Chapter 02 - Accounting for Business Transactions

chapter 2

Accounting for Business TRANSACTIONS

Related Assignment Materials

Student Learning Objectives /
Questions / Quick Studies* /
Exercises* /
Problems* / Beyond the Numbers
Conceptual objectives:
LO1 – Define the accounting equation and each of its components / 1, / 2-1, 2-2,2-4 / 2-1, 2-2, 2-3, 2-4, 2-5, 2-6, 2-14 / 2-1, 2-2 / RIA, EC, TWIA
LO2 – Analyze business transactions using the accounting equation / 2, 3, 4,7, / 2-5,2-6,2-7,2-8 / 2-2, 2-3, 2-4, 2-5, 2-6,2-14 / 2-1, 2-2, 2-3, 2-4, / EC, EIB, TWIA
LO3 – Identify and prepare basic financial statements and explain how they interrelate / 5, 6, 8, 9, 10,11 / 2-3 / 2-7, 2-8,2-9,2-10,2-11, 2-12,2-13,
2-15 / 2-3, 2-4, / WC, TITTN, EIB

Additional Information on Related Assignment Material

The Serial Problem for Success Systems continues in this chapter.
Problems 2-3A and 2-4A can be completed usingExcel
Connect Accounting(available on the instructor’s course-specific website) repeats all numerical Quick Studies all Exercises and Problems Set A. Connect Accounting provides new numbers each time the Quick Study, Exercise or Problem is worked. It allows instructors to monitor, promote, and assess student learning. It can be used in practice, homework, or exam mode.

Synopsis of Chapter Revisions

• New Opener,SPANX, with new entrepreneurialassignment

• Simplified discussion of 3-step process for analyzing transactions

• New exhibit on links between financial statements

• New discussion of financial statement headings and alternativenames

• Clarified discussion of items that impact owner’s equity

Chapter Outline

Notes

I.Transaction Analysis and the Accounting Equation
A.Accounting equation (Assets = Liabilities + Equity)—elements of the equation include:

Assets—resources owned or controlled by a company. (e.g. cash, supplies, equipment and land)
Liabilities—creditors’ claims on assets. These claims reflect obligations to transfer assets or provide products or services to others.
Equity—owner’s claim on assets. Also called net assets or residual equity.

a.Investments—assets an owner puts into the company result in an increase in equity. Recorded under the title Owner, Capital.
b.Revenues—gross increases in equity resulting from a company’s earning activities.
c.Owner’s withdrawals—assets an owner takes from the company for personal use (results in decrease in equity).
d.Expenses—cost of assets or services used to earn revenues (results in decrease in equity).
e.Expanded Accounting Equation: Assets = Liabilities + Owner’s Capital – Owner’s Withdrawal + Revenues – Expenses
f.Net Income = Revenue - Expenses

Transaction and the Accounting Equation—each transaction and event always leaves the equation in balance. (Assets = Liabilities + Equity)

1.Transaction types

External value exchanges between two entities.
Internal exchanges within an entity.

2.Accounts are used to record transactions and events.

Transaction Analysis Illustration

Investment by owner
+Asset (Cash) = + Owner’s Equity (Owner, Capital)
reason: investment
Increase on both sides of equation keeps equation in balance

b. Purchased supplies for cash
+Asset (Supplies) = – Asset (Cash)
Increase and decrease on one side of the equation keeps the equation in balance.
c.Purchase equipment for cash
+ Asset (Equipment) = – Asset (Cash)
Increase and decrease on one side of the equation keeps the equation in balance.
d.Purchase supplies on credit
+ Asset (Supplies) = + Liability (Account Payable)
Increase on both sides of equation keeps equation in balance.
e.Provided services for cash
+ Asset (Cash) = + Owner’s Equity (reason: revenue earned)
Increase on both sides of equation keeps equation in balance.
f.Payment of expense in cash (salaries, rent etc.)
– Asset (Cash) = – Owner’s Equity (reason: expense incurred)
Decrease on both sides of equation keeps equation in balance.
g. Payment of expense in cash (salaries, rent etc.)
– Asset (Cash) = – Owner’s Equity (reason: expense incurred)
Decrease on both sides of equation keeps equation in balance.
h.Provided services and facilities for credit
+ Asset (Accts Receivable) = + Owner’s Equity (reason: revenue earned)
Increase on both sides of equation keeps equation in balance.
i. Receipt of cash from account receivable
+ Asset (Cash) = – Asset (Accounts Receivable)
Increase and decrease on one side of the equation keeps the equation in balance.

Payment of accounts payable
–Asset (Cash) = – Liability (Accounts Payable)
Decrease on both sides of equation keeps equation in balance.
Withdrawal of cash by owner
–Asset (Cash) = – Owner’s Equity (reason: owner’s withdrawal)
Decrease on both sides of equation keeps equation in balance.

II. Financial Statements
A.The basic financial statements and their purposes are:
1.Income Statement—describes a company’s revenues and expenses along with the resulting net income or loss over a period of time. (Net income occurs when revenues exceed expenses. Net loss occurs when expenses exceed revenues.)
2.Statement of Owner’s Equity—explains changes in equity from net income (or loss) and from owner investment and withdrawals over a period of time.
3. Balance Sheet—describes a company’s financial position (types and amounts of assets, liabilities, and equity) at a point in time

VISUAL #1

WARNING: NO MATTER WHAT HAPPENS

ALWAYS KEEP THIS SCALE

IN BALANCE

Basic Accounting Equation

ASSETS = LIABILITIES + OWNER’S EQUITY

TRANSACTION ANALYSIS RULES

1) Every transaction affects at least two items.

2) Every transaction must result in a balanced equation.

TRANSACTION ANALYSIS POSSIBILITIES:
A / = / L / + / OE
(1) / + / and / +
or (2) / - / and / -
or (3) / + and - / and / No change
or (4) / No change / and / + and -

Alternate Demonstration Problem

Chapter Two

One summer, Bill Smith decided to earn money as a lawn service professional. He solicited business in the neighborhood and obtained enough lawn servicing jobs that he thought he could be successful. On the basis of these commitments, Bill went to the bank, withdrew $2,000 of his savings and deposited the funds in a business bank account. At the end of the summer, Bill tried to figure out how well he had done. He examined his business bank account checkbook and noted the following:

Deposits, all from customer collections, totaled $11,400.

Checks written:

Truck and equipment rental, $1,800
Gas, oil, and lubrication, $880
Miscellaneous supplies used, $90
Helpers, $4,700; including payroll taxes, $500
Insurance, $175
Telephone, $100

Transfer from business bank account to his personal savings account, $2,000.

Bill also had records that showed:

Customers still owed him $600 for services that were performed.
He still owed another $100 to a vendor for gas and oil.

Required:

1. Show the effect of each transaction on the accounting equation.

2. Prepare an income statement for Bill for his summer business.

3. Prepare a statement of owner’s equity for Bill for his summer business.

4. Prepare a balance sheet for Bill at the end of the summer.

Solution: Alternate Demonstration Problem

Chapter Two

1.
Item / Assets / = / Liabilities / + / Equity
a. / Cash investment / + / $ 2,000 / + / $ 2,000
b. / Revenue received / + / 11,400 / + / 11,400
c. / Truck and equipment rental / - / 1,800 / - / 1,800
d. / Truck expenses / - / 880 / - / 880
e. / Miscellaneous supplies used / - / 90 / - / 90
f. / Helpers / - / 4,700 / - / 4,700
g. / Payroll taxes / - / 500 / - / 500
h. / Insurance / - / 175 / - / 175
i. / Telephone / - / 100 / - / 100
j. / Withdrawal / - / 2,000 / - / 2,000
k. / Revenue earned-not collected / + / 600 / + / 600
l. / Oil and gas bill not yet paid / + / $100 / - / 100
$3,755 / $100 / $3,655
2. / BILL SMITH’S LAWN SERVICE CO.
Income Statement
For the period from June 1 through August 31 20XX
Total revenue ($11,400 + $600)...... / $12,000
Expenses:
Truck expenses ($880 + $100)...... / $ 980
Truck and equipment rental...... / 1,800
Supplies...... / 90
Helpers...... / 4,700
Payroll taxes...... / 500
Insurance...... / 175
Telephone...... / 100
Total expenses...... / 8,345
Net income...... / $ 3,655
4. / BILL SMITH’S LAWN SERVICE CO.
Statement of Owner’s Equity
For the period from June 1 through August 31 20XX
W. Smith, Capital – June 1 / $ 0
Add: Investments by Owner / 2,000
Net Income / 3,655
Less: Owner Withdrawals / (2,000)
W. Smith, Capital – August 31, 20XX / $ 3,655
4. / BILL SMITH’S LAWN SERVICE CO.
Balance Sheet
August 31, 20XX
Assets / Liabilities and Owner’s Equity
Cash...... / $3,155 / Accounts payable ...... / $ 100
Accounts receivable..... / 600 / Bill Smith, Capital...... / 3,655
Total assets...... /
$3,755 / Total liabilities and
owner’s equity...... /
$3,755

2-1