1 McGraw-Hill Ryerson College Accounting First Canadian Edition Price Haddock Brock Hahn Reed

ANALYZING BUSINESS TRANSACTIONS CHAPTER 2 2

OBJECTIVE 1 Define, identify, and understand the relationship between asset, liability, and owner’s equity accounts. OBJECTIVE 1 Define, identify, and understand the relationship between asset, liability, and owner’s equity accounts. 3

PROPERTY = ASSETS Examples: Cash Supplies Prepaid Rent Equipment 4

FINANCIAL INTEREST = LIABILITIES & OWNER’S EQUITY 5 LIABILITIES Example - Accounts Payable OWNER’S EQUITY Example - John Arrow, Capital

6 STARTING A BUSINESS ARROW EMPLOYMENT SERVICES John Arrow, CGA - Owner Virginia Richey - Office Manager ARROW ACCOUNTING SERVICES Arrow Accounting Services

OBJECTIVE 2 State the accounting equation 7

The business now has $40,000 of property in the form of cash, which has been deposited in the bank. Arrow has a $40,000 financial interest in the business; this is called equity or capital. TRANSACTION #1 Owner Made Investment in Company 8 John Arrow invested $40,000 of his savings into the business.

Property = Financial Interest Cash = J. Arrow, Capital (b) Increased equity + $40,000 (a) Invested cash + $40,000 TRANSACTION #1 9

The firm prepaid the rent for the next eight months in the amount of $20,000. TRANSACTION #2 Prepaid Rent 10 Rent is paid for the next eight months. The firm decreased its cash balance by $20,000.

Property = Financial Interest Cash + Prepaid Rent = J. Arrow, Capital Previous balances $40,000 = $40, TRANSACTION #2 (c) Rented facilities + $20,000 (d) Paid cash - 20,000 New balances $20,000 + $20,000 = $40,000

The firm purchased new property -- equipment for $10,000. TRANSACTION #3 Purchased Equipment for Cash 12 Arrow purchased equipment for $10,000 in cash. The firm paid out $10,000 in cash.

Property = Financial Interest Prepaid J. Arrow, Cash + Rent + Equipment = Capital Previous balances $20,000 + $20,000 = $40,000 TRANSACTION #3 13 (e) Purch. equip. + $10,000 (f) Paid cash -10,000 New balances $10,000 + $20,000 + $10,000 = $40,000

The firm purchased new property on account from Organ, Inc., in the form of equipment that cost $5,000. TRANSACTION #4 Purchased Equipment on Credit 14 The firm owed $5,000 to Organ, Inc. Arrow purchased equipment for $5,000 on account.

Property = Financial Interest Prepaid Accts. J. Arrow, Cash + Rent + Equip. = Pay. + Capital Previous balances $10,000 + $20,000 + $10,000 = + $40, TRANSACTION #4 (g) Purch. equip. + 5,000 (h) Incurred debt = +5,000 New balances $10,000 + $20,000 + $15,000 = $5,000 + $40,000

The firm purchased supplies that cost $1,000. TRANSACTION #5 Purchased Supplies 16 Arrow purchased supplies for cash. The firm paid $1,000 in cash.

Property =Financial Interest Ppd. J. Arrow, Cash + Supplies + Rent + Equip. = A/P + Capital Previous balances $10,000 + $20,000 + $15,000 = $5,000 + $40,000 TRANSACTION #5 (i) Purch. supplies + 1,000 (j) Paid cash -1,000 New balances $9,000 + $1,000 + $20,000 + $15,000 = $5,000 + $40,000 17

The Firm paid $1,000 in cash. TRANSACTION #6 Paying a Creditor 18 Arrow paid Organ $1,000 on account. The claim of Organ, Inc., against the firm decreased by $1,000.

Property =Financial Interest Ppd. J. Arrow, Cash + Supplies + Rent + Equip. = A/P + Capital Previous balances $ 9,000 $1,000 + $20,000 + $15,000 = $5,000 + $40,000 TRANSACTION #6 (k) Paid cash - 1,000 (j) Decreased debt = -1,000 New balances $8,000 + $1,000 + $20,000 + $15,000 = $4,000 + $40,000 19

Property = Financial Interest Assets = Liab. + Owner’s Equity Ppd. J. Arrow, Cash + Supplies + Rent + Equip. = A/P + Capital 20 THE FUNDAMENTAL ACCOUNTING EQUATION

ARROW ACCOUNTING SERVICES Balance Sheet November 30, 20X5 Ppd. J. Arrow, Cash + Supplies + Rent + Equip. = A/P + Capital New bal. $8,000 + $1,000 + $20,000 + $15,000 = $4,000 + $40, Assets Cash 8, Supplies 1, Prepaid Rent 20, Equipment 15, Total Assets 44, Liabilities Accounts Payable 4, Owner’s Equity John Arrow, Capital 40, Liab. & O/E 44,000.00

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. 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. 22

ASSETS = LIABILITIES + OWNER’S EQUITY $44,000 = $4,000 + $40, FUNDAMENTAL ACCOUNTING EQUATION

ASSETS = LIABILITIES + O\E 1. ? = $6,000 + $50,000 (SOLUTION: $46,000) (SOLUTION: $56,000) 2. $60,000 = ? + $52,000 (SOLUTION: $8,000) 3. $50,000 = $4,000 + ? 24 STUDENT ACTIVITY

REVENUE Sometimes called income. Produced from the inflow of money or other assets that result from the sale of goods or services. Added to the column headings under the Owner’s Equity section. Temporary O/E account. Closed out to O/E at the end of the accounting period. 25

The firm received $10,500 in cash for services provided to clients. TRANSACTION #7 Selling Services for Cash 26 Arrow earned $10,500 in revenue from cash clients. The owner’s equity increased by $10,500 because of this inflow of assets from revenue. (Revenue, such as fees earned, always increases the owner’s equity)

Assets = Liab. + Owner’s Equity Prepaid Accounts J. Arrow Cash + Supplies + Rent + Equip. = Payable + Capital + Revenue Previous bal. $ 8,000 + $1,000 + $20,000 + $15,000 = $4,000 + $40, TRANSACTION #7 (m) Rec. cash +10,500 (n) Owner's equity incr. by revenue + 10,500 New balances $ 18,500 + $1,000 + $20,000 + $15,000 = $4,000 + $40,000 + $10,500 $54,500 27

The firm provided services to clients, charging their accounts in the amount of $3,500. TRANSACTION #8 Selling Services on Credit 28 Arrow earned $3,500 in fees from clients who charged the amount to their accounts. The owner’s equity increased by $3,500 because of this inflow of assets from revenue. Revenue, such as fees earned, always increases the owner’s equity. The company did not receive cash since the transaction was on account; accounts receivable was increased.

Assets = Liab. + Owner's Equity Accts. Prepaid Arrow, Cash + Rec. + Supplies + Rent + Equip. = A/P + Capital + Rev. Pre. bal. $18,500 + $1,000 + $20,000 + $15,000 = $4,000 + $40,000 + $10,500 _______ ______ _____ ______ _______ _____ _______ ______ (o) Rec. new asset + 3,500 (p) O/E incr. by revenue + 3,500 New bal. $18,500 +$ $1,000 + $20,000 + $15,000 = $4,000 + $40,000 + $14,000 $58,000 TRANSACTION #8

The firm received $1,500 in cash. TRANSACTION #9 Collected Receivable 30 Arrow received $1,500 in payments from charge clients. Accounts receivable decreased by $1,500.

Assets = Liab. + Owner's Equity Accts. Prepaid Arrow, Cash + Rec. + Supplies + Rent + Equip. = A/P + Capital + Rev. Pre. bal. $18,500 + $3,500 + $1,000 + $20,000 + $15,000 = $4,000 + $40,000 + $14,000 _______ ______ ______ ______ ______ ______ _______ ______ q) Rec. cash. +1,500 (r) A/R decr. -1,500 New bal. $20,000 + $2,000 + $1,000 + $20,000 + $15,000 = $4,000 + $40,000 + $14,000 $58,000 TRANSACTION #9

EXPENSES 32 Involve the various costs of doing business. Examples: labour (salaries expense) utilities (telephone bill)

Cash was reduced by payment of $2,500 to cover the salaries. TRANSACTION #10 Employees’ Salaries 33 Arrow paid salaries for the month. Owner's equity decreased by the $2,500 expense.

Assets = Liab. + Owner's Equity Accts. Prepaid Arrow, Cash + Rec. + Supplies + Rent + Equip. = A/P + Capital + Rev. - Exp. Pre. bal. $20,000 + $2,000 + $1,000 + $20,000 + $15,000 = $4,000 + $40,000 + $14,000 ______ ______ ______ ______ ______ ______ _______ ______ _____ TRANSACTION #10 (s) Paid cash -2,500 (t) O/E decr. by sal. exp. -2,500 New bal. $17,500 + $2,000 + $1,000 + $20,000 + $15,000 = $4,000 + $40,000 + $14,000 -2,500 $55,500

Cash was reduced by payment of $300 for utilities. TRANSACTION #11 Utilities Expense 35 Arrow paid utilities for the month. Owner's equity decreased by the $300 expense.

Assets = Liab. + Owner's Equity Accts. Prepaid Arrow, Cash + Rec. + Supplies + Rent + Equip. = A/P + Capital + Rev. - Exp. Pre. bal. $17,500 + $2,000 + $1,000 + $20,000 + $15,000 = $4,000 + $40,000 + $14,000 -2,500 ______ _____ ______ ______ ______ ______ _______ ______ _____ TRANSACTION #11 (u) Paid cash (v) O/E decr. by util. exp New bal. $17,200 + $2,000 + $1,000 + $20,000 + $15,000 = $4,000 + $40,000 + $14,000 -2,800 $55,200 36

OBJECTIVE 4 Prepare an income statement. OBJECTIVE 4 Prepare an income statement. 37

THE INCOME STATEMENT Reports the results of business operations. Date of income statement represents a specific period of time such as a month, a quarter, or a year. Shows the income and expenses for the period. 38

ARROW ACCOUNTING SERVICES INCOME STATEMENT Month Ended December 31, 20X5 39 Revenue Fees Income 14, Expenses Salaries Expense 2, Utilities Expense Total Expenses 2, Net Income 11,200.00

Assets = Liab. + Owner's Equity Accts. Prepaid = Accts. J. Arrow, Cash + Rec. + Supplies + Rent + Equip. = Payable + Capital + Rev. - Exp. 16, , , , ,000 = 4, , , , $54,200 $54,200 ARROW ACCOUNTING SERVICES Income Statement Month Ended December 31, 20X5 40 Revenue Fees Income14, Expenses Salaries Expense 2, Utilities Expense Total Expenses 2, Net Income, 11,200.00

OBJECTIVE 5 Prepare a statement of owner’s equity. OBJECTIVE 5 Prepare a statement of owner’s equity. 41

37 ARROW ACCOUNTING SERVICES STATEMENT OF OWNER’S EQUITY Month Ended December 31, 20X5 John Arrow, Capital, December 1, 20X5 Net Income for December Less Withdrawals for December Increase in Capital John Arrow, Capital, December 31, 20X5 11, , , , ,200.00

OBJECTIVE 6 Prepare a balance sheet. OBJECTIVE 6 Prepare a balance sheet. 43

ARROW ACCOUNTING SERVICES BALANCE SHEET December 31, 20X5 Assets = Liab. + Owner's Equity Accts. Prepaid = Accts. J. Arrow, Cash + Rec. + Supplies + Rent + Equip. = Payable + Capital + Rev. - Exp. 16, , , , ,000 = 4, , , , $54,200 $54, Liabilities Accounts Payable 4, Assets Cash16, Accounts Receivable 2, Supplies 1, Prepaid Rent20, Equipment 15, Total Assets54, Owner’s Equity John Arrow, Capital50, Total Liab. & Owners Equity 54,200.00

ARROW ACCOUNTING SERVICES INCOME STATEMENT Month Ended December 31, 20X5 Revenue Fees Income 14, Expenses Salaries Expense2, Utilities Expense Total Expenses 2, Net Income 11, ARROW ACCOUNTING SERVICES STATEMENT OF OWNER’S EQUITY Month Ended December 31, 20X5 John Arrow, Capital, Dec. 1, 20X5 40, Less Withdrawals for December 1, Net Income for December11, Increase in Capital 10, John Arrow, Capital, Dec. 31, 20X5 50,

ARROW ACCOUNTING SERVICES STATEMENT OF OWNER’S EQUITY Month Ended December 31, 20X5 John Arrow, Capital, December 1, 20X540, Net Income for December 11, Less Withdrawals for December 1, Increase in Capital10, John Arrow, Capital, December 31, 20X550, ARROW ACCOUNTING SERVICES BALANCE SHEET December 31, 20X5 Assets Liabilities Cash16, Accounts Payable 4, Accounts Receivable 2, Supplies 1, Prepaid Rent20,000.00Owner’s Equity Equipment15, Total Assets54, Total Liab. & O.E. 54, John Arrow, Capital 50,200.00

OBJECTIVE 7 Calculate simple return on investment. OBJECTIVE 7 Calculate simple return on investment. 47

Money in Savings Account would earn 3.75% annual interest. For the month, the bank would have paid $125 interest on $40,000. (Interest (I) = Principle (p) x Interest Rate (r) x Time (t) OR $40,000 x x1/12) From the operation of Arrow Employment Services, John’s money has earned $11,200 in one month. His return on investment is 24.8% Net income / Average Investment = $11,200 / (40, ,200) / 2 48 CALCULATE SIMPLE RETURN ON INVESTMENT