GLENCOE / McGraw-Hill

Analyzing Business Transactions

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. Section Objectives The Accounting Equation and Financial Statements

The Fundamental Accounting Equation Page 30

QUESTION: What is the fundamental accounting equation? Page 30 ANSWER: The fundamental accounting equation is the relationship between assets and liabilities plus owner’s equity.

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 Fundamental Accounting Equation Page 30

If any two parts of the equation are known, the third part can be determined. Page 30 The entire accounting process of analyzing, recording and reporting business transactions is based on the fundamental accounting equation (Assets = Liabilities + Owner’s Equity).

Earning Revenue and Incurring Expenses Page 30

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. Page 30

QUESTION: What is revenue? Page 30 ANSWER: 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.

QUESTION: What is an expense? Page 31 ANSWER: An expense is an outflow of cash, use of other assets, or incurring of a liability.

Page 31 Selling Services for Cash

During the month of December, Carter Consulting Services earned a total of $21,000 in revenue from clients. The total effect of these transactions is analyzed below. Page 31 Analysis: (m) The firm received $21,000 in cash for services provided to clients. (n) Revenues increased by $21,000, which results in a $21,000 increase in owner’s equity.

An increase in revenue is an increase in owner’s equity. Page 31 Revenue $21,000 Owner’s Equity $21,000

Assets = Liab. + Owner’s Equity Prepaid Accounts L. Carter, Cash + Supplies + Rent + Equip. = Payable + Capital + Revenue Previous balances $49,000 + $2,000 + $6,000 + $35,000 = $12,000 + $80,000 (m) Recd. cash +21,000 (n) Increased owner's equity + 21,000 Page 31 New balances $70,000 + $2,000 + $6,000 + $35,000 = $12,000 + $80,000 + $21,000 $113,000 = $113,000 The fundamental accounting equation remains in balance.

Recording Revenue Amounts Why are revenue amounts recorded in a separate column under the Owner’s Equity section? QUESTION: Firms can easily calculate total revenue while preparing financial statements. ANSWER: Page 31

Page 31 Selling Services on Credit

QUESTION: What are accounts receivable? Page 31 ANSWER: Accounts receivable are claims for future collection from customers.

Page 31 Analysis: (o) The firm acquired a new asset, accounts receivable, of $7,000. (p) Revenue increases by $7,000, which results in a $7,000 increase in owner’s equity. During December Carter Consulting Services earned $7,000 of revenue from charge account clients. The effect of these transactions in the month is analyzed below.

Assets = Liab. + Owner's Equity Accts. Prepaid Accts. L. Carter, Cash + Rec. + Supplies + Rent + Equip. = Pay. + Capital + Rev. Previous balances $70,000 + $2,000 + $6,000 + $35,000 = $12,000 + $80,000 + $21,000 _______ ______ _____ ______ ______ _____ ______ ______ (o) Received new asset + $7,000 (p) Increased owner’s equity + 7,000 New bal. $70,000 + $7,000 + $2,000 + $6,000 + $35,000 = $12,000 + $80,000 + $28,000 Page 32 $120,000 = $120,000 The fundamental accounting equation remains in balance.

Page 32 Collecting Receivables

Page 32 Analysis: (q) The firm received $3,000 in cash. (r) Accounts receivable decreased by $3,000. During December Carter Consulting Services received $3,000 on account from clients who owed money for services previously billed. The effect of these transactions is analyzed below.

Assets = Liab. + Owner's Equity Accts. Prepaid Accts. L. Carter, Cash + Rec. + Supplies + Rent + Equip. = Pay. + Capital + Rev. Previous Balances $70,000 + $7,000 + $2,000 + $6,000 + $35,000 = $12,000 + $80,000 + $28,000 _______ ______ ______ ______ ______ ______ ______ ______ (q) Recd. cash +3,000 (r) Decreased accts. rec. - 3,000 New bal. $73,000 + $4,000 + $2,000 + $6,000 + $35,000 = $12,000 + $80,000 + $28,000 Page 32 $120,000 = $120,000 The fundamental accounting equation remains in balance.

Collecting Receivables Why didn’t revenue increase when money was received from charge account clients? QUESTION: The revenue was already recorded when the original sale took place. ANSWER: Page 32

Paying Employees’ Salaries Page 33

Page 33 Analysis: (s) The firm decreased its cash balance by $5,000. (t) The firm paid salaries expense in the amount of $5,000, which decreased owner’s equity. Business Transaction In December Carter Consulting Services paid $5,000 in salaries for the accounting clerk and the office manager. The effect of this transaction is analyzed below.

An increase in expense is a decrease in owner’s equity. Expense $5,000 Owner’s Equity $5,000 Page 33

Assets = Liab. + Owner's Equity Accts. Prepaid Accts. L. Carter, Cash + Rec. + Supplies + Rent + Equip. = Pay. + Capital + Rev. - Exp. Previous balances $73,000 + $4,000 + $2,000 + $6,000 + $35,000 = $12,000 + $80,000 + $28,000 ______ ______ ______ ______ ______ ______ ______ ______ _____ (s) Paid cash -5,000 (t) Decreased owner’s equity - 5,000 New bal. $68,000 + $4,000 + $2,000 + $6,000 + $35,000 = $12,000 + $80,000 + $28,000 - $5,000 Page 33 $115,000 = $115,000 The fundamental accounting equation remains in balance.

Page 33 Paying Utilities Expenses

Page 33 Analysis: (u) The firm decreased its cash balance by $600. (v) The firm paid utilities expense of $600, which decreased owner’s equity. Business Transaction Carter Consulting Services issued a check for $600 to pay the utilities bill. The effect of this transaction is analyzed below.

Assets = Liab. + Owner's Equity Accts. Prepaid Accts. L. Carter, Cash + Rec. + Supplies + Rent + Equip. = Pay. + Capital + Rev. - Exp. Previous balances $68,000 + $4,000 + $2,000 + $6,000 + $35,000 = $12,000 + $80,000 + $28, ,000 ______ ______ _______ _______ _______ ________ _______ _______ ______ (u) Paid cash -600 (v) Decreased owner’s equity -600 New bal. $67,400 + $4,000 + $2,000 + $6,000 + $35,000 = $12,000 + $80,000 + $28,000 -$5,600 Page 34 $114,400 = $114,400 The fundamental accounting equation remains in balance.

Page 34 Effect of Owner’s Withdrawals

QUESTION: What are withdrawals? Page 34 ANSWER: Withdrawals are funds taken from the business by the owner for personal use.

Page 34 Analysis: (w) The firm decreased its cash balance by $3,000. (x) Owner’s equity decreased by $3,000. Business Transaction At the end of December, Linda Carter withdrew $3,000 in cash for personal use. The effect of this transaction is analyzed below.

Assets = Liab. + Owner’s Equity Accts. Prepaid Accts. L. Carter, Cash + Rec. + Supp. + Rent + Equip. = Pay. + Capital + Rev. - Exp. Previous balances $67,400 + $4,000 + $2,000 + $6,000 + $35,000 = $12,000 + $80,000 + $28,000 - $5,600 ______ _____ _____ ______ ______ ______ ______ ______ ______ (w) Withdrew cash -3,000 (x) Decreased owner's equity -3,000 New bal. $64,400 + $4,000 + $2,000 + $6,000 + $35,000 = $12,000 + $77,000 + $28,000 - $5,600 $111,400 = $111,400 The fundamental accounting equation remains in balance. Page 34

Transactions of Carter Consulting Services Through December 31, 2004 $111,400 = $111,400 Page 35

The Income Statement Page 34

Objective 4 Prepare an income statement. Page 34

QUESTION: What is an income statement? Page 35 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.

The income statement shows the difference between revenue from services or goods sold and the amount spent to operate the business. The difference is known as net income or net loss. Page 36 Income Statement

QUESTION: What is net income? Page 36 ANSWER: Net income is the result of an excess of revenue over expenses.

QUESTION: What is net loss? Page 36 ANSWER: Net loss is the result of an excess of expenses over revenue.

Revenue Fees Income 28, Expenses Salaries Expense 5, Utilities Expense Total Expenses 5, Net Income 22, Who? What? When? The income statement has a three-line heading. Page 36

Revenue Fees Income 28, Expenses Salaries Expense 5, Utilities Expense Total Expenses 5, Net Income 22, Carter Consulting Services Income Statement Month Ended December 31, 2004 The income statement has a three-line heading. Page 35/36

Revenue Fees Income 28, Expenses Salaries Expense 5, Utilities Expense Total Expenses 5, Net Income 22, Carter Consulting Services Income Statement Month Ended December 31, 2004 The third line shows that the report covers operations over a period of time. Page 35/36

Revenue Fees Income 28, Expenses Salaries Expense 5, Utilities Expense Total Expenses 5, Net Income 22, Carter Consulting Services Income Statement Month Ended December 31, 2004 The income statement reports revenue. Page 35/36

Revenue Fees Income 28, Expenses Salaries Expense 5, Utilities Expense Total Expenses 5, Net Income 22, Carter Consulting Services Income Statement Month Ended December 31, 2004 The income statement also reports expenses. Page 35/36

Revenue Fees Income 28, Expenses Salaries Expense 5, Utilities Expense Total Expenses 5, Net Income 22, Carter Consulting Services Income Statement Month Ended December 31, 2004 The result is net income or net loss for the period. Page 35/36

The Statement of Owner’s Equity and the Balance Sheet Page 36

Objective 5 Prepare a statement of owner’s equity and a balance sheet. Page 36

QUESTION: What is a statement of owner’s equity? Page 36 ANSWER: A statement of owner’s equity is a formal report of changes that occurred in the owner’s financial interest during a reporting period.

37 Linda Carter, Capital, December 1, 2004 Net Income for December Less Withdrawals for December Increase in Capital Linda Carter, Capital, December 31, , , , , , Who? What? When? The statement of owner’s equity has a three-line heading. Page 37/38

37 Linda Carter, Capital, December 1, 2004 Net Income for December Less Withdrawals for December Increase in Capital Linda Carter, Capital, December 31, , , , , , Carter Consulting Services Statement of Owner’s Equity Month Ended December 31, 2004 The statement of owner’s equity has a three-line heading. Page 37/38

37 Linda Carter, Capital, December 1, 2004 Net Income for December Less Withdrawals for December Increase in Capital Linda Carter, Capital, December 31, , , , , , Carter Consulting Services Statement of Owner’s Equity Month Ended December 31, 2004 The statement of owner’s equity shows the capital at the beginning of the period. Page 37/38

37 Linda Carter, Capital, December 1, 2004 Net Income for December Less Withdrawals for December Increase in Capital Linda Carter, Capital, December 31, , , , , , Carter Consulting Services Statement of Owner’s Equity Month Ended December 31, 2004 Net income or net loss for the period is included. Page 37/38

37 Linda Carter, Capital, December 1, 2004 Net Income for December Less Withdrawals for December Increase in Capital Linda Carter, Capital, December 31, , , , , , Carter Consulting Services Statement of Owner’s Equity Month Ended December 31, 2004 The withdrawals and additional investments for the period are shown. Page 37/38

37 Linda Carter, Capital, December 1, 2004 Net Income for December Less Withdrawals for December Increase in Capital Linda Carter, Capital, December 31, , , , , , Carter Consulting Services Statement of Owner’s Equity Month Ended December 31, 2004 The increase or decrease in capital for the period is reported. Page 37/38

37 Linda Carter, Capital, December 1, 2004 Net Income for December Less Withdrawals for December Increase in Capital Linda Carter, Capital, December 31, , , , , , Carter Consulting Services Statement of Owner’s Equity Month Ended December 31, 2004 The result is the capital balance at the end of the period. Page 37/38

Note that Linda Carter did not make any additional investments in December. Additional investments such as cash or equipment would appear in a new line in the statement of owner’s equity. An investment made in a form other than cash is recorded at its fair market value. Page 38 Additional Investments

Assets Cash 64, Accounts Receivable 4, Supplies 2, Prepaid Rent 6, Equipment 35, Total Assets 111, Liabilities Accounts Payable 12, Owner’s Equity Linda Carter, Capital 99, Total Liabilities and Owner’s Equity 111, Page 39 The balance sheet has a three-line heading. Who? What? When?

Assets Cash 64, Accounts Receivable 4, Supplies 2, Prepaid Rent 6, Equipment 35, Total Assets 111, Liabilities Accounts Payable 12, Owner’s Equity Linda Carter, Capital 99, Total Liabilities and Owner’s Equity 111, Carter Consulting Services Balance Sheet December 31, 2004 Page 39 The balance sheet has a three-line heading.

Carter Consulting Services Balance Sheet December 31, 2004 Assets Cash 64, Accounts Receivable 4, Supplies 2, Prepaid Rent 6, Equipment 35, Total Assets 111, Liabilities Accounts Payable 12, Owner’s Equity Linda Carter, Capital 99, Total Liabilities and Owner’s Equity 111, Page 39 Balance sheets prepared using the account form show “Total Assets” on the same horizontal line as “Total Liabilities and Owner’s Equity.” 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.

Carter Consulting Services Income Statement Month Ended December 31, 2004 Carter Consulting Services Statement of Owner’s Equity Month Ended December 31, 2004 Carter Consulting Services Balance Sheet December 31, 2004 Notice that the income statement and the statement of owner’s equity cover a period of time, while the balance sheet is dated as of a single date, December 31, Page 40

Income statement Statement of owner’s equity Balance sheet Page 38 Financial statements are prepared in a specific order:

Carter Consulting Services Income Statement Month Ended December 31, 2004 Revenue Fees Income 28, Expenses Salaries Expense5, Utilities Expense Total Expenses 5, Net Income 22, Page 40 Step 1 – Prepare the income statement. Step 2 – Prepare the statement of owner's equity. Net income from the income statement is used to prepare the statement of owner’s equity.

Carter Consulting Services Income Statement Month Ended December 31, 2004 Revenue Fees Income 28, Expenses Salaries Expense5, Utilities Expense Total Expenses 5, Net Income 22, Carter Consulting Services Statement of Owner’s Equity Month Ended December 31, 2004 Linda Carter, Capital, December 1, 2004 Net Income for December Less Withdrawals for December Increase in Capital Linda Carter, Capital, December 31, , , , , , Page 40

Carter Consulting Services Statement of Owner’s Equity Month Ended December 31, 2004 Linda Carter, Capital, December 1, 2004 Net Income for December Less Withdrawals for December Increase in Capital Linda Carter, Capital, December 31, , , , , , The ending capital balance from the statement of owner’s equity is used to prepare the balance sheet. Step 3 – Prepare the balance sheet. Page 40

Carter Consulting Services Statement of Owner’s Equity Month Ended December 31, 2004 Linda Carter, Capital, December 1, 2004 Net Income for December Less Withdrawals for December Increase in Capital Linda Carter, Capital, December 31, , , , , , Carter Consulting Services Balance Sheet December 31, 2004 Assets Cash 64, Accounts Receivable 4, Supplies 2, Prepaid Rent 6, Equipment 35, Total Assets 111, Liabilities Accounts Payable 12, Owner’s Equity Linda Carter, Capital 99, Total Liabilities and Owner’s Equity 111, Page 40

The Importance of Financial Statements Page 39

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. Page 39 The Importance of Financial Statements

REVIEWREVIEW The _____________________________ is the relationship between assets and liabilities plus owner’s equity. ________ is the inflow of money or other assets that results from the sales of goods or services or from the use of money or property. An increase in expense leads to a ________ in owner’s equity. decrease Revenue Complete the following sentences: fundamental accounting equation

REVIEWREVIEW The ________________________ reports the changes that occurred in the owner’s financial interest during the reporting period. The ________________ shows the results of business operations for a specific period of time such as a month, a quarter, or a year. The financial statement that is dated as of a single date is the _____________. balance sheet statement of owner’s equity income statement Complete the following sentences:

Thank You for using College Accounting, Tenth Edition Price Haddock Brock