CHAPTER 2
Linking Personal Accounting to Business Accounting
Chapter 2
 Business Accounts
Different Types of Businesses
Recording Revenue
Recording Expenses
Business Transactions
Financial Statements
Ethics
In Summary
Exercise
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2
Business Accounts
Accounting in the personal context is similar to accounting in a business context.
Some key differences include:
 The category of net worth in personal balance sheet is referred to as equity for businesses.
 Surplus (deficit) on the personal income statement is called net income (loss) for businesses.
 A business usually has more types of expenses.
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3
Business Accounts
Equity vs. Net Worth
Equity is the net worth of a business, after all assets have been sold and all liabilities have been
paid.
For a company, total assets minus total liabilities is the ownership claim on total assets and is
called owner’s equity.
Owner’s Equity
=
Total Assets
-
Total Liabilities
Owner’s contributions
The amount of cash or assets invested in the business by the owner.
Owner’s withdrawals
The amount of cash or assets taken by the owner for personal use.
Ending Owner’s Equity = Beginning Owner’s Equity + Owner’s Contributions + Net Income (Loss) − Owner’s Withdrawals
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Business Accounts
The assets of a business are claimed by either creditors or owners. To find out what belongs to
owners, we subtract the creditors’ claims (the liabilities) from assets.
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In business accounting, unpaid accounts is referred to as:
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In business accounting, unpaid accounts is referred to as:
c. Accounts Payable
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What is the net worth referred to as in the context of a business?
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Net Equity
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Owner’s Equity
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Net business worth
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What is the net worth referred to as in the context of a business?
b. Owner’s Equity
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Chapter 2
 Business Accounts
 Different Types of Businesses
Recording Revenue
Recording Expenses
Business Transactions
Financial Statements
Ethics
In Summary
Exercise
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10
Different Types of Businesses
Different types of businesses use different financial statement layouts:
A small restaurant would use a very simple income statements.
A complex manufacturing company requires a more detail and more complex statements to
provide more information to operate the business effectively.
Service Business
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Merchandising Business
Manufacturing Business
11
Different Types of Businesses
Service Business
A commercial enterprise that provides work performed in an expert manner by an individual
or team for the benefit of its customers.
Examples of services include hotels, casinos, amusement parks, entertainment, and tour
operators.
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Different Types of Businesses
Merchandising Business
Any company that buys goods to resell to customers is considered a merchandising business.
A common example is a retail store.
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Different Types of Businesses
Manufacturing Business
A manufacturing company makes the products that it sells. Examples of manufacturers
include auto makers, steel mills and furniture makers.
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An event organizer company recognizes partially completed work as work in
progress in its cost of sales. Which type of business does the company belong?
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An event organizer company recognizes partially completed work as work in progress
in its cost of sales. Which type of business does the company belong?
a. Service business
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Which of the following listing of liabilities is in the correct order for the balance sheet
of a business?
c.
Mortgage Payable, Notes Payable, Accounts Payable
d.
Accounts Payable, Notes Payable, Mortgage Payable
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Which of the following listing of liabilities is in the correct order for the balance sheet of
a business?
d. Accounts Payable, Notes Payable, Mortgage Payable
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If the income statement of a company does not have ‘Cost of goods sold’ as a line
item, what type of company is it likely to be?
d.
Corporation
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If the income statement of a company does not have ‘Cost of goods sold’ as a line
item, what type of company is it likely to be?
a. Service
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Chapter 2
 Business Accounts
 Different Types of Businesses
 Recording Revenue
Recording Expenses
Business Transactions
Financial Statements
Ethics
In Summary
Exercise
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21
Recording Revenue
Revenues are recorded or recognized when they are earned regardless of when cash
payment is received from the customer. Cash can be received at three different times.
1. Cash is received before services are performed.
2. Cash is received when services are performed.
3. Cash is received after services are performed.
Before Services
Record
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When Services
Record
After Services
Record
22
Recording Revenue
Cash Received before the Service is Performed
When a customer pays a business for services before they are performed, it is known as a
customer deposit.
Example:
A caterer receives a deposit of $1,100 from a customer one month before a wedding dinner is
to be catered. The prepayment by the customer is a liability for the business because the
business now has an obligation to provide a wedding dinner to the customer.
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Recording Revenue
Cash Received when the Service is Performed
When a company performs a service and the customer pays for it immediately, the
transaction is fairly straightforward.
Example:
Tourism company’s customer pays $100 cash immediately after taking a one-day bus tour,
then cash and service revenue will be affected. It will increase the owner’s equity.
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Recording Revenue
Cash Received after the Service is Performed
Most businesses provide customers with payment terms which allow customers to pay after
they have received the product or service.
Example:
A hotel provides a company with rooms at $1,100 and sent an invoice to be paid in one
month. This causes net income and accounts receivable to increase. It will increase the
owner’s equity.
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In January, a company receives cash deposit from a customer for a service that will
be performed and completed in February. Which of the following is true?
a.
Owner’s equity increases in January
b.
Receipt of cash deposit is recorded only after the service is completed
c.
No accounting transaction is required in February
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Liability increases in January
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In January, a company receives cash deposit from a customer for a service that will
be performed and completed in February. Which of the following is true?
d. Liability increases in January
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Chapter 2




Copyright © 2020 AME Learning Inc.
Business Accounts
Different Types of Businesses
Recording Revenue
Recording Expenses
Business Transactions
Financial Statements
Ethics
In Summary
Exercise
28
Recording Expenses
Expenses, similar to revenues, are recorded when they are incurred, not necessarily when they
are paid. This leads to three different timings of the cash payments for expenses.
1. Cash is paid before the expense is incurred.
2. Cash is paid when the expense is incurred.
3. Cash is paid after the expense is incurred.
Pay Before
Record
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Pay When
Record
Pay After
Record
29
Recording Expenses
Pay Cash before the Expense is Incurred
When a company pays before the expense has been incurred, this is a supplier prepayment.
Example:
The hotel pays $3,600 for insurance on January 1, 2021, for insurance coverage throughout
2021. On January 1, 2021, the business’s cash decreases by $3,600 and prepaid insurance
increases by $3,600. At this point, equity is not affected, because one asset was exchanged for
another asset.
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Recording Expenses
Pay Cash when the Expense is Incurred
When a company incurs an expense and pays for it immediately, the cash decreases and
equity decreases. The decrease in equity is recorded as an expense on the income
statement, which reduces net income.
Example:
A business paid $800 cash for
the cost to travel to a client’s
head office. This reduces cash
by $800 and increases travel
expense by the same amount.
The $800 increase in expenses
decreases equity by $800.
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Recording Expenses
Pay Cash after the Expense is Incurred
When expenses are paid after they have been incurred this is referred to as “paying on
account”. Accounting standards require expenses to be recorded at the time they are
incurred, regardless of when the payment is made.
Example:
A restaurant hires a plumber to make
repairs to a washroom. When the work is
finished, the plumber invoiced the
restaurant $700 for the services rendered.
This transaction increases both accounts
payable and maintenance expenses by
$700. The $700 increase in expenses
means there is a $700 decrease in equity.
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Fineday contacted an entertainer in June to sing in its office party. The service
was rendered in July. In August Fineday received the invoice, which it paid in
September. When should the expense be recognized?
July
c.
August
d.
September
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When should the expense be recognized?
b. July
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Chapter 2





Copyright © 2020 AME Learning Inc.
Business Accounts
Different Types of Businesses
Recording Revenue
Recording Expenses
Business Transactions
Financial Statements
Ethics
In Summary
Exercise
35
Business Transactions
A transaction occurs when it causes a change in assets, liabilities or equity. This could include
services, products, cash, a promise to pay money or the right to collect money.
The ultimate goal of recording business transactions is to be able to create financial
statements and assess how well the business is performing.
Events
Purchase computer
Criterion
Discuss with customer
Pay rent
Is the financial position (assets, liabilities, or owner’s equity) of the company changed?
Record/
Don’t Record
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Yes
No
Yes
Record
Don’t Record
Record
36
Business Transactions
Example
Transaction 1: The owner deposited $30,000 cash into the new business’s bank account.
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Business Transactions
Example
Transaction 2: Complete Catering borrowed $10,000 from the bank.
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Business Transactions
Example
Transaction 3: Complete Catering bought $8,000 worth of equipment with cash.
Equipment and other similar assets are considered to be long-term assets.
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Business Transactions
Example
Transaction 4: A customer paid $2,000 cash for catering services to be provided next month.
Unearned revenue represents the obligation the business has to provide services or products
to customers in the future.
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Business Transactions
Example
Transaction 5: Complete Catering provided services to customers and received $15,000 cash.
The sale of services is called revenue and it is the primary way a service business increases
owner’s equity.
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Business Transactions
Example
Transaction 6: Complete Catering provided services for $4,000 on account.
Services were provided so revenue must be affected, however cash cannot be affected
since there has been no payment.
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Business Transactions
Example
Transaction 7: Complete Catering paid $6,000 cash for a one-year insurance policy, which
starts on the first of next month.
The item that is prepaid is initially recorded as an asset on the balance sheet.
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Business Transactions
Example
Transactions 8 to 10: Complete Catering paid cash for rent, salaries and interest for the month.
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Business Transactions
Example
Transaction 11 to 12: Complete Catering received a telephone bill for $300, which will be paid
later.
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Business Transactions
Example
Transaction 13: Complete Catering repaid $3,000 toward the bank loan.
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Business Transactions
Example
Transaction 14: The owner withdrew $2,000 cash for personal use.
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Business Transactions
Example
Transaction 15: A customer paid $500 cash for the amount owing for services provided earlier
in the month.
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Business Transactions
Example
Transaction 16: Complete Catering paid the telephone bill received earlier in the month.
300
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300
49
Which transaction would result in an increase in cash and an increase in liability?
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Received cash from a customer for service performed
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50
Which transaction would result in an increase in cash and an increase in liability?
c. Received cash deposit from a customer for a service that has not been performed.
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Chapter 2






Copyright © 2020 AME Learning Inc.
Business Accounts
Different Types of Businesses
Recording Revenue
Recording Expenses
Business Transactions
Financial Statements
Ethics
In Summary
Exercise
52
Financial Statements
All financial statements follow certain formatting standards when being created.
 Each statement will have three lines at the top to identify the company (e.g. Complete
Catering), the statement (e.g. Income Statement) and the time period or date the
statement covers (e.g. For the Month Ended March 31, 2021).
 The first number in each column will have a dollar sign to indicate the currency of values.
 The last number in a calculated column will have a single underline to indicate a total or
subtotal.
 The final number on the financial statement, or in the case of the balance sheet the total
assets and the total liabilities and owner’s equity figures, will have a dollar sign and be
double underlined.
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Financial Statements
This income statement is for the month ended March 31, 2021 and shows a net income of
$9,400.
1
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Financial Statements
The Statement of Owner’s Equity is the formal statement to show how owner’s equity changed
during the month.
a
b
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Financial Statements
The balance sheet can be created to report on the balances of assets, liabilities and owner’s
equity on March 31, 2021.
c
b
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Financial Statements
Sequence of Assets and Liabilities
The Assets of a business are listed in sequence according to their liquidity. Cash is the most
liquid asset. Liabilities are also listed in sequence that those that are payable within the
shortest amount of time are listed first.
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Financial Statements
The statement of cash flows is the last financial statement prepared after the other three
financial statements are created.
c
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Which of the following information is not included in the three lines at the top of a
company’s financial statement?
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59
Which of the following information is not included in the three lines at the top of a
company’s financial statement?
b. The Company’s industry sector
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Chapter 2







Copyright © 2020 AME Learning Inc.
Business Accounts
Different Types of Businesses
Recording Revenue
Recording Expenses
Business Transactions
Financial Statements
Ethics
In Summary
Exercise
61
Ethics
Ethics are a set of guidelines that define if a behavior is moral or not.
An ethical dilemma can occur when a decision may positively affect a group of individuals
while negatively affecting another group at the same time.
When it comes to ethics in accounting, the owners and managers have an ethical
responsibility to record and report revenue and expenses in a way that best represents
economic reality, even if doing so means the company reports an unfavorable result.
Reporting not “what is,” but “what the owners and managers want it to be,” is an accounting
fraud.
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Ethics
Fraud Triangle
Fraud is caused when three factors are present, including pressure, rationalization and
opportunity.
Example
The owner of a banquet hall requires additional financing
from the bank to help pay for an expansion to the hall and
feels her income may not be enough to get the loan
(Pressure). While the owner knows that she’s not supposed to
manipulate the numbers, she believes that doing so is
necessary not only for herself, but also for her employees,
who need their jobs at the banquet hall to make their living
(Rationalization). To make her net income appear higher, the
owner records the customer deposits as revenue instead of a
liability. Because the owner also acts as the company’s
accountant, and there’s no one else to double check the
accuracy of the financial statements (Opportunity), By
inflating her revenue and profits, she hopes the bank will
grant her the loan she needs. This action is unethical.
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63
Which of the following is unethical?
The owner withdraws cash for personal use and
records it in the owner’s withdrawals account
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Recording expenses when they are incurred to
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64
Which of the following is unethical?
b. Recording customer deposits as revenue before services are performed to inflate net
income
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Chapter 2








Copyright © 2020 AME Learning Inc.
Business Accounts
Different Types of Businesses
Recording Revenue
Recording Expenses
Business Transactions
Financial Statements
Ethics
In Summary
Exercise
66
In Summary
List the differences between personal accounts and business accounts
 Some differences include: surplus (deficit) is called net income (loss); revenue is
classified as sales revenue or service revenue; the net worth section is replaced with the
owner’s equity section.
Describe the sequence of assets and liabilities as they appear on the balance sheet
 The assets of a business are listed in sequence, cash first and then all the other assets
according to their liquidity. While liabilities of a business are listed in sequence, starting
with those that are payable within the shortest amount of time and ending with longterm debts.
Describe the three main types of businesses
 A service business provides services to clients; a merchandising business buys inventory
and resells it to customers; and a manufacturing business makes its own products.
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67
In Summary
Record revenue based on the concept of accruals
 Revenue is recorded when services have been provided to customers, regardless of
when cash is received. Unearned revenue is used to record cash receipts before
services are performed and accounts receivable is used when a customer will pay after
services are performed.
Record expenses based on the concept of accruals
 Expenses are recorded when they are incurred, regardless of when cash is paid.
Prepaid expenses are used to record cash payments before expenses are incurred and
accounts payable is used when suppliers will be paid after expenses are incurred.
Financial Statement and Business Ethics
 A business should report its financial statements in a way that reflects the true substance
of business transactions and economic reality.
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Chapter 2









Copyright © 2020 AME Learning Inc.
Business Accounts
Different Types of Businesses
Recording Revenue
Recording Expenses
Business Transactions
Financial Statements
Ethics
In Summary
Exercise
69
Exercise
For each of the given transactions, determine the effect on owner’s equity by selecting the
appropriate cell.
Effect on Owner’s Equity
Transaction:
Increase
Decrease
No Effect
Sold services on account
Received cash for services
rendered today
Bought equipment with cash
Owner withdrew assets from the
business
Incurred maintenance expense, to
be paid in one month
Paid the principal portion of a bank
loan
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