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CHAPTER TWO

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  1. CHAPTER TWO ANALYZING TRANSACTIONS: The Accounting Equation

  2. BUSINESS ENTITY • An individual, association, or organization • That engages in economic activities • And controls specific economic resources • Business entity’s finances kept separate from those of owner (Business Entity Concept)

  3. ASSETS MUST BE “OWNED” NOT RENTED ITEMS OWNED BY A BUSINESS THAT WILL PROVIDE FUTURE BENEFITS

  4. ASSETS BUT DOESN’T HAVE TO BE PAID OFF, COULD STILL BE MAKING PAYMENTS ON IT ITEMS OWNED BY A BUSINESS THAT WILL PROVIDE FUTURE BENEFITS

  5. ASSETS • CASH • MERCHANDISE • FURNITURE • FIXTURES • MACHINERY • BUILDINGS • LAND EXAMPLES: • ACCOUNTS RECEIVABLE

  6. ACCOUNTS RECEIVABLE • The amount of money owed to the business • By its customers • As a result of making sales “on account” or “on credit” • Simply, customers who have promised to pay sometime in the future

  7. LIABILITIES IN OTHER WORDS, DEBTS OR OBLIGATIONS OF THE BUSINESS THAT CAN BE PAID WITH CASH, GOODS , OR SERVICES PROBABLE FUTURE OUTFLOW OF ASSETS AS A RESULT OF A PAST TRANSACTION OR EVENT

  8. LIABILITIES • ACCOUNTS PAYABLE • NOTES PAYABLE EXAMPLES:

  9. 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” Be careful!! Don’t confuse Accounts Receivable and Accounts Payable. Ask yourself, are we waiting to receive? Or waiting to pay?

  10. NOTES PAYABLE • Formal written promises to pay suppliers or lenders • Specific sums of money at definite future times

  11. OWNER’S EQUITY ALSO CALLED: AMOUNT BY WHICH THE BUSINESS ASSETS EXCEED THE BUSINESS LIABILITIES CAPITAL NET WORTH OR

  12. EXAMPLE: If a business has total Assets of $100,000 and total Liabilities of $60,000, what is the Owner’s Equity? Once the debts are paid, the remaining assets belong to the owner (Owner’s Equity).

  13. EXAMPLE: If a business has total Assets of $100,000 and total Liabilities of $60,000, what is the Owner’s Equity? FORMULA: = ASSETS LIABILITIES OWNER’S EQUITY $40,000 = $100,000 $60,000 Can also be expressed as: Assets = Liabilities + Owner’s Equity

  14. BUSINESS ENTITY CONCEPT • Owner may have business assets and liabilities and nonbusiness assets and liabilities • Nonbusiness assets and liabilities are not included in the entity’s accounting records • If owner invests money or other assets in the business, the item is now a business asset

  15. ACCOUNTING EQUATION Assets = Liabilities Owner’s Equity + Left side: Assets

  16. ACCOUNTING EQUATION + Assets = Liabilities Owner’s Equity Right side shows where the money came from to buy the assets

  17. BUSINESS TRANSACTION • An economic event that has a direct impact on the business • Usually requires an exchange with an outside entity • Must be able to measure this exchange in dollars • All transactions affect the accounting equation through specific accounts

  18. ACCOUNT A separate record used to summarize changes in each asset, liability, and owner’s equity of a business

  19. ANALYZING BUSINESS TRANSACTIONS THREE QUESTIONS:

  20. QUESTION #1 WHAT HAPPENED? Make certain you understand the event that has taken place.

  21. QUESTION #2 WHICH ACCOUNTS ARE AFFECTED? • Identify the accounts that are affected. • Classify these accounts as assets, liabilities, or owner’s equity.

  22. QUESTION #3 HOW IS THE ACCOUNTING EQUATION AFFECTED? • Determine which accounts have increased or decreased. • Make certain that the accounting equation remains in balance after the transaction has been entered.

  23. Let’s analyze the effect of transactions on the accounting equation for Mary Adams Consulting

  24. EXAMPLE: MARY ADAMS, THE OWNER, INVESTED $25,000 IN THE BUSINESS

  25. QUESTION #1 What happened? Mary took $25,000 from her personal bank account and deposited it in a new account in the business’ name

  26. QUESTION #2a Identify accounts that are affected CASH M. A. CAPITAL

  27. QUESTION #2b Classify these accounts M. A. CAPITAL CASH OWNER’S EQUITY ASSET

  28. QUESTION #3a Determine whether the accounts have increased or decreased M. A. CAPITAL CASH INCREASED INCREASED

  29. QUESTION #3b Does accounting equation balance? + ASSETS = LIABILITIES OWNER’S EQUITY CASH = M. A.,CAPITAL +$25,000 +$25,000 = It Balances! Assets of $25,000 = Liab. of $0 plus Owner’s Equity of $25,000

  30. EXAMPLE: PURCHASED OFFICE SUPPLIES FOR $800 CASH

  31. QUESTIONS #1 & #2 Understand the transaction, Identify and Classify the affected accounts OFFICE SUPPLIES CASH ASSET ASSET

  32. QUESTION #3a Increase or Decrease? CASH OFFICE SUPPLIES ASSET ASSET INCREASED DECREASED

  33. QUESTION #3b Let’s look at the accounting equation + ASSETS = LIAB. O. E. + OFF. SUPPLIES CASH = +$800 + -$800 = Right hand side of equation is not affected

  34. QUESTION #3b Does transaction balance? + ASSETS = LIAB. O. E. + OFF. SUPPLIES CASH = +$800 + -$800 = Yes! Total Assets stayed the same. One Asset increased, the other decreased. No change in Liabilities or Owner’s Equity

  35. PROVING ACCOUNTING EQUATION BALANCES: ASSETS: CASH OFFICE SUPPLIES $25,000 - $800 $800 $24,200 $800 BALANCE LEFT SIDE OF EQUATION: CASH $24,200 SUPPLIES $ 800 TOTAL ASSETS $25,000

  36. PROVING ACCOUNTING EQUATION BALANCES: LIABILITIES OWNER’S EQUITY $ 0 $25,000 BALANCE $ 0 $25,000 BALANCE RIGHT SIDE OF EQUATION: $ 0 LIABILITIES $25,000 OWNER’S EQUITY $25,000 TOTAL LIAB. & O.E.

  37. EXAMPLE PURCHASED EQUIPMENT ON ACCOUNT FOR $3,000

  38. 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

  39. QUESTIONS #1 & #2 Understand the transaction, Identify and Classify the affected accounts EQUIP. ACCOUNTS PAYABLE LIABILITY ASSET

  40. QUESTION #3a Increase or Decrease? ACCOUNTS PAYABLE EQUIP. ASSET LIABILITY INCREASED INCREASED

  41. QUESTION #3b Let’s look at the accounting equation: + ASSETS = LIABILITIES OWNER’S EQUITY ACCOUNTS PAYABLE EQUIP. = This transaction had no effect on Owner’s Equity + $3,000 + $3,000 =

  42. QUESTION #3b Does transaction balance? + ASSETS = LIABILITIES OWNER’S EQUITY ACCOUNTS PAYABLE EQUIP. = + $3,000 + $3,000 = It Balances! Assets increased by $3,000 = Liab. Increased by $3,000

  43. PROVING ACCOUNTING EQUATION BALANCES: ASSETS: + + EQUIPMENT CASH SUPPLIES $25,000 - $800 $800 $24,200 $800 BAL. +$3,000 BAL. $24,200 $800 $3,000 SUPPLIES $ 800 $24,200+$800+$3,000= $28,000 TOTAL ASSETS $25,000

  44. PROVING ACCOUNTING EQUATION BALANCES: LIABILITIES OWNER’S EQUITY M. A., CAPITAL ACCTS. PAY. +$25,000 $25,000 BAL. +$3,000 $3,000 $25,000 BAL. $3,000 + $25,000 =$28,000 TOTAL LIAB. & O. E.

  45. EXAMPLE MADE $400 PAYMENT ON EQUIPMENT

  46. QUESTIONS #1 & #2 Understand the transaction, Identify and Classify the affected accounts CASH ACCOUNTS PAYABLE LIABILITY ASSET

  47. QUESTION #3a Increase or Decrease? ACCOUNTS PAYABLE CASH ASSET LIABILITY DECREASED DECREASED

  48. QUESTION #3b Let’s look at the accounting equation: + ASSETS = LIABILITIES OWNER’S EQUITY ACCOUNTS PAYABLE CASH = This transaction had no effect on Owner’s Equity - $400 - $400 =

  49. QUESTION #3b Does transaction balance? + ASSETS = LIABILITIES OWNER’S EQUITY ACCOUNTS PAYABLE CASH = - $400 - $400 = It Balances! Assets decreased by $400 = Liab. decreased by $400

  50. PROVING ACCOUNTING EQUATION BALANCES: ASSETS: EQUIPMENT CASH SUPPLIES $25,000 - $800 $800 $24,200 $800 BAL. +$3,000 BAL. $800 $24,200 $3,000 -$400 SUPPLIES $23,800 $3,000 $800 BAL. $27,600