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Chapter

2
Analyzing Business
Transactions
Section 1: Property and Financial Interest
Section Objectives

1. Record in equation form the financial


effects of a business transaction.

2. Define, identify, and understand the


relationship between asset, liability, and
owner’s equity accounts.

McGraw-Hill © 2009 The McGraw-Hill Companies, Inc. All rights reserved.


Meet JT’s Consulting Services.

JT’s Consulting
 JT’s Consulting Services is a firm that provides a wide range of
accounting and consulting services.
 Jason Taylor is the sole proprietor of the firm.
 Tennille Brisbane is the office manager of the firm.
 Every month the firm bills clients for the services provided that
month.
 Customers can also pay in cash when the services are provided.

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Steps to analyze the effect of a
business transaction.

1. Describe the financial event.


 Identify the property.
 Identify who owns the property.
 Determine the amount of increase or decrease.

2. Make sure the equation is in balance.

Property = Financial Interest

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Objective 1 Record in equation form the financial
effects of a business transaction

Business Transaction

Jason Taylor withdrew $90,000 from personal


savings and deposited it in a new checking account
in the name of JT’s Consulting Services.

Analysis:

(a) The business received $90,000 of property in the


form of cash.

(b) Taylor had an $90,000 financial interest in the business.

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The owner invested cash into the business.

Property = Financial Interest

Cash = Jason Taylor, Capital

(a) Invested cash + $90,000

(b) Increased equity + $90,000

New balances $90,000 = $90,000

Jason Taylor now has $90,000 equity in JT’s


Consulting Services.

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The company buys equipment for $10,000 cash.
Property = Financial Interest

Cash + Equipment = Jason Taylor, Capital

Previous balances $90,000 = $90,000

(c) Purchased equip. + $10,000

(d) Paid cash - 10,000

New balances $80,000 + $10,000 = $90,000

$90,000 = $90,000

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The company buys $12,000 of equipment
on account.
Property = Financial Interest

Accounts Jason Taylor,


Cash + Equipment = Payable + Capital
Previous balances $80,000 + $10,000 = $90,000

(e) Purchased equipment +12,000

(f) Incurred debt +$12,000

New balances $80,000 + $22,000 = $12,000 + $90,000

$102,000 = $102,000

Notice the new claim against the firm’s


property – the creditor’s claim of $12,000.

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The firm purchases supplies for $3,000 cash.
Property = Financial Interest

Accounts Jason Taylor,


Cash + Supplies + Equipment = Payable + Capital
Previous
balances $80,000 + $22,000 = $12,000 + $90,000
(g) Purchased
supplies $3,000

(h) Paid cash -3,000

New
balances $77,000 + $3,000 + $22,000 = $12,000 + $90,000

$102,000 = $102,000

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The firm makes a payment of $5,000 on account.

Property = Financial Interest

Accounts Jason Taylor,


Cash + Supplies + Equipment = Payable + Capital
Previous
balances $77,000 + $3,000 + $22,000 = $12,000 + $90,000
(i) Paid cash -5,000
(j) Decreased
debt -$5,000

New
balances $72,000 + $3,000 + $22,000 = $7,000 + $90,000

$97,000 = $97,000

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The firm makes a payment of $7,000 rent
in advance.
Property = Financial Interest

Cash + Supplies + Prepaid + Equipment Accounts Jason Taylor,


Rent = Payable + Capital
Previous
balances $72,000 + $3,000 + $22,000 = $7,000 + $90,000
(k) Paid -7,000
cash
(l) Prepaid
rent +$7,000

New
balances $65,000 + $3,000 + $7,000 + $22,000 = $7,000 + $90,000

$97,000 = $97,000

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Objective 2 Define, identify, and understand the relationship
between asset, liability, and owner’s equity accounts

Assets, Liabilities, and


Owner’s Equity

QUESTION:

What are assets?

ANSWER:

Assets are property owned by a


business.
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Liabilities and Equity
QUESTION:
What are liabilities?
ANSWER:

Liabilities are debts or obligations of a


business.
QUESTION:
What is owner’s equity?
ANSWER:

Owner’s equity is the term used for sole


proprietorships. It is the financial interest of
an owner of a business. It is also called
proprietorship or net worth.
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QUESTION:

What is a Balance Sheet?


ANSWER:

A balance sheet is a formal report of a


business’s financial condition on a certain
date. It reports the assets, liabilities, and
owner’s equity of the business.

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JT’s Consulting Services
Balance Sheet
November 30, 2010

Assets Liabilities

Cash 65,000.00 Accounts Payable 7,000.00


Supplies 3,000.00
Prepaid Rent 7,000.00 Owner’s Equity
Equipment 22,000.00 Jason Taylor, Capital 90,000.00
Total Assets 97,000.00 Total Liabilities and Owner’s Equity 97,000.00

 Assets – the amount and types of property owned by the business


 Liabilities – the amount owed to the creditors
 Equity – the owner’s interest

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Liabilities +
Financial
Owner’s
Assets
Property Interest
Equity

Property equals Financial Interest

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Chapter

2
Analyzing Business Transactions

Section 2: The Accounting Equation and


Financial Statements
Section Objectives
3. Analyze the effects of business transactions on a
firm’s assets, liabilities, and owner’s equity and
record these effects in accounting equation form.
4. Prepare an income statement.
5. Prepare a statement of owner’s equity and a
balance sheet.
McGraw-Hill © 2009 The McGraw-Hill Companies, Inc. All rights reserved.
QUESTION:

What is the fundamental accounting


equation? ANSWER:

The fundamental
accounting equation
is the relationship
between assets and
liabilities plus owner’s
equity.

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The Fundamental Accounting Equation
 In accounting terms the firm’s assets must equal the
total of its liabilities and owner’s equity.
 This equality can be expressed in equation form as:

Assets = Liabilities + Owner’s Equity


 The entire accounting process of analyzing,
recording and reporting business transactions is
based on the fundamental accounting equation
 If any two parts of the equation are known, the third
part can be determined.

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Objective 3

Analyze the effects of


business transactions on a
firm’s assets, liabilities,
and owner’s equity and
record these effects in
accounting equation form.

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QUESTION:

What is revenue?
ANSWER:

A revenue is an inflow of money or


other assets that results from the
sales of goods or services or from
the use of money or property. It is
also called income.

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QUESTION:

What is an expense?

ANSWER:

An expense is an outflow of cash,


use of other assets, or incurring of a
liability.

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The firm receives $26,000 in cash for services
provided to clients.

Assets = Liab. + Owner’s Equity

Prepaid Accounts J. Taylor,


Cash + Supplies + Rent + Equip. = Payable + Capital + Revenue
Previous
balances $65,000 + $3,000 + $7,000 + $22,000 = $7,000 + $90,000
(m) Recd. cash +26,000
(n) Increased
owner's equity + 26,000
New balances $91,000 + $3,000 + $7,000 + $22,000 = $7,000 + $90,000 + $26,000
$123,000 = $123,000

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The company performs services on account
for $9,000.
Assets = Liab. + Owner's Equity

Accts. Prepaid Accts. J. Taylor,


Cash + Rec. + Supplies + Rent + Equip. = Pay. + Capital + Rev.
Previous
balances $91,000 + $3,000 + $7,000 + 22,000 = $7,000 + $90,000 + $26,000

(o) Received
new asset + $9,000
(p) Increased
owner’s equity + 9,000
_______ ______ _____ ______ ______ _____ ______ ______
New bal. $91,000 + $9,000 + $3,000 + $7,000 + $22,000 = $7,000 + $90,000 + $35,000

$132,000 = $132,000

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Collection of $4,000 from customers
on account.

Assets = Liab. + Owner's Equity

Accts. Prepaid Accts. J. Taylor,


Cash + Rec. + Supplies + Rent + Equip. = Pay. + Capital + Rev.
Previous
Balances $91,000 + $9,000 + $3,000 + $7,000 + $22,000 = $7,000 + $90,000 + $35,000
(q) Recd.
cash +4,000

(r) Decreased
accts. rec. - 4,000
_______ ______ ______ ______ ______ ______ ______ ______
New bal. $95,000 + $5,000 + $3,000 + $7,000 + $22,000 = $7,000 + $90,000 + $35,000

$132,000 = $132,000

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The firm pays $7,000 in salaries expense
for the month.

Assets = Liab. + Owner's Equity

Accts. Prepaid Accts. J. Taylor,


Cash + Rec. + Supplies + Rent + Equip. = Pay. + Capital + Rev. - Exp.
Previous
balances $95,000 + $5,000 + $3,000 + $7,000 + $22,000 = $7,000 + $90,000 + $35,000

(s) Paid
cash -7,000
(t) Decreased
owner’s equity - 7,000
______ ______ ______ ______ ______ ______ ______ ______ _____
New bal. $88,000 + $5,000 + $3,000 + $7,000 + $22,000 = $7,000 + $90,000 + $35,000 - $7,000

$125,000 = $125,000

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The firm pays $500 for utilities
expenses.
Assets = Liab. + Owner's Equity

Accts. Prepaid Accts. J. Taylor,


Cash + Rec. + Supplies + Rent + Equip. = Pay. + Capital + Rev. - Exp.
Previous
balances $88,000 + $5,000 + $3,000 + $7,000 + $22,000 = $7,000 + $90,000 + $35,000 - 7,000

(u) Paid
cash -500

(v) Decreased
owner’s equity -500

______ ______ _______ _______ _______ ________ _______ _______ ______


New bal. $87,500 + $5,000 + $3,000 + $7,000 + $22,000 = $7,000 + $90,000 + $35,000 - $ 7,500
$124,500 = $124,500

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The firm records a withdrawal by the owner
of $4,000.
Assets = Liab. + Owner’s Equity

Accts. Prepaid Accts. J. Taylor,


Cash + Rec. + Supp. + Rent + Equip. = Pay. + Capital + Rev. - Exp.

Previous
balances $87,500 + $5,000 + $3,000 + $7,000 + $22,000 = $7,000 + $90,000 + $35,000 - $7,500
(w) Withdrew
cash -4,000

(x) Decreased
owner's equity -4,000

New bal. $83,500


______ + $5,000
_____ + _____
$3,000 + ______
$7,000 + $22,000
______ = ______
$7,000 + $86,000
______ + $35,000
______ - $7,500
______

$120,500 = $120,500

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Objective 4 Prepare An Income Statement

QUESTION:

What is an income statement?

ANSWER:

An income statement is a formal


report of business operations
covering a specific period of time. It
is also called a profit and loss
statement or a statement of income
and expenses.

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The income statement has The third line shows that the report covers
a three-line heading. operations over a period of time.

JT’s Consulting Services


Income Statement
Month Ended December 31, 2010

Revenue
Fees Income $35,000.00

Expenses
Salaries Expense $7,000.00
Utilities Expense 500.00
Total Expenses 7,500.00

Net Income $ 27,500.00

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The income statement reports revenue.

JT’s Consulting Services


Income Statement
Month Ended December 31, 2010

Revenue
Fees Income $35,000.00

Expenses
Salaries Expense 7,000.00
Utilities Expense 500.00
Total Expenses 7,500.00

Net Income $ 27,500.00

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The income statement also reports expenses.

JT’s Consulting Services


Income Statement
Month Ended December 31, 2010

Revenue
Fees Income $35,000.00

Expenses
Salaries Expense 7,000.00
Utilities Expense 500.00
Total Expenses 7,500.00

Net Income $27,500.00

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The result is net income or net loss for the period.

JT’s Consulting Services


Income Statement
Month Ended December 31, 2010

Revenue
Fees Income $35,000.00

Expenses
Salaries Expense 7,000.00
Utilities Expense 500.00
Total Expenses 7,500.00

Net Income $27,500.00

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Objective 5 Prepare a Statement of Owner’s
Equity and Balance Sheet
A Statement of Owner’s Equity
JT’s Consulting Services
Statement of Owner’s Equity
Month Ended December 31, 2010

Jason Taylor, Capital, December 1, 2010 $90,000.00


Net Income for December $27,500.00
Less Withdrawals for December 4,000.00
Increase in Capital 23,500.00
Jason Taylor, Capital, December 31, 2010 $113,500.00
37

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The Balance Sheet
JT’s Consulting Services
Balance Sheet
December 31, 2010

Assets Liabilities

Cash 83,500.00 Accounts Payable 7,000.00


Accounts Receivable 5,000.00
Supplies 3,000.00
Prepaid Rent 7,000.00 Owner’s Equity
Equipment 22,000.00 Jason Taylor, Capital 113,500.00
Total Assets 120,500.00 Total Liabilities and Owner’s Equity 120,500.00

 A single line shows that the amounts above it are being added or
subtracted. A double line indicates final amounts for the column or section
of a report.

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The Importance of Financial
Statements
Business managers and
owners use the balance
sheet and the income
statement to control current
operations and plan for the
future.

Creditors, prospective
investors, governmental
agencies, and others are
interested in the profits of
the business and in the
asset and equity structure.

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Financial statements are prepared in
a specific order:

1st Income Statement

2nd Statement of Owner’s equity

3rd Balance Sheet

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JT’s Consulting Services
Statement of Owner’s Equity
Month Ended December 31, 2010

Jason Taylor, Capital, December 1, 2010 80,000.00


Net Income for December 22,400.00
Less Withdrawals for December 3,000.00
Increase in Capital 19,400.00
Jason Taylor, Capital, December 31, 2010 113,500.00

JT’s Consulting Services


Balance Sheet
December 31, 2010
Assets Liabilities
Cash $83,500.00 Accounts Payable $7,000.00
Accounts Receivable 5,000.00
Supplies 3,000.00
Prepaid Rent 7,000.00 Owner’s Equity
Equipment 22,000.00 Jason Taylor, Capital 113,500.00
Total Assets $ 120,500.00 Total Liabilities and Owner’s Equity $ 120,500.00

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Thank You
for using

College Accounting, 12th Edition

Price • Haddock • Farina

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