Week 1

Account is to give an explanation of something, to report, to be responsible.

Accounting is analyzing, recording, reporting, and interpreting financial information.◦ Analyzing: what happened? How is organization affected?◦ Recording: capturing and entering information.◦ Reporting: summarize and provide information.◦ Interpreting: how do all the pieces fit together?

Who uses this information?◦ Internal users: business personnel (managers and

owners)◦ External users: government, general public, investors

Sole proprietorship: one owner. Easy to form, owners makes all decisions, could lose personal assets to meet business obligations.

Partnership: owned by more than one person. Share decision making, partners combine skills and resources, partners could lose personal assets to meet business obligations.

Corporation: owned by stockholders. Can be difficult to form. Stockholders not personally liable for debts of corporation. Board of directors hire management team to run the business.

Service: perform an activity for a fee.◦ Doctors, lawn care, hotel, airline

Merchandiser: sell products.◦ Home Depot, Barnes & Noble, JC Penney, Best

Buy

Manufacturer: make products.◦ Ford, General Electric, Nintendo, Motorola

Assets: things of value that are OWNED.◦ Cash, equipment, furniture, supplies, etc.

Equity: rights of financial claim to an asset.

ASSETS = EQUITIES Every asset has an owner.

Owner’s Equity: rights of owner to the assets of the business. Known as Capital.

Liabilities: business buys assets on account. Liability is an obligation to pay in the future. So, some assets the business possesses are actually OWNED by another entity (creditor) until the business pays for them.

ASSETS = LIABILITIES + OWNER’S EQUITY

ASSETS = LIABILITIES + OWNER’S EQUITY

Assets◦ Anything of value that is owned.

Ex. Cash to buy supplies for the business. Liabilities

◦ The amount of assets owed by a business Ex. “Buy” computer equipment on account. Buy now, pay later.

Owner’s Equity◦ Owner’s financial interest in the business assets.

ASSETS = LIABILITIES + OWNER’S EQUITY

A business has assets of $150,000 and liabilities of $50,000. What is owner’s equity?

$150,000 = $50,000 + ? Owner’s Equity = $100,000 How would the equation look?

◦ $150,000 = $50,000 + $100,000

Business activities that change the accounting equation are called transactions.

After each transaction the accounting equation must remain in balance.

ASSETS = LIABILITIES + OWNER’S EQUITY

Received cash from owner as an investment $10,000◦ Cash (asset)

Increases by $10,000◦ Capital (Owner’s Equity)

Increase by $10,000

$10,000 = $0 + $10,000

Cash is an asset. Business owner has financial claim to the asset.

ASSETS = LIABILITIES + OWNER’S EQUITY

Paid cash for supplies $750◦ Cash (asset)

Decreased by $750◦ Supplies (asset)

Increases by $750 Cash: $10,000-$750 = $9,250 Supplies: 0 + $750 = $750 $9,250+ $750 = $0 + $10,000 Exchange one asset for another asset. Still $10,000 in total assets however the

composition of assets has changed.

ASSETS = LIABILITIES + OWNER’S EQUITY

Paid cash for insurance $1,000 Cash (asset)

◦ Decrease by $1,000 Insurance (asset)

◦ Increases by $1,000 Cash: $9,250 - $1000= $8,250 Supplies: = $750 Insurance: $0 + 1,000 = $1,000 Capital (Owner’s Equity) = $10,000 $8,250 + $750 + $1,000 = $0 + $10,000

Insurance is usually prepaid and covers business in the event of fire, theft, etc.

ASSETS = LIABILITIES + OWNER’S EQUITY

Business “buys” supplies on account for $250 Supplies (asset)

◦ Increases $250 Accounts Payable (Liability)

◦ Increases by $250 Cash: $8,250 Supplies: $750 + $250 = $1,000 Insurance: $1,000 Liabilities: 0 + $250 = $250 Capital (Owner’s Equity) = $10,000 $8,250 + $1,000 + $1,000 = $250 + $10,000

Accounts Payable reflects the obligation that business OWES payment on assets.

ASSETS = LIABILITIES + OWNER’S EQUITY

Paid cash on account $150 Cash (asset)

◦ Decrease $150 Accounts Payable (Liability)

◦ Decreases by $150 Cash: $8,250 - $150 = $8,100 Supplies: $1,000 Insurance: $1,000 Liabilities: $250 - $150 = $100 Capital (Owner’s Equity) = $10,000

$8,100 + $1,000 + $1,000 = $100 + $10,000

ASSETS = LIABILITIES + OWNER’S EQUITY

Revenue – generated when business makes a sale, INCREASES OWNER’s EQUITY◦ After all, revenue generated from business

operations belongs to the owner, right? Cash Sale: customer pays business at time

of sale Sale on Account: customer does NOT pay at

time of sale but pays business in future.◦ Since no cash received from customer this sale

creates an asset called Accounts Receivable.

Business earns $1,000 in cash sales (REVENUE)

Cash (asset) increases $1,000◦ $8,100 + $1,000 = $9,100

Capital (Owner’s Equity) increases $1,000 ◦ $10,000 + $1,000 = $11,000◦ The $1,000 is revenue generated from business operations

$9,100 + $1,000 + $1,000 = $100 + $11,000

ASSETS = LIABILITIES + OWNER’S EQUITY

Business sells $750 of services on account (REVENUE)

Accounts Receivable (asset) increases $750◦ $0 + $750 = $750

Capital (Owner’s Equity) increases $750◦ $11,000 + $750 = $11,750◦ The $750 is revenue generated from business operations

even though the customer did not actually pay yet.

$9,100 + $750 + $1,000 + $1,000 = $100 + $11,750

ASSETS = LIABILITIES + OWNER’S EQUITY

Expense – a cost incurred in operating the business, DECREASES OWNER’S EQUITY

Expenses are paid in order to support the running of the business which in turn helps to generate revenue.◦ Rent expense◦ Utilities expense: electricity, water, gas, etc.◦ Advertising expense: promote business◦ Telephone expense◦ Salary expense: pay employees

Paid $500 for rent Cash (asset) decreases $500

◦ $9,100 - $500 = $8,600 Capital (Owner’s Equity) decreases $500

◦ $11,750 - $500 = $11,250◦ Using the business owner’s asset to pay an expense.

$8,600 + $750 + $1,000 + $1,000 = $100 + $11,250

ASSETS = LIABILITIES + OWNER’S EQUITY

Customer pays $750 on account Cash (asset) increases $750

◦ $8,600 + $750 = $9,350 Accounts Receivable (assets) decreases $750

◦ $750 - $750 = $0◦ Revenue was previously recognized at time of sale.

Customer is paying an amount they owe business for prior sale on account.

$9,350 + $0 + $1,000 + $1,000 = $100 + $11,250

ASSETS = LIABILITIES + OWNER’S EQUITY

Owner withdraws $1,000 from business. Withdrawals signify assets taken out of the

business by the owner for personal use that do NOT relate to the business.

Cash (asset) decreases $1,000◦ $9,350 - $1,000 = $8,350

Capital (Owner’s Equity) decreases $1,000◦ $11,250 - $1,000 = $10,250◦ Owner taking asset OUT of business. Since asset no

longer in business the owner no longer has equity.

$8,350 + $0 + $1,000 + $1,000 = $100 + $10,250

ASSETS = LIABILITIES + OWNER’S EQUITY

Assets = Liabilities + Owner’s Equity + Revenue – Expenses – Withdrawals

As revenue increases owner’s equity increases As expenses increase owner’s equity decreases As withdrawals increase owner’s equity decreases

What accounts are affected? Classify the accounts.

◦ Asset? Liability? Owner’s Equity? Determine if account is increasing or decreasing. Does accounting equation remain in

balance?◦ Does left side equal right side?

Questions?