Chapter 1: Starting a Proprietorship

What is Accounting?

Planning, recording, and interpreting financial information is Accounting.
An accounting system is a planned process for providing financial information that will be useful to management.
Organized summaries of a business financial activity are called accounting records.
Accounting is the language of business.
Owner’s, manager’s, and accounting personnel use their knowledge of accounting to understand the information provided in the accounting reports.
Financial reports that summarize the financial condition and operations of a business are called financial statements.
Inaccurate accounting records often contribute to businesses failure and bankruptcy.
Failure to understand accounting information can result in poor business decisions for both business and nonprofit organizations.
Nearly everyone in the U.S. earns money and must submit income tax reports to the federal & state government.
Everyone must plan ways to keep spend with in available income.

The Business—Techknow Consulting

A business that performs an activity for a fee is called a service business.

Kim Park started her own business helping set up and troubleshoot computer networks.

A business owned by one person is called a proprietorship.

Since this is a new business Kim must design the accounting system that will be used to keep accounting records.

She must be careful to keep her personal records separate from her business records.

The accounting concept Business Entity is applied when a business’s financial information is recorded and reported separately from the owner’s personal financial information.

Lesson 1-1: The Accounting Equation

The Accounting Equation

Assets = Liabilities + Owner’s Equity

LeftRight Side Amounts

Side

Amt.

Techknow Consulting will own items such as cash and supplies that will be used to conduct daily operations.
Anything of value that is owned is called an ASSET.
Assets have value because they can be used to acquire other assets or be used to operate a business.
Financial rights to the assets of a business are called EQUITIES.
A business has 2 types of equities: (1) Equity of those to whom money is owed.
An amount owed by a business is called a LIABILITY.

(2) Equity of the owner. Ms. Park will own Techknow Consulting and invest in the assets of the business.

The amount remaining after the value of all liabilities is subtracted from the value of all assets is called OWNER’S EQUITY.
The relationship among asset, liabilities, and owner’s equity can be written as an equation.
An equation showing the relationship among Assets, Liabilities, & Owner’s Equity is called the accounting equation.
The accounting equation is most often stated as:
Assets = Liabilities + Owner’s Equity
The accounting equation must be in balance to be correct, the total of the amounts on the left side of the equation must ALWAYS equal the total of the amounts on the right side.

Lesson 1-2: How Business Activities Change the Accounting Equation

Receiving Cash

Business activities change the amounts in the accounting equation.
A business activity that changes assets, liabilities, or Owner’s Equity is called a transaction.
After each transaction, the accounting equation must remain in balance.

Received cash from owners as an investment

Transaction 1: 8/1 received cash from owner as an investment, $5,000.00
Ms. Park uses $5,000.00 of her own money to invest in Techknow Consulting.
A record summarizing all the information pertaining to a single item in the accounting equation is called an account.
The name given to an account is called an account title.
One of the asset accounts is titled CASH.
The cash account is used to summarize information about the amount of money the business has available.
In this transaction, CASH has increased by the amount received by the business, $5,000.
This increase is on the left side of the equation.
The amount in an account is called the account balance.
The account used to summarize the Owner’s Equity or O.E. in a business is called Capital.
The Capital account is an O.E. account.
In this transaction the O.E. account is increased by $5,000.
This is on the right side of the accounting equation.
The accounting equation has changed as a result of the receipt of cash as the owner’s investment.
Both sides of the equation are changed by the same amount, $5,000.
Therefore, the accounting equation is still in balance.

Paying Cash

Techknow Consulting needs supplies to operate the business.
Transaction 2: 8/3 Paid cash for supplies, $275.00.
In this transaction, two assets are changes.
One asset, is cash, has been exchanged for another asset, supplies.
Remember assets are things owned by the business.
Cash has decreased and supplies has increased.
When changes are made on only one side of the accounting equation, the equation must still be in balance.
Therefore, if one account is increased, another account on the same side of the equation must be decreased.
The accounting equation is still in balance.

Paid cash for insurance

Insurance premiums must be paid in advance.
Transaction 3: 8/4 Paid cash for insurance, $1,200.00.
In return for this payment, Techknow Consulting is entitled to insurance coverage for the length of the policy.
The insurance coverage is something valued so it is an asset.
These premiums are recorded in an asset account titled PREPAID INSURANCE.
In this transaction, two assets are changed.
Cash is decreased; your paying for insurance, and Prepaid Insurance has increased.

Transactions on Account

TechKnow Consulting needs to buy additional supplies.
It is a common business practice to buy items and pay for them at a future date.
Another way to state this activity is to say that those items are bought on account.
Transaction 4: 8/7 Bought supplies on account from Supplies Depot, $500.
In this transaction, one asset and one liability are changed.
The liabilities account Accounts Payable-Supplies Depot is increased by $500, the amount owed for the supplies. This means that Supplies Depot will have a claim against some of TechKnow Consulting’s assets until they pay for the supplies they bought.
The asset account Supplies is increased by $500 the amount of supplies bought.
Therefore, the accounting equation is still in balance.

Paid Cash on Account

Transaction 5: 8/11 Paid cash on account to Ling Music Supplies, $300.00.
In this transaction, one asset and one liability are changed.
The asset account Cash is decreased by the amount of cash paid out.
After the payment, TechKnow Consulting owes less money to Supply Depot.
Therefore, the liability account, Account Payable-Supply Depot is decreased by $300, the amount paid on account. They will pay the remaining balance at a later date.
Each side of the equation has had activities so the equation is equal.

Lesson 1-3: How transactions change Owner’s Equity in an Accounting Equation

Revenue Transactions

Received Cash from Sale
A transaction for the sale of goods or services results in an increase in Owner’s Equity.
An increase in Owner’s Equity resulting from the operation of a business called revenue.
When cash is received from a sale the total amount of assets & O.E. is increased.
When TechKnow Consulting receives cash for services performed, the asset account, Cash, is increased by the amount of cash received.
The O.E. account, Barbara Trevino Capital, is increased by the same amount.
Transaction 6: 8/12 received cash from sales, $295.00
Cash is increased by $295, and Kim Park, Capital is increased.
Each side of the equation has been increased, so the accounting equation remains equal.

Sold Services on Account

A sale for which cash will be received at a later date is called a sale on account, or a charge sale.
When TechKnow Consulting sells services on account, the asset account A/R-Oakdale School, is increased by the amount of cash that will be received.
Regardless of when payment is made, the revenue should be received at the time of sale.
The O.E. account, Kim Park, Capital is also increase by the amount of sale.
Transaction 7: 8/12 sold services on account to Oakdale School, $350.00
A/R-Oakdale School is increased by $350 (Left side) and Kim Park, Capital is also increased by $350 (Right side).

Paid Cash for Expenses

A transaction to pay for goods or services needed to operate a business results in a decrease in O.E.
A decrease in O.E. resulting from the operation of a business is called an expense.
The asset account, Cash, is decreased and the O.E., Capital is also decreased.
Transaction 8: 8/12 paid cash for rent, $350.00.
The asset account, Cash is decreased by $350 and Capital is also decreased by $350.

Paid Cash for Telephone Bill

Transaction 9: 8/12 paid cash for telephone bill, $40.00

The asset account Cash is decreased by $40, and the owners equity account Kim Park, Capital is descreased.

Other expense transactions might be for advertising, equipment rentals or repairs, charitable contributions, and other miscellaneous items.

All expense transactions affect the accounting equation in the same way as in Transactions 8 & 9.

Received Cash on Account

When a company receives cash from a customer for a prior sale, the transaction increases the cash account balance and decreases the accounts receivable balance.
Transaction 10: 8/12 Received cash on account from Oakdale School $200.00
Cash is increased and A/R-Oakdale School is decreases, so the balance has decreased.
The left side of the equation was increased and decreased so the equation is still in balance.

Paid cash to owner for personal use

Assets taken out of a business for the owner’s personal use are called withdrawals.
A withdrawal decreases O.E.
The withdrawal decreases the account balance of the withdrawn asset, such as Cash.
Transaction 11: 8/12 Paid cash to owner for personal use, $125.00
Cash is decreased and Kim Park, Capital is decreased.
A decrease in O.E because of a withdrawal is not a result of the normal operations of a business, therefore, a withdrawal is not an expense.

Summary of Changes in Owner’s Equity

Take a look at pg. 16 to show all of the changes that have taken place in this chapter.