1. ANALYZING TRANSACTIONS: The Accounting Equation
CHAPTER ONE
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. ITEMS OWNED BY A BUSINESS THAT WILL PROVIDE FUTURE BENEFITS
ASSETS
ITEMS OWNED BY A BUSINESS THAT WILL PROVIDE FUTURE BENEFITS
MUST BE “OWNED”
NOT RENTED

4. ASSETS EXAMPLES: CASH MACHINERY MERCHANDISE BUILDINGS FURNITURE LAND
FIXTURES
MACHINERY
BUILDINGS
LAND
ACCOUNTS RECEIVABLE
Can chickens be an asset?

5. 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

6. What the business owes others
LIABILITIES
What the business owes others
In other words. . .
DEBTS OR OBLIGATIONS OF THE
BUSINESS THAT must be paid later.

7. LIABILITIES EXAMPLES: ACCOUNTS PAYABLE (short term credit)
NOTES PAYABLE (longer term credit)
We don’t want Guido the Enforcer coming to collect. We will always pay our bills on time!

8. ACCOUNTS PAYABLE
“I need those supplies now but I want to pay for them later! I will buy them “on account” for now.”
Be careful!! Don’t confuse Accounts
Receivable and Accounts Payable.
Ask yourself, are we waiting to receive? Or
waiting to pay?

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

10. OWNER’S EQUITY ALSO CALLED: OR Once the liabilities are paid,
the remaining assets belong
to the owner (Owner’s Equity).
ALSO CALLED:
NET
WORTH
CAPITAL OR

11. Can also be expressed as: Assets = Liabilities + Owner’s Equity
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

12. BUSINESS ENTITY CONCEPT
Owner may have business assets and liabilities and personal assets and liabilities.
Personal assets and liabilities are not included in the entity’s accounting records
A sauna owned by the owner is not a business asset.

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

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

15. 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

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

17. ANALYZING BUSINESS TRANSACTIONS
QUESTION #1
What happened?
Make certain you understand the event that has taken place.

18. Which accounts are affected?
QUESTION #2
Which accounts are affected?
Identify the accounts that are affected.
Classify these accounts as assets, liabilities, or owner’s equity.

19. How is the accounting equation affected?
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.

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

21. EXAMPLE:
Mary Adams, the owner, invested $25,000 of her own money in the business.

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

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

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

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

26. Does accounting equation balance? plus Owner’s Equity of $25,000
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

27. I guess M&M’s wouldn’t be considered an office supply. . .doggonit!
EXAMPLE:
PURCHASED OFFICE SUPPLIES FOR $800 CASH
I guess M&M’s wouldn’t be considered an office supply. . .doggonit!

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

29. QUESTION #3a
Increase or Decrease?
OFFICE SUPPLIES
CASH
ASSET
ASSET

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

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

32. Is ourAccounting Equation in Balance after both transactions?+
ASSETS =
LIAB.
O. E. + =
CASH
OFF. SUPPLIES
M. A.,CAPITAL a.
$25,000
$25,000 b.
-800
+800
$24,200
$800
$25,000
bal $0
$25,000
$25,000 + =
Yes!
Total Assets =Liabilities + Owner’s Equity

33. Transaction #3 (She paid no cash today.)
Mary is buying this $3,000 copy machine
“on account.” She will be making
payments on it over the next few
years.
(She paid no cash today.)

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

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

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

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

38. Is the Accounting Equation in Balance after all transactions?+ =
ASSETS
LIAB.
O. E. + + =
CASH
OFF. SUPPLIES
Equip.
Accts. payable
M. A.,CAPITAL a.
25,000
25,000 = b.
-800
+800 =
+3,000
+3,000 c. =
25,000
bal
24,200
+800
+3,000 + =
$3,000
$25,000
$28,000

39. Mary made a $400 payment on the copy machine she bought earlier.
EXAMPLE
Mary made a $400 payment on the copy machine she bought earlier.
400.00
Four Hundred

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

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

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

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

44. TOTAL Owner’s Equity EXPENSES REVENUES DRAWING INVESTMENTS
**You should be listening to a recorded lecture right now about how the owner equity items affect owner’s equity.
TOTAL Owner’s Equity
These cause Owner’s Equity to DECREASE:
These cause Owner’s Equity to INCREASE:
EXPENSES
REVENUES
You should be listening to a lecture right now about how the owner equity items affect owner’s equity.
DRAWING
INVESTMENTS

45. Record ALL EARNED revenue!!
Amount a business charges customers for products sold or services performed
Record ALL EARNED revenue!!
EXAMPLES:
Delivery Fees
Consulting Fees
Rent Revenue (if business rents space to others)
Interest Revenue (for interest earned on bank deposits)
Sales (for sales of merchandise)

46. EXPENSES EXAMPLES: Rent Salaries Supplies Consumed Taxes
Represent the decrease in assets as a result of efforts made to produce revenues
Separate accounts are maintained for each type of expense
EXAMPLES:
Rent
Salaries
Supplies Consumed
Taxes
Would I record this utility bill that I got in the mail as an expense? I don’t intend to pay it until next month. . .

47. $1,000 NET INCOME = = $6,000 $5,000 REVENUE EXPENSES NET INCOME
REVENUE Greater than EXPENSES = NET INCOME
EXAMPLE: Lance Armpit performed $6,000 of Catering services (Revenue) this year and incurred expenses of $1,500 for Rent, $500 for Supplies, and $3,000 in Salaries.
REVENUE
EXPENSES =
NET INCOME
$1,000
$6,000
$5,000 =
$1,500 + $500 + $3,000

48. NET LOSS ($1,500) = = $8,000 $9,500 REVENUE EXPENSES NET LOSS
EXPENSES Greater than REVENUE = NET LOSS
EXAMPLE: John Elwho performed $8,000 of Delivery services (Revenue) this year and incurred Expenses of $3,500 for Rent, $500 for Supplies, $3,000 in Salaries and $2,500 for Gasoline. =
REVENUE
EXPENSES
NET LOSS
($1,500)
$8,000
$9,500 =
$3,500 + $500 + $3,000 + $2,500

49. ACCOUNTING PERIOD CONCEPT
Says that income can be determined for any period of time (month, quarter, year, etc.)
Any accounting period of twelve months is called a FISCAL YEAR

50. WITHDRAWALS
The owner taking (withdrawing) cash or other assets from the business for personal use
Reduces Owner’s Equity and Assets
Also referred to as Drawing

51. REVENUE EXAMPLE:
Mary did some consulting work for a local company. Her consulting revenue was $4,500 and she was paid in cash immediately.

52. The two accounts effected are:
QUESTIONS #1 & #2
The two accounts effected are:
CASH
CONSULTING
FEES
(ASSET)
(OWNER’S EQUITY-
REVENUE)

53. Does transaction balance? Owner’s Equity increased by $4,500
QUESTION #3b
Does transaction balance? +
ASSETS =
LIAB.
OWNER’S EQUITY
CASH
CONSULT. FEES =
+$4,500 =
+$4,500
It Balances!
Assets increased by $4,500 =
Owner’s Equity increased by $4,500

54. Left side of the Accounting Equation :
ASSETS:
CASH +
SUPPLIES
EQUIPMENT +
$23,800
$800
$3,000
BAL.
+ $4,500
$28,300
$800
$3,000
BAL.
$32,100

55. Right Side of the Accounting Equation
LIABILITIES
OWNER’S EQUITY +
ACCOUNTS. PAYABLE. +
M. A., CAPITAL +
CONSULTING. FEES
$25,000
$2,600
BAL.
+ $4,500
BAL.
$2,600
$25,000
$4,500
$32,100

56. Mary paid her assistant $750 in wages
EXPENSE EXAMPLE
Mary paid her assistant $750 in wages

57. QUESTIONS #1 & #2 WHICH ACCOUNTS WERE EFFECTED? CASH WAGES EXPENSE
**Even though the Expense account went up,
It caused TOTAL Owner’s Equity to go down!
CASH
WAGES EXPENSE
ASSET
OWNERS EQUITY- EXPENSE

58. QUESTION #3b + Does transaction balance? CASH WAGES EXPENSE = - $750 =
As expenses go up,
Owner’s Equity goes down!!!
Does transaction balance? +
ASSETS =
LIAB.
OWNER’S EQUITY
CASH
WAGES EXPENSE =
- $750 =
+$750
It Balances!
Assets decreased by $750 =
Owner’s Equity decreased by $750

59. Left side of the a Accounting Equation:
ASSETS:
CASH +
SUPPLIES +
EQUIPMENT
$28,300
$800
$3,000
BAL.
- $750
BAL.
$27,550
$800
$3,000
$31,350

60. Right Side of the Accounting Equation:
LIAB.
OWNER’S EQUITY
ACCTS. PAY.
M. A., CAPITAL + +
REV. -
EXPENSES
$25,000
$4,500
$2,600
BAL.
+ $750
BAL.
$2,600
$25,000
$4,500
$750
$2,600 + $25,000 + $4, $750 = $31,350

61. REVENUE ON ACCOUNT EXAMPLE:
MARY PERFORMED $6,000 OF SERVICES
“ON ACCOUNT”

62. QUESTIONS #1 & #2
Understand the transaction, Identify and Classify the affected accounts
Mary has performed services for this
client. Client will be paying Mary
at a later date.
IT IS REVENUE EVEN THOUGH NO
CASH CHANGED HANDS TODAY!

63. Which accounts were affected?
QUESTIONS #1 & #2
Which accounts were affected?
CONSULTING FEES
ACCOUNTS RECEIVABLE
O.E. -REVENUE
ASSET

64. Does transaction balance? Owner’s Equity increased by $6,000
QUESTION #3b
Does transaction balance? +
ASSETS =
LIAB.
OWNER’S EQUITY
ACCTS. RECEIVABLE
CONSULT. FEES =
+$6,000 =
+$6,000
It Balances!
Assets increased by $6,000 =
Owner’s Equity increased by $6,000

65. CUSTOMER PAYMENT EXAMPLE
Received $2,500 in cash for services performed in previous transaction

66. QUESTIONS #1 & #2
Understand the transaction, Identify and Classify the affected accounts
When Mary provided the consulting
services, this client agreed to pay
at a later date.
TODAY THEY GAVE MARY CASH
OF $2,500 AS A PARTIAL PAYMENT.

67. QUESTIONS #1 & #2
Understand the transaction, Identify and Classify the affected accounts
CASH
ACCOUNTS RECEIVABLE
ASSET
ASSET

68. QUESTION #3b + Does transaction balance? = +$2,500 -$2,500 = ASSETS
LIAB. =
O. E.
CASH
ACCTS. REC. =
+$2,500
-$2,500 =
Yes!
Total Assets stayed the same.
One Asset increased, the other
decreased. No change in
Liabilities or Owner’s Equity

69. DRAWING EXAMPLE:
Mary withdrew $1,500 so she could take a personal vacation to Tahiti

70. QUESTIONS #1 & #2
Understand the transaction, Identify and Classify the affected accounts
Mary is withdrawing some of her
equity in the business by taking home an
asset (Cash). This will also
reduce her Owner’s Equity.

71. QUESTIONS #1 & #2 What accounts are affected? M. A., DRAWING CASH
BE CAREFUL! Just like Expenses, the
Drawing account will increase in this situation,
but it will cause an overall
DECREASE IN OWNER’S EQUITY.
What accounts are affected?
M. A., DRAWING
CASH
ASSET
O.E.- DRAWING

72. Does the transaction balance? Owner’s Eq. decreased by $1,500
QUESTION #3b
Does the transaction balance? +
ASSETS =
LIAB.
OWNER’S EQUITY
CASH
- M.A., DRAWING =
-$1,500 =
+$1,500
It Balances!
Assets decreased by $1,500 =
Owner’s Eq. decreased by $1,500