chapter two analyzing transactions: the accounting equation
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BUSINESS ENTITY
An individual, association, or organization
That engages in economic activities And controls specific economic resourcesBusiness entity’s finances kept separate
from those of owner (Business Entity Concept)
ASSETS
ITEMS OWNED BY A BUSINESS THAT WILL PROVIDE FUTURE BENEFITS
BUT DOESN’T HAVE TO BE PAID OFF,
COULD STILL BE MAKING PAYMENTS ON IT
ACCOUNTS RECEIVABLE
The amount of money owed to the business
By its customersAs a result of making sales “on account”
or “on credit”Simply, customers who have promised to
pay sometime in the future
LIABILITIES
PROBABLE FUTURE OUTFLOW OF ASSETS AS A RESULT OF A PAST
TRANSACTION OR EVENT
IN OTHER WORDS,DEBTS OR OBLIGATIONS OF THE
BUSINESS THAT CAN BE PAID WITHCASH, GOODS , OR SERVICES
ACCOUNTS PAYABLE
Unwritten promise to pay a supplier for assets purchased or services rendered
Referred to as making a purchase “on account” or “on credit”
Be careful!! Don’t confuse AccountsReceivable and Accounts Payable.
Ask yourself, are we waiting to receive? Or waiting to pay?
NOTES PAYABLE
Formal written promises to pay suppliers or lenders
Specific sums of money at definite future times
OWNER’S EQUITY
AMOUNT BY WHICH THE BUSINESS ASSETS EXCEED THE BUSINESS
LIABILITIES
NET WORTH
CAPITAL
ALSO CALLED:
OR
EXAMPLE:
If a business has total Assets of $100,000 and total Liabilities of $60,000, what is the Owner’s Equity?
Once the debts are paid, the remaining assets belong
to the owner (Owner’s Equity).
EXAMPLE:
If a business has total Assets of $100,000 and total Liabilities of $60,000, what is the Owner’s Equity?
FORMULA:
$100,000 $60,000 = $40,000ASSETS LIABILITIES =OWNER’S EQUITY
Can also be expressed as:Assets = Liabilities + Owner’s Equity
BUSINESS ENTITY CONCEPT
Owner may have business assets and liabilities and nonbusiness assets and liabilities
Nonbusiness assets and liabilities are not included in the entity’s accounting records
If owner invests money or other assets in the business, the item is now a business asset
ACCOUNTING EQUATION
Assets Liabilities = Owner’s Equity+
Right side shows wherethe money came from to
buy the assets
BUSINESS TRANSACTION
An economic event that has a direct impact on the business
Usually requires an exchange with an outside entity
Must be able to measure this exchange in dollars
All transactions affect the accounting equation through specific accounts
ACCOUNT
A separate record used to summarize changes in each asset, liability, and owner’s equity of a business
QUESTION #2
WHICH ACCOUNTS ARE AFFECTED?
•Identify the accounts that are affected.
•Classify these accounts as assets, liabilities, or owner’s equity.
QUESTION #3
HOW IS THE ACCOUNTING EQUATION AFFECTED?
•Determine which accounts have increased or decreased.
•Make certain that the accounting equation remains in balance after the transaction has been entered.
QUESTION #1
What happened?
Mary took $25,000 from herpersonal bank account and deposited itin a new account in the business’ name
QUESTION #3a
Determine whether the accounts have increased or decreased
CASH M. A. CAPITAL
INCREASED INCREASED
QUESTION #3b
Does accounting equation balance?
ASSETS = LIABILITIES + OWNER’S EQUITY
+$25,000CASH M. A.,CAPITAL=
+$25,000=
It Balances!Assets of $25,000 = Liab. of $0 plus Owner’s Equity of $25,000
QUESTIONS #1 & #2
Understand the transaction, Identify and Classify the affected
accountsOFFICE
SUPPLIESCASH
ASSET ASSET
QUESTION #3b
Let’s look at the accounting equation
ASSETS = LIAB. O. E.
-$800CASH =
=+ OFF. SUPPLIES
+$800
Right hand sideof equation is not affected
+
+
QUESTION #3b
Does transaction balance?
ASSETS = LIAB. O. E.
-$800CASH =
=Yes!
Total Assets stayed the same.One Asset increased, the other
decreased. No change in Liabilities or Owner’s Equity
OFF. SUPPLIES+$800
+++
PROVING ACCOUNTING EQUATION BALANCES:
ASSETS:CASH
$25,000- $800
$24,200
OFFICE SUPPLIES
$800$800BALANCE
LEFT SIDE OF EQUATION:CASH $24,200SUPPLIES $ 800TOTAL ASSETS $25,000
PROVING ACCOUNTING EQUATION BALANCES:
LIABILITIES
$25,000
$25,000BALANCE
OWNER’S EQUITY
RIGHT SIDE OF EQUATION:
LIABILITIES $ 0OWNER’S EQUITY $25,000
TOTAL LIAB. & O.E. $25,000
$ 0
BALANCE $ 0
QUESTIONS #1 & #2
Understand the transaction, Identify and Classify the affected
accountsMary is buying this copy machine“on account.” She will be making payments on it over the next few
years. NO CASH WAS EXCHANGED TODAY
QUESTIONS #1 & #2
Understand the transaction, Identify and Classify the affected
accountsEQUIP. ACCOUNTS
PAYABLEASSET LIABILITY
QUESTION #3b
Let’s look at the accounting equation:
ASSETS = LIABILITIES OWNER’S EQUITY
+ $3,000
EQUIP. =
=
ACCOUNTS PAYABLE
+ $3,000 This transaction hadno effect on
Owner’s Equity
+
QUESTION #3b
Does transaction balance?
ASSETS = LIABILITIES OWNER’S EQUITY
+ $3,000
EQUIP. =
=
It Balances!Assets increased by $3,000 =
Liab. Increased by $3,000
ACCOUNTS PAYABLE
+ $3,000
+
PROVING ACCOUNTING EQUATION BALANCES:
ASSETS:CASH
$25,000- $800
$24,200
SUPPLIES
$800$800BAL.
SUPPLIES $ 800$25,000
EQUIPMENT
+$3,000$24,200 $800 $3,000
$24,200+$800+$3,000=
$28,000 TOTAL ASSETS
BAL.
+ +
PROVING ACCOUNTING EQUATION BALANCES:
LIABILITIES
+$25,000
$25,000BAL.
OWNER’S EQUITYACCTS. PAY. M. A., CAPITAL
+$3,000$3,000 $25,000BAL.
$3,000 + $25,000 =$28,000 TOTAL LIAB. & O. E.
QUESTIONS #1 & #2
Understand the transaction, Identify and Classify the affected
accountsCASH ACCOUNTS
PAYABLEASSET LIABILITY
QUESTION #3b
Let’s look at the accounting equation:
ASSETS = LIABILITIES OWNER’S EQUITY
- $400
CASH =
=
ACCOUNTS PAYABLE
- $400 This transaction hadno effect on
Owner’s Equity
+
QUESTION #3b
Does transaction balance?
ASSETS = LIABILITIES OWNER’S EQUITY
- $400
CASH =
=
It Balances!Assets decreased by $400 =
Liab. decreased by $400
ACCOUNTS PAYABLE
- $400
+
PROVING ACCOUNTING EQUATION BALANCES:
ASSETS:CASH
$25,000- $800
$24,200
SUPPLIES
$800$800BAL.
SUPPLIES
EQUIPMENT
+$3,000$24,200 $800 $3,000
-$400$23,800 $800 $3,000
$27,600
BAL.
BAL.
PROVING ACCOUNTING EQUATION BALANCES:
LIABILITIES
+$25,000
$25,000BAL.
OWNER’S EQUITYACCTS. PAY. M. A., CAPITAL
+$3,000$3,000 $25,000BAL.
$25,000BAL.
-$400$2,600
$27,600
REVENUE
Amount a business charges customers for products sold or services performed
Recognized when earned (even if cash has not yet been received)
Increases both Assets (Cash or Accounts Receivable) and Owner’s Equity
REVENUE
EXAMPLES: Delivery Fees
Consulting Fees
Rent Revenue (if business rents space to others)
Interest Revenue (for interest earned on bank deposits)
Sales (for sales of merchandise)
EXPENSES
Represent the decrease in assets as a result of efforts made to produce revenues
Separate accounts are maintained for each type of expense
Either decrease assets or increase liabilities, but ALWAYS decrease Owner’s Equity
NET INCOME
REVENUE Greater than EXPENSES = NET INCOME
EXAMPLE: Luke Perkins performed $6,000 of Tax services (Revenue) this year and incurred expenses of $1,500 for Rent, $500 for Supplies, and $3,000 in Salaries.
REVENUE EXPENSES = NET INCOME
$6,000 $5,000 = $1,000$1,500 + $500 + $3,000
NET LOSS
EXPENSES Greater than REVENUE = NET LOSS
EXAMPLE: John Atwood performed $8,000 of Delivery services (Revenue) this year and incurred Expenses of $3,500 for Rent, $500 for Supplies, $3,000 in Salaries and $2,500 for Gasoline.
REVENUE EXPENSES = NET LOSS
$8,000 $9,500 = ($1,500)$3,500 + $500 + $3,000 + $2,500
ACCOUNTING PERIOD CONCEPT
Say that income can be determined for any period of time (month, quarter, year, etc.)
Any accounting period of twelve months is called a FISCAL YEAR
WITHDRAWALS
The owner taking (withdrawing) cash or other assets from the business for personal use
Reduces Owner’s Equity and Assets
Also referred to as Drawing
QUESTIONS #1 & #2
Understand the transaction, Identify and Classify the affected
accountsCONSULT.
FEESCASH
O.E. REVENUE
ASSET
QUESTION #3b
Does transaction balance?
ASSETS = LIAB. OWNER’S EQUITY
+$4,500
CASH =
=
It Balances!Assets increased by $4,500 =
Owner’s Equity increased by $4,500
CONSULT. FEES
+$4,500
+
PROVING ACCOUNTING EQUATION BALANCES:
ASSETS:CASH SUPPLIES EQUIPMENT
$23,800 $800 $3,000
$32,100
BAL.
+ $4,500BAL.$28,300 $800 $3,000
PROVING ACCOUNTING EQUATION BALANCES:
LIAB. OWNER’S EQUITYACCTS.
PAY.M. A.,
CAPITAL$25,000BAL. $2,600
$32,100
CONSULT. FEES
+ $4,500BAL. $2,600 $25,000 $4,500
QUESTIONS #1 & #2
Understand the transaction, Identify and Classify the affected
accountsWAGES
EXPENSECASH
O.E. EXPENSE
ASSET
QUESTION #3
Increase or Decrease?
WAGES EXPENSE
CASH
BE CAREFUL! While incurring an expense will increase the Expense account,
it will cause an overallDECREASE IN OWNER’S EQUITY
QUESTION #3b
Does transaction balance?
ASSETS = LIAB. OWNER’S EQUITY
- $750
CASH =
=
It Balances!Assets decreased by $750 =
Owner’s Equity decreased by $750
WAGES EXPENSE
+$750
+
PROVING ACCOUNTING EQUATION BALANCES:
ASSETS:CASH SUPPLIES EQUIPMENT
$31,350
BAL.$28,300 $800 $3,000- $750
$27,550 $800 $3,000BAL.
PROVING ACCOUNTING EQUATION BALANCES:
LIAB. OWNER’S EQUITYACCTS.
PAY.M. A.,
CAPITAL$25,000BAL. $2,600
$2,600 + $25,000 + $4,500 $750 = $31,350
REV.
BAL. $2,600 $25,000
$4,500
$4,500
EXPENSES
+ $750$750
QUESTIONS #1 & #2
Understand the transaction, Identify and Classify the affected accounts
Mary has performed services for this client. Client will be paying Mary
at a later date.
IT IS REVENUE EVEN THOUGH NO CASH CHANGED HANDS TODAY!
QUESTIONS #1 & #2
Understand the transaction, Identify and Classify the affected accounts
CONSULT. FEES
ACCOUNTS RECEIVABLE
O.E. REVENUE
ASSET
QUESTION #3b
Does transaction balance?
ASSETS = LIAB. OWNER’S EQUITY
+$6,000
ACCTS. RECEIVABLE
=
=
It Balances!Assets increased by $6,000 =
Owner’s Equity increased by $6,000
CONSULT. FEES
+$6,000
+
PROVING ACCOUNTING EQUATION BALANCES:
ASSETS:CASH SUPPLIES EQUIP.
$37,350
BAL. $800 $3,000
$27,550 $800 $3,000BAL.
$27,550
ACCTS. REC.
+ $6,000$6,000
PROVING ACCOUNTING EQUATION BALANCES:
LIAB. OWNER’S EQUITYACCTS.
PAY.M. A.,
CAPITAL$25,000BAL. $2,600
$2,600 + $25,000 + $10,500 $750 = $37,350
REV.
BAL. $2,600 $25,000
$4,500
$10,500
EXPENSES
$750+ $6,000
$750
QUESTIONS #1 & #2
Understand the transaction, Identify and Classify the affected accounts
When Mary provided the consultingservices, this client agreed to pay
at a later date.TODAY THEY GAVE MARY CASH
OF $2,500 AS A PARTIAL PAYMENT.
QUESTIONS #1 & #2
Understand the transaction, Identify and Classify the affected accounts
CASH ACCOUNTS RECEIVABLE
ASSET ASSET
QUESTION #3b
Does transaction balance?
ASSETS = LIAB. O. E.
+$2,500CASH =
=Yes!
Total Assets stayed the same.One Asset increased, the other
decreased. No change in Liabilities or Owner’s Equity
ACCTS. REC.-$2,500
+
PROVING ACCOUNTING EQUATION BALANCES:
ASSETS:CASH SUPPLIES EQUIP.
$37,350
BAL. $800 $3,000
$30,050 $800 $3,000BAL.
$27,550
ACCTS. REC.$6,000
$3,500+$2,500 -$2,500
PROVING ACCOUNTING EQUATION BALANCES:
LIAB. OWNER’S EQUITYACCTS.
PAY.M. A.,
CAPITAL$25,000BAL. $2,600
No Change to Right Side of Equation.
Still = $37,350
REV.
BAL. $2,600 $25,000
$10,500
$10,500
EXPENSES
$750
$750
QUESTIONS #1 & #2
Understand the transaction, Identify and Classify the affected accounts
Mary is withdrawing some of her equity in the business by taking home an
asset (Cash). This will reduce the Assets &reduce her Owner’s Equity.
QUESTIONS #1 & #2
Understand the transaction, Identify and Classify the affected
accountsM. A.,
DRAWINGCASH
O.E. DRAWING
ASSET
QUESTION #3a
Increase or Decrease?
M. A., DRAWING
CASH
BE CAREFUL! Just like Expenses, Drawing account will increase in this situation,
but it will cause an overallDECREASE IN OWNER’S EQUITY.
QUESTION #3b
Does transaction balance?
ASSETS = LIAB. OWNER’S EQUITY
-$1,500
CASH =
=It Balances!
Assets decreased by $1,500 = Owner’s Eq. decreased by $1,500
M.A., DRAWING
+$1,500
+
PROVING ACCOUNTING EQUATION BALANCES:
ASSETS:CASH SUPPLIES EQUIP.
$35,850
BAL. $800 $3,000
$28,550 $800 $3,000BAL.
$30,050
ACCTS. REC.
$3,500-$1,500
$3,500
PROVING ACCOUNTING EQUATION BALANCES:
LIAB. OWNER’S EQUITYACCTS.
PAY.M. A., CAP.
$25,000BAL. $2,600
$2,600 + $25,000 - $1,500 + $10,500 -$750
= $35,850
REV.
BAL. $2,600 $25,000
$10,500
$10,500
EXP.
$750
$750
M. A., DRAWING
+$1,500$1,500
FINANCIAL STATEMENTS
THREE COMMONLY PREPARED FINANCIAL STATEMENTS:o INCOME STATEMENTo STATEMENT OF OWNER’S EQUITYo BALANCE SHEET
INCOME STATEMENT
Reports the profitability of business operations
For a specific period of timeExpenses are subtracted from Revenues
to determine Net Income/LossAlso called Profit and Loss Statement or
Operating Statement
Jessica Jane’s Campus DeliveryIncome Statement
For Month Ended June 30, 20--
Financial Statement headings:1st line: Name of Company2nd line: Title of statement
3rd line: Time period or specific date
Jessica Jane’s Campus DeliveryIncome Statement
For Month Ended June 30, 20--
This column is usedfor listing items
to be totaled
Jessica Jane’s Campus DeliveryIncome Statement
For Month Ended June 30, 20--
This column is usedfor Totals
Jessica Jane’s Campus DeliveryIncome Statement
For Month Ended June 30, 20--
Revenues:Consulting Fees $2,150
First item at the top ofa column should include
“$”
Jessica Jane’s Campus DeliveryIncome Statement
For Month Ended June 30, 20--
Revenues:Consulting Fees
Expenses:Wages ExpenseRent ExpenseTelephone Expense
Total Expenses
$2,150
$ 65020050
900
Underline before totaling
Jessica Jane’s Campus DeliveryIncome Statement
For Month Ended June 30, 20--
Revenues:Consulting Fees
Expenses:Wages ExpenseRent ExpenseTelephone Expense
Total ExpensesNet Income
$2,150
$ 650200
50900
$1,250
Revenues are greater than Expenses, therefore total is called NET INCOME
Jessica Jane’s Campus DeliveryIncome Statement
For Month Ended June 30, 20--
Revenues:Consulting Fees
Expenses:Wages ExpenseRent ExpenseTelephone Expense
Total ExpensesNet Income
$2,150
$ 650200
50900
$1,250
Double underline
STATEMENT OF OWNER’S EQUITY
Reports the activities that affected Owner’s Equity
For a specific period of timeUses Net Income from Income Statement
Jessica Jane’s Campus DeliveryStatement of Owner’s Equity
For Month Ended June 30, 20--
Jessica Jane, capital, June 1, 20-- $2,000Net Income for June $1,250
Instead of showing Revenue increasing & Expenses decreasing the Owner’s Equity,
this statement uses the net effect (Net Income/Loss) from the
Income Statement.
Jessica Jane’s Campus DeliveryStatement of Owner’s Equity
For Month Ended June 30, 20--
Jessica Jane, capital, June 1, 20-- $2,000Net Income for JuneLess withdrawal for JuneIncrease in Capital
$1,250150
1,100
$1,250 Net Income - $150 Withdrawal =$1,100 increase in Capital
Jessica Jane’s Campus DeliveryStatement of Owner’s Equity
For Month Ended June 30, 20--
Jessica Jane, capital, June 1, 20-- $2,000Net Income for JuneLess withdrawal for JuneIncrease in Capital
$1,250150
1,100Jessica Jane, capital, June 30, 20-- $3,100
$2,000 beginning O. E. + $1,100 increase =
$3,100
BALANCE SHEET
Confirms the accounting equation has remained in balance
Includes: Assets, Liabilities, Owner’s Equity
Also called Statement of Financial Position or Statement of Financial Condition
Jessica Jane’s Campus DeliveryBalance Sheet June 30, 20--
Balance Sheet reports Assets,Liabilities and Owner’s Equity
on a SPECIFIC DATE,Not a period of time
Jessica Jane’s Campus DeliveryBalance Sheet June 30, 20--
Assets LiabilitiesCash $ 370Accounts Receivable 650Supplies 80Prepaid Insurance 200Delivery Equipment 3,600
$4,900Total Assets
Accounts Payable
Owner’s Equity
Jessica Jane, Capital
$1,800
3,100
Total Liabilities andOwner’s Equity $4,900
It Balances!!!
PROCESSING
•Identify accounts
•Classify accounts
•Increase or Decrease?
•Enter transaction and verify balance
OUTPUT INCOME
STATEMENT
REVENUES
minus
EXPENSESequals
NET INCOME
STATEMENT OF OWNER’S EQUITY
BEGINNING CAPITALplus
INVESTMENTSplus
NET INCOMEminus
WITHDRAWALSequals
ENDING CAPITAL
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