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©CourseCollege.com 1 2 Learning Objectives 1.Describe and use the fundamental accounting equation. 2.Identify five basic classes of accounts 3.Explain five essential accounting concepts 4.Analysis: Percentage of sales (common size income statements) Unit 2 The Equation
©CourseCollege Publishing 2 Objective 2.1: The accounting equation The following slides use Jack & Jill Enterprises to demonstrate the fundamental accounting equation O2.1
©CourseCollege.com 3 Jack and Jill Enterprises Hey Jill! Lets fetch water and make some money O2.1 You fetch I’ll supervise
©CourseCollege.com 4 Jack and Jill Enterprises We receive $1 for each pail of water we fetch And we pay $1 to replace each shoe we wear out O2.1
©CourseCollege.com 5 Cash Pails2 3 5Total Assets First, we can list all of J & J’s assets in a blue box. O2.1
©CourseCollege.com 6 Assets Cash Pails Mom payable Jack & Jill, Capital Equity 2 23 5 3 5 Total Next, list all the claims against the assets in a red box. The red box has two parts, creditors and owners. O2.1 Liabilities
©CourseCollege.com 7 Assets Cash Pails Liabilities Mom payable Jack & Jill, Capital Equity 2 23 5 3 5 Total The most important thing to remember is the total in the blue box must always equal the total in the red box. A = L + E O2.1
©CourseCollege.com 8 This is the BALANCE SHEET
©CourseCollege.com 9 O2.1 Now lets see how this system works for J & J Enterprises. (Remember, Assets must always equal Liabilities Plus Owner’s Equity.
©CourseCollege.com 10 Assets Cash Pails Liabilities Mom payable J&J, Capital Equity 2 3 5 3 2 Total assetsTotal Liab. + Equity 5 Jack and Jill Enterprises 4 4 6 6 6 8 6 8 7 9 7 9 5 7 5 7 8 10 8 7 9 7 9 Fetch 1 Pail Fetch 2 Pails Fetch 1 Pail Buy 2 Shoes Fetch 3 Pails Buy 1 Shoe O2.1
©CourseCollege.com 11 O2.1 We increased Equity with each sale We decreased Equity for each expense. The system stayed in balance
©CourseCollege.com 12 Answer: With this simplified system, you would have have to memorize the total sales. O2.1 So what are the total sales earned by Jack and Jill so far? Sales ?
©CourseCollege.com 13 Assets Cash Pails Liabilities Mom payable J&J, Capital Equity 2 3 5 3 2 Total assetsTotal Liab. + Equity 5 Jack and Jill Enterprises 4 4 6 6 6 8 6 8 7 9 7 9 5 7 5 7 8 10 8 7 9 7 9 I wish I could remember what our sales were. O2.1
©CourseCollege.com 14 Solution: The Income Statement O2.1 BALANCE SHEET INCOME STATEMENT We need a better method to keep track of salesexpenses sales and expenses for each time period
©CourseCollege.com 15 O2.1 To keep track of sales and expenses for any given period. BALANCE SHEET INCOME STATEMENT Income Statement A separate “temporary” list of Sales and Expenses
©CourseCollege.com 16 O2.1 The Sales and Expenses are collected on the Income Statement BALANCE SHEET INCOME STATEMENT AssetsLiabilities EquityExpenses Sales
©CourseCollege.com 17 O2.1 The resulting Profit or Loss is calculated BALANCE SHEET INCOME STATEMENT AssetsLiabilities EquityExpenses Sales Profit Loss
©CourseCollege.com 18 O2.1 At the end of the time period The Profit or Loss is moved to Equity BALANCE SHEET INCOME STATEMENT AssetsLiabilities EquityExpenses Sales Profit Loss Let’s try it
©CourseCollege.com 19 Cash Pails Total assets Assets Mom payable J&J, Capital Total Liab & Equity Liabilities + Equity Balance Sheet Revenue Income Statement Shoe Expense OR 23 2 5 3 5 Jack and Jill Enterprises 1 1 0 4 6 6 8 3 3 7 9 4 4 5 7 2 2 8 10 7 5 7 9 3 4 Fetch 1 Pail Fetch 2 Pails Fetch 1 Pail Buy 2 Shoes Fetch 3 Pails Buy 1 Shoe O2.1
©CourseCollege.com 20 The Income Statement is used to collect sales and expenses for a given time period -for example a month or a year. O2.1 This is a big improvement. The Income Statement allows us to tell at a glance what the sales and expense totals are.
©CourseCollege.com 21 Cash Pails Total assets Assets Mom payable J&J, Capital Total Liab & Equity Liabilities + Equity Balance Sheet Revenue Income Statement Shoe Expense OR 23 2 5 3 5 Jack and Jill Enterprises 1 1 0 4 6 6 8 3 3 7 9 4 4 5 7 2 2 8 10 7 5 7 9 3 4 The systems stays balanced –you must consider the change in J&J Capital that is being recorded in the Income Statement O2.1
©CourseCollege.com 22 Assets = Liabilities + Equity + Revenues - Expenses O2.1 Following are exercises using the fundamental accounting equation
©CourseCollege.com 23 AssetsLiabilities Equity 78 150 Total AssetsTotal Liab & Equity O2.1 Total Liabilities Total Equity ? 72 What is Total Equity?
©CourseCollege.com 24 AssetsLiabilities Equity 1750 Total AssetsTotal Liab & Equity O2.1 Total Liabilities Total Equity ? 658 What are Total Liabilities? 1092
©CourseCollege.com 25 AssetsLiabilities Equity 9,850 Total AssetsTotal Liab & Equity O2.1 Total Liabilities Total Equity ? 3,430 What are Total Assets? 6,420 9,850
©CourseCollege.com 26 Total assets Assets Total Liabilities Owner, Capital (Beginning ) Total Liab & Equity Liabilities + Equity Balance Sheet Revenue Income Statement Expenses OR 870 ? 5 1 1 0 68 3 3 9 4 4 7 2 2 10 0 5 1,275 0 0 What is the total Owner, Capital? O2.1 405 1,275
©CourseCollege.com 27 Total assets Assets Total Liabilities Owner, Capital (Beginning ) Total Liab & Equity Liabilities + Equity Balance Sheet Revenue Income Statement Expenses OR 870 ? 5 1 1 0 68 3 3 9 4 4 7 2 2 10 100 5 1,350 25 75 What is the total Owner, Capital? (consider the Income Statement also) O2.1 405 Beg. Owner Capital 405 plus Revenue 100 minus Expenses 25 = 480 Ending Owner, Capital
©CourseCollege Publishing 28 Objective 2.2: Account Classification The following slides offer an expanded Balance Sheet and Income Statement to help understand the 5 classes of accounts O2.2
©CourseCollege.com 29 Cash Accounts Receivable Supplies Inventory Land Buildings Equipment Copyrights Assets Accounts Payable Wages Payable Taxes Payable Unearned Revenue Notes Payable Owner’s, Capital Liabilities + Equity Balance Sheet Revenue Income Statement Cost of Goods Sold Wages Expense Taxes Expense Rent Expense Utilities Expense Interest expense Profit Loss OR There are 5 basic classes of accounts 1. Assets 5. Expenses 2. Liabilities 3. Equity 4. Revenue O2.2
©CourseCollege.com 30 Note the words on the following slide and the classification they indicate O2.2 There are a number of words used in account descriptions that help us identify the classification.
©CourseCollege.com 31 Remember where these words belong! O2.2
©CourseCollege.com 32 Where does this account belong? O2.2
©CourseCollege.com 33 Where does this account belong? O2.2
©CourseCollege.com 34 Where does this account belong? O2.2
©CourseCollege.com 35 Where does this account belong? O2.2
©CourseCollege.com 36 Where does this account belong? O2.2
©CourseCollege.com 37 Where does this account belong? O2.2
©CourseCollege.com 38 Where does this account belong? O2.2
©CourseCollege.com 39 Where does this account belong? O2.2
©CourseCollege.com 40 Where does this account belong? O2.2
©CourseCollege.com 41 Where does this account belong? O2.2
©CourseCollege.com 42 Where does this account belong? O2.2
©CourseCollege.com 43 Where does this account belong? O2.2
©CourseCollege.com 44 Where does this account belong? O2.2
©CourseCollege.com 45 Where does this account belong? O2.2
©CourseCollege.com 46 Where does this account belong? O2.2
©CourseCollege.com 47 Where does this account belong? O2.2
©CourseCollege.com 48 Where does this account belong? O2.2
©CourseCollege Publishing 49 Objective 2.3: Concepts The following slides present 6 important concepts that guide many accounting practices and decisions. O2.3
©CourseCollege.com 50 Concepts Objectivity Concept Unit of Measure (Monetary Unity) Concept Periodicity Concept Matching Concept Cost Concept O2.3 Revenue Recognition Concept
©CourseCollege.com 51 Unit of Measure (Monetary Unity) Concept Simply put, we must express accounts in monetary units such as dollars. The monetary unit used is specific to the country in which business activity is conducted. $ £ ¥ DM O2.3
©CourseCollege.com 52 O2.3 Periodicity Concept Accounting information should be separated into regular time periods such as months, quarters and years. Information collected in time periods allows comparisons that help us track financial progress.
©CourseCollege.com 53 O2.3 For any accounting time period, all expenses that were incurred to earn revenues for that period must be matched (recorded as an expense) in that same time period. This concept is one that guides a great deal of accounting activity in the production of accrual financial statements Matching Concept
©CourseCollege.com 54 O2.3 Historical cost is used to record values in the accounts (in most cases) rather than current market values or replacement costs This concept is part of the conservative approach to financial reporting that is required by FASB Cost Concept
©CourseCollege.com 55 O2.3 When recording values where historical cost is not relevant, objective information is required rather than (subjective) values based on opinion or educated guesses. Objective information is provided by reliable, unbiased third parties, generally from market data Objectivity Concept
©CourseCollege.com 56 O2.3 Revenue should be recorded when it is earned and receivable. Record revenue when the seller has completed everything necessary to have the right to receive payment Revenue Recognition Concept
©CourseCollege.com 57 What concept is involved? O2.3 Tom buys 12 new kayaks to add to his inventory paying $425 each from a dealer going out of business. Tom buys the same kayak from the manufacturer for $675. What value should be recorded in the accounts for this purchase? 12 @ $425 each Cost Concept
©CourseCollege.com 58 What concept is involved? O2.3 Thao wants to invest a 2 year old delivery van owned personally into her florist business. She saw two identical vans for sale at $36,000. She paid $47,000 for the van two years ago. Current published values for the van indicate a value of $31,000. What value should be recorded in the accounts for this investment? $31,000 Objectivity Concept
©CourseCollege.com 59 What concept is involved? O2.3 It is important to express accounting information in a common denominator of units that is simple, reliable, universally available and understandable. Unit of Measure (Monetary Unity) Concept $ £ ¥ DM
©CourseCollege.com 60 What concept is involved? O2.3 There would be limited value in accounting information that continuously accumulated sales and expenses month after month, year after year without interruption. Periodicity Concept
©CourseCollege.com 61 What concept is involved? O2.3 Tom sells a kayak for $950 and records the revenue. What else should Tom record as a result of this sale? Tom should record the expense (Cost of Goods Sold) for the cost incurred to acquire this inventory item. Matching Concept
©CourseCollege.com 62 What concept is involved? O2.3 Mark’s Hydraulic Repair receives a repair job from a credit customer on May 15, completes the job on May 18 and bills the customer. The customer picks up the repair on May 22. When can Mark’s record the revenue? Mark’s can record the revenue on the day the work was completed, May 18 Revenue Recognition Concept
©CourseCollege Publishing 63 Objective 2.4: Common size income statement Useful information can be obtained by expressing income statement items in terms of their percentage of sales. O2.4
©CourseCollege.com 64 46,400/268,000 = 17% A standard common size percentage calculated is net profit as a percentage of sales. This allows comparison from one period to the next O2.4
©CourseCollege.com 65 End of Unit 2
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