– Concept of duality must be applied to every

transaction

– Worksheet will not balance if only one part of transaction is entered

2. 2. Transposition error– Occurs when 2 of the digits are transposed

• e.g. Payment of $5,340 cash is recorded as $5,430 decrease in profit – difference of $90

– A transposition error is always divisible by 9

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Errors in recording business transactions

3. Incorrect entry

– Recording 2 increases or 2 decreases on one side

or

– Recording an increase to one side and a decrease to the other side

• e.g. Owner withdraws cash of $4,000 and records the transaction as an increase in cash and a decrease in equity. Asset side will be $8,000 higher than claims side

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Using the accounting equationto solve for missing figures

• The accounting equation can also help us solve for missing figures because the assets side must always equal the claims side

– Example

• T. Faff has current assets of $17,000, current liabilities of $4,000, non-current liabilities of $40,000 and equity of $80,000. What is the amount of non-current assets?

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Assets = Liabilities + Equity

17 000 + ? = 4 000 + 40 000 + 80 000

(see other side) ? = 44 000 + 80 000 – 17 000

? = 107 000

Capturing Accounting Information:Journal and Ledger Accounts

• Analysing each transaction by using the accounting equation is not appropriate for a large number of transactions

• Instead, we can use the journal or ledger to effectively and efficiently capture accounting information

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Slides 23 to 26

Note

The topics on slides 23 to 26 being:

• The Journal;

• The Ledger; and

• The Trial balance

are not taught in unit 200101 AIM.

They are shown here for a students general

awareness and knowledge.

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The Journal

• Journals record transaction information found on source documents

• Entered in date order

• The journal entry will consist of

– the transaction date,

– the name of the two accounts affected by the transaction,

– and whether each account is debited or credited.

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The Journal (cont)

• There are five separate journals– Cash Receipts Journal (for cash received by the

business)

– Cash Payments Journal (for cash paid by the business)

– Sales Journal (for credit sales to customers)

– Purchases Journal (for credit purchases from suppliers)

– General Journal (any transaction not related to the above)

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The Ledger

• A ledger is an account that accumulates all the information about changes in specific account balances.

• Each ledger account will have

– a debit (left side)

– a credit (right side)

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The Trial Balance

• The trial balance is a list of ledger account balances that is prepared at the end of the period.

• The purpose of the trial balance is

– To assist in the preparation of the financial statements

– To check the accuracy of the ledger or journal entries

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Summary

• Business transactions are occurrences that affect the assets, liabilities and equity items in an entity

• business transactions are an exchange of goods that occurs between the entity and an outside entity

• The accounting equation

– Assets = Liabilities + Equity

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Summary (Cont)

• A transaction has a dual effect on the equation– Cash movement effect

– Category of transaction effect

• Transaction analysis1. Read the transaction

2. Identify the cash effect

3. Identify the nature of the transaction

4. Check the equation balances.

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Summary (cont)

• An accounting worksheet is a summary of business transactions

– Good for smaller businesses

• Larger businesses will have Journals and Ledgers - we do not teach and students do not have to learn journals, ledgers and the trial balance for unit 200101 AIM

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Prepared by Simon Lenthen

University of Western Sydney

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