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ANALYZING TRANSACTIONS:
The Accounting Equation
BUSINESS ENTITY
An individual, association, or
organization
That engages in economic activities
And controls specific economic resources
Business entitys finances kept separate
from those of owner (Business Entity
Concept)
ASSETS
MUST BE OWNED
NOT RENTED
ASSETS
IN OTHER WORDS,
DEBTS OR OBLIGATIONS OF THE
BUSINESS THAT CAN BE PAID WITH
CASH, GOODS , OR SERVICES
LIABILITIES
EXAMPLES:
ACCOUNTS PAYABLE
NOTES PAYABLE
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
ALSO CALLED:
NET
WORTH
OR CAPITAL
EXAMPLE:
If a business has total Assets of $100,000
and total Liabilities of $60,000, what is the
Owners Equity?
Left side:
Assets
ACCOUNTING EQUATION
Assets = Liabilities + Owners Equity
WHAT HAPPENED?
CASH M. A.
CAPITAL
QUESTION #2b
Classify these accounts
CASH M. A.
CAPITAL
ASSET OWNERS
EQUITY
QUESTION #3a
Determine whether the accounts
have increased or decreased
CASH M. A.
CAPITAL
INCREASED INCREASED
QUESTION #3b
Does accounting equation balance?
INCREASED DECREASED
QUESTION #3b
Lets look at the accounting equation
ASSETS = LIAB. + O. E.
CASH + OFF. SUPPLIES =
-$800 + +$800 =
Right hand side
of equation is
not affected
QUESTION #3b
Does transaction balance?
ASSETS = LIAB. + O. E.
CASH + OFF. SUPPLIES =
-$800 + +$800 =
Yes!
Total Assets stayed the same.
One Asset increased, the other
decreased. No change in
Liabilities or Owners Equity
PROVING ACCOUNTING
EQUATION BALANCES:
ASSETS:
CASH OFFICE SUPPLIES
$25,000
- $800 $800
BALANCE $24,200 $800
LEFT SIDE OF EQUATION:
CASH $24,200
SUPPLIES $ 800
TOTAL ASSETS $25,000
PROVING ACCOUNTING
EQUATION BALANCES:
LIABILITIES OWNERS EQUITY
BALANCE $0 $25,000
BALANCE $0 $25,000
RIGHT SIDE OF EQUATION:
LIABILITIES $ 0
OWNERS EQUITY $25,000
TOTAL LIAB. & O.E. $25,000
EXAMPLE
PURCHASED EQUIPMENT ON
ACCOUNT FOR $3,000
QUESTIONS #1 & #2
Understand the transaction,
Identify and Classify the affected
accounts
Mary 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
accounts
EQUIP. ACCOUNTS
PAYABLE
ASSET LIABILITY
QUESTION #3a
Increase or Decrease?
EQUIP. ACCOUNTS
PAYABLE
ASSET LIABILITY
INCREASED INCREASED
QUESTION #3b
Lets look at the accounting equation:
BAL. $25,000
+$3,000
BAL. $3,000 $25,000
DECREASED DECREASED
QUESTION #3b
Lets look at the accounting equation:
$27,600
PROVING ACCOUNTING
EQUATION BALANCES:
LIABILITIES OWNERS EQUITY
ACCTS. PAY. M. A., CAPITAL
+$25,000
BAL. $25,000
+$3,000
BAL. $3,000 $25,000
-$400
BAL. $2,600 $25,000
$27,600
OWNERS EQUITY
TRANSACTIONS
FOUR TYPES:
DECREASE: INCREASE:
EXPENSES REVENUES
DRAWING INVESTMENTS
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 Owners 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
Owners Equity
EXPENSES
EXAMPLES:
INCREASE INCREASE
QUESTION #3b
Does transaction balance?
$32,100
PROVING ACCOUNTING
EQUATION BALANCES:
LIAB. OWNERS EQUITY
ACCTS. M. A., CONSULT.
PAY. CAPITAL FEES
BAL. $2,600 $25,000
+ $4,500
BAL. $2,600 $25,000 $4,500
$32,100
EXPENSE EXAMPLE
INCREASE DECREASE
QUESTION #3
Increase or Decrease?
WAGES CASH
EXPENSE
BE CAREFUL! While incurring an
expense will increase the Expense account,
it will cause an overall
DECREASE IN OWNERS EQUITY
QUESTION #3b
Does transaction balance?
$31,350
PROVING ACCOUNTING
EQUATION BALANCES:
LIAB. OWNERS EQUITY
ACCTS. M. A., REV. EXPENSES
PAY. CAPITAL
BAL. $2,600 $25,000 $4,500
+ $750
BAL. $2,600 $25,000 $4,500 $750
CONSULT. ACCOUNTS
FEES RECEIVABLE
O.E. ASSET
REVENUE
QUESTION #3a
Increase or Decrease?
CONSULT. ACCOUNTS
FEES RECEIVABLE
INCREASE INCREASE
QUESTION #3b
Does transaction balance?
$37,350
PROVING ACCOUNTING
EQUATION BALANCES:
LIAB. OWNERS EQUITY
ACCTS. M. A., REV. EXPENSES
PAY. CAPITAL
BAL. $2,600 $25,000 $4,500 $750
+ $6,000
BAL. $2,600 $25,000 $10,500 $750
INCREASE DECREASE
QUESTION #3b
Does transaction balance?
ASSETS = LIAB. + O. E.
CASH ACCTS. REC. =
+$2,500 -$2,500 =
Yes!
Total Assets stayed the same.
One Asset increased, the other
decreased. No change in
Liabilities or Owners Equity
PROVING ACCOUNTING
EQUATION BALANCES:
ASSETS:
CASH ACCTS. SUPPLIES EQUIP.
REC.
BAL. $27,550 $6,000 $800 $3,000
+$2,500 -$2,500
BAL. $30,050 $3,500 $800 $3,000
$37,350
PROVING ACCOUNTING
EQUATION BALANCES:
LIAB. OWNERS EQUITY
ACCTS. M. A., REV. EXPENSES
PAY. CAPITAL
BAL. $2,600 $25,000 $10,500 $750
BAL. $2,600 $25,000 $10,500 $750
INCREASE DECREASE
QUESTION #3a
Increase or Decrease?
M. A., CASH
DRAWING
$35,850
PROVING ACCOUNTING
EQUATION BALANCES:
LIAB. OWNERS EQUITY
ACCTS. M. A., M. A., REV. EXP.
PAY. CAP. DRAWING
BAL. $2,600 $25,000 $10,500 $750
+$1,500
BAL. $2,600 $25,000 $1,500 $10,500 $750
Revenues:
Consulting Fees $2,150
Revenues:
Consulting Fees $2,150
Expenses:
Wages Expense $ 650
Rent Expense 200
Telephone Expense 50
Total Expenses 900
Revenues:
Consulting Fees $2,150
Expenses:
Wages Expense $ 650
Rent Expense 200
Telephone Expense 50
Total Expenses 900
Net Income $1,250
Revenues:
Consulting Fees $2,150
Expenses:
Wages Expense $ 650
Rent Expense 200
Telephone Expense 50
Total Expenses 900
Net Income $1,250
Double underline
STATEMENT OF OWNERS
EQUITY
It Balances!!!
ACCOUNTING PROCESS
Transactions
provide the
necessary
input
PROCESSING
Identify accounts
Classify accounts
Increase or Decrease?
Enter transaction and
verify balance
OUTPUT
INCOME STATEMENT OF
STATEMENT OWNERS EQUITY
REVENUES BEGINNING CAPITAL
minus plus
INVESTMENTS
EXPENSES plus
equals NET INCOME
minus
NET INCOME WITHDRAWALS
equals
ENDING CAPITAL
OUTPUT
BALANCE SHEET
ASSETS
equal
LIABILITES
plus
OWNERS EQUITY
(Ending Capital)