Class 5, Accounting, REI faculty, 1st year, 2023-2024
Transactions effects on the accounting equation
Example: prepare a balance sheet dated December 31, 20x1, in horizontal format,
for the Vulcan Corporation, based on the following items:
Item
Amount (RON) Item
Amount (RON)
Cash
30.000 Accounts receivable
80.000
Short term bank loans
65.000 Retained earnings
40.000
Share capital
60.000 Accounts payable
35.000
Equipment
75.000 Merchandise
15.000
Table 1
VULCAN CORPORATION
Balance sheet prepared as at 31, 20x1
Noncurrent assets
Owners’ equity
Intangible assets
Share capital
Tangible assets
Retained earnings
Financial assets
Profit for the period
Current assets
Noncurrent liabilities
Inventories
Bank loans
Receivables
Provisions
Investments
Current liabilities
Bank loans
Cash
Accounts payable
Wages payable
Total Assets = …………
Total OE + L = ……… + ……….
Expressed like this, the equation stands for the static view of the balance sheet. As such,
the SFP represents the financial condition of an entity at a noted date (the end of the
financial year, usually, but not always, corresponding to the end of the civil year) (in our
case, the date is December 31, 20xx). Each passing transaction or event brings about a
change in the overall financial position of the entity. Business activities will impact
various asset, liability, and/or equity items, but they will not disturb the equality of the
accounting equation.
Let us look at four specific transactions conducted by the Vulcan Corporation in January
20x2, to see how each transaction impacts the individual asset, liability, and equity items,
without upsetting the basic accounting equality.
Prof.univ.dr. Catalin Albu, ASE Bucharest
1
Class 5, Accounting, REI faculty, 1st year, 2023-2024
T1) Vulcan Corporation collects accounts receivable: Vulcan Corporation collected
10.000 RON from a customer on an existing account receivable (i.e., this is not a new
sale, but the collection of an amount that is due from a previous sale on account).
Two items are affected by the transaction:
-…………………, in the amount of…………..
-…………………, in the amount of…………..
Accordingly, the balance sheet would be revised as follows:
Table 2
Noncurrent assets
Equipment
VULCAN CORPORATION
Balance sheet after transaction 1
RON
Owners’ equity
Share capital
Retained earnings
Current assets
Merchandise
Accounts receivable
Cash
Total Assets
RON
Current liabilities
Bank loans
Accounts payable
Total OE & L
The accounting equation is rewritten as follows: …………..=…………..+………………
T2) Vulcan Corporation buys merchandise on credit: Vulcan Corporation purchased
merchandise for 5.000 RON, agreeing to pay for it later (i.e., on credit).
Two items are affected by the transaction:
-…………………, in the amount of…………..
-…………………, in the amount of…………..
Accordingly, the balance sheet would be revised as follows:
Table 3
Noncurrent assets
Equipment
Current assets
Merchandise
Accounts receivable
Cash
Total Assets
VULCAN CORPORATION
Balance sheet after transaction 2
RON
Owners’ equity
Share capital
Retained earnings
RON
Current liabilities
Bank loans
Accounts payable
Total OE & L
The equation is rewritten as follows: …………..=…………..+………………
Prof.univ.dr. Catalin Albu, ASE Bucharest
2
Class 5, Accounting, REI faculty, 1st year, 2023-2024
T3) Vulcan Corporation pays accounts payable: Vulcan Corporation pays 15.000
RON to a supplier on an existing account payable (i.e., it is not a new purchase, just the
payment of an amount that is due from a previous purchase on credit).
Two items are affected by the transaction:
-…………………, in the amount of…………..
-…………………, in the amount of…………..
Accordingly, the balance sheet would be revised as follows:
Table 4
Noncurrent assets
Equipment
Current assets
Merchandise
Accounts receivable
Cash
Total Assets
VULCAN CORPORATION
Balance sheet after transaction 3
RON
Owners’ equity
Share capital
Retained earnings
RON
Current liabilities
Bank loans
Accounts payable
Total OE & L
The equation is rewritten as follows: …………..=…………..+………………
T4) Vulcan Corporation sells on credit half the merchandise on hand for 15.000
RON: Vulcan Corporation sells to one of its customers some 10.000 RON worth of
merchandise for a selling price of 15.000 RON, to be collected in a subsequent period.
The items that are affected by this transaction are:
-…………………, in the amount of…………..
-…………………, in the amount of…………..
………………… is also generated, in the amount of…………..
Accordingly, the balance sheet would be revised as follows:
Table 5
VULCAN CORPORATION
Balance sheet after transaction 4
Noncurrent assets
RON
Owners’ equity
Equipment
Share capital
Retained earnings
Profit
Current assets
Current liabilities
Merchandise
Bank loans
Accounts receivable
Accounts payable
Cash
Total Assets
Total OE & L
Prof.univ.dr. Catalin Albu, ASE Bucharest
RON
3
Class 5, Accounting, REI faculty, 1st year, 2023-2024
The equation is finally rewritten as follows: …………..=…………..+………………
1st remark: since T4 is an exchange transaction with third parties resulting from central
activities, …………… is also realized (in the amount of 5.000 RON).
2nd remark: the accounting treatment of T4 (earnings making) is more complicated and
will be developed in further classes. Since ……….. is made, the transaction requires the
recognition of ……………. and ……………… (there are two steps in earnings
recognition, revenue recognition and expense recognition). This is a more complex
transaction , one that will be exemplified in subsequent classes.
Conclusions:
- even if each passing transaction or event brings about a change in the overall
financial position of an entity, impacting various asset, liability, and/or equity
items, ……….………………………………………………………………
- several items have not been affected by the above-mentioned transactions. These
items are:
o ………………..: this is because the entity ………..……………………
………………………………………………………………..…………..…
o ………………..: this is because the entity ………..……………………
………………………………………………………………..…………..…
o ………………..: this is because the entity ………..……………………
………………………………………………………………..…………..…
o ………………..: this is because the entity ………..……………………
………………………………………………………………..…………..…
Prof.univ.dr. Catalin Albu, ASE Bucharest
4
Class 5, Accounting, REI faculty, 1st year, 2023-2024
Information processing in accounting
1) Accounts
The previous material showed how transactions caused financial statement amounts to
change. It really would be far too complicated for entities to keep track of these changes
somewhere within the organization, on a blackboard or whiteboard. Even if a business
could manage to figure out what its financial statements are supposed to be, it probably
could not systematically describe the transactions that produced those results. Obviously,
a system is needed. Consequently, it is imperative that businesses develop a reliable
accounting system to capture and summarize its voluminous transaction data. The
system must be sufficient to fuel the preparation of financial statements and be capable of
maintaining retrievable documentation for each transaction. In other words, some
transaction logging process must be in place. In general terms, an accounting system is
one where transactions and events are reliably processed and summarized into useful
financial statements and reports. This system is nowadays mostly automated, at least for
large entities, but the core of the system will mostly contain the following basic
processing tools: accounts, debits and credits, journals, the general ledger, and a trial
balance. These tools assist entities in preparing their financial statements. Let’s look at
them in turn.
ACCOUNTS: The records that are kept for the individual asset, liability, equity, revenue,
and expense items are known as accounts. In other words, a business would maintain an
account for Cash, other accounts for different types of Inventories, and so forth for every
financial statement element. All accounts, collectively, are said to comprise a firm's
general ledger (see below). In a manual processing system, you could imagine the
general ledger as a notebook, with a separate page for every account. Thus, you could
thumb through the notebook to see the "ins" and "outs" of every account, as well as
existing balances.
An account could be no more complex than the following (for “Cash at bank in lei”):
ACCOUNT: Cash at bank in lei
Date
Description
Jan. 1, 2023
Beginning balance
Jan. 5, 2023
Collected receivable
Jan. 10, 2023
Paid rent expense
Jan. 12, 2023
Cash sale
Jan. 25, 2023
Borrowing from a bank
Account no. 5121
Credits Balance
10.000
5.000
15.000
7.000
8.000
12.000
20.000
8.000
28.000
Debits
This account reveals that “Cash at bank in lei” has a balance of 28.000 RON as of
January 25, 2023. By examining the account, you can see the various transactions that
caused increases and decreases to the 10.000 RON beginning of month cash balance. If
you were to prepare a balance sheet dated January 25, 2023, you would include Cash at
bank in lei for the indicated amount on that date (i.e., 28.000 RON) (and so forth for each
of the other accounts comprised in the financial statements).
Prof.univ.dr. Catalin Albu, ASE Bucharest
5
Class 5, Accounting, REI faculty, 1st year, 2023-2024
DEBITS AND CREDITS: Debits and credits are accounting tools to describe the
change in a particular account that is necessitated by a transaction. In other words, instead
of saying that “cash increased” or that “cash decreased”, we can say instead that “cash
debited" or that “cash credited”. The words debit and credit should not, however, be
confused with increase and decrease or vice versa: we debit asset accounts for increases
of the corresponding items, and we credit them for decreases. By convention, asset
accounts have debit opening and ending balances. The opposite happens for equity and
liabilities accounts: we credit them for increases of the corresponding items, and we debit
them for decreases; and they have credit opening and closing balances. This treatment is
known as the mechanics of double-entry accounting; these mechanics are such that
every transaction affects and is recorded in two or more accounts with equal debits and
credits. Transactions are so recorded because the equal debits and credits offer a means
of proving the recording accuracy. The proof is, if every transaction is recorded with
equal debits and credits, then the debits entered within the accounting period must equal
the credits, and consequently the accounting equality is maintained.
We will not use accounts for the purpose of this course, nor will we devise debit/credit
rules, but there are two important observations to keep in mind for the accounting cycle:
(1) Every transaction can be described in debit/credit form; and
(2) For every transaction, debits = credits
2) The General Journal (GJ) (ro. Registrul jurnal)
Primary documents are reviewed and interpreted as to the accounts involved. Then, they
are documented in the General Journal via their debit/credit format. As such the general
journal becomes a logbook of recordable transactions and events. The journal is not
sufficient, by itself, to prepare financial statements. But maintaining the GJ is mandatory,
and the beginning point toward that objective.
This process of recording transactions in the General Journal is called Journalizing. Then,
the debit and credit information about each transaction is copied (or “posted”) from GJ to
the specific accounts. This is important when errors are made since the journal records
make it possible to trace the debits and credits into the accounts and to see if they are
equal and properly recorded.
The following is an extract from the entity’s General Journal, referring only to the
transactions that affected the Cash account presented above:
No.
Date
1
Jan. 5, 2023
2
Jan. 10, 2023
3
4
Jan. 12, 2023
Jan. 25, 2023
General journal
Explanation
Accounts
Debit
Credit
Collected receivable
Cash
Accounts
receivable
Paid rent expense
Rent
Cash
expense
Cash sale
Cash
Sales
Borrowing from a bank Cash
Bank loans
Prof.univ.dr. Catalin Albu, ASE Bucharest
Amounts
Debit
Credit
5.000
5.000
7.000
7.000
12.000
8.000
12.000
8.000
6
Class 5, Accounting, REI faculty, 1st year, 2023-2024
Note that the GJ is in chronological order, with each transaction of the business being
reduced to the short description of its debit/credit effects. Also, note that each transaction
is accompanied by a brief narrative description; this is a good practice to provide further
documentation, and help detect errors.
In addition to the GJ there are special journals. All transactions and events can be
recorded in the general journal. However, a business may sometimes use "special
journals", typically employed when there are many recurring transactions. Thus, a
company could have special journals for each of the following: cash receipts, cash
payments, sales, purchases, and/or payroll. These special journals do not replace the
general journal. Instead, they just strip out recurring-type transactions and place them in
their own separate journal.
3) The General Ledger (GL) (ro. Registrul cartea mare)
As you just saw, the General Journal is, in essence, a notebook that contains page after
page of detailed accounting transactions. The General Ledger is, in essence, another
notebook that contains a page for each account in use by a company. The GL for our
company would include the “Cash at bank in lei” page as previously illustrated on the
bottom of page 5. Our company's transactions involve using the following accounts:
Cash, Accounts receivable, Rent expense, Sales, and Bank loans. Consequently, all these
accounts will appear in the GL of our company, through a process called posting =
copying journal entries or records to their respective ledger account.
4) The Trial Balance (TB) (ro. Balanţa de verificare)
After all transactions have been posted from the journal to the ledger, and before we start
preparing the financial statements, it is good practice to prepare a trial balance. A trial
balance is a listing of the ledger accounts along with their respective debit or credit
balances.
The TB is not a formal financial statement, but a mandatory self-check to determine
that debits equal credits. The TB is intended to test the equality of the debits and the
credits as proof of the recording accuracy.
The TB is prepared by:
(1) determining the balance of each account in the ledger;
(2) listing the accounts having balances, with the debit balances in one column and the
credit balances in another;
(3) adding the debit balances (for assets and expenses);
(4) adding the credit balances (for equity, liabilities and revenues); and finally
(5) comparing the sum of debit and credit balances.
Prof.univ.dr. Catalin Albu, ASE Bucharest
7
Class 5, Accounting, REI faculty, 1st year, 2023-2024
The following is the trial balance of our entity based on the transactions we saw before,
prepared on January 31, 2023 (equipment has a balance of 40.000 RON and share capital
has a balance of 40.000 RON):
Trial balance
Drawn January 31, 2023
Debit balances Credit balances
Equipment
40.000
Cash
28.000
Accounts receivable
15.000
Sales
12.000
Rent expense
7.000
Share capital
40.000
Long term bank loans
38.000
Totals
90.000
90.000
Note that its columns totals are equal, or in other words, the TB is in balance. When a TB
is in balance, debits equal credits in the ledger, and it is ASSUMED that no errors were
made in recording transactions. Some errors may still appear, because of overlooked
postings (e.g., completely forgotten to post a transaction), for example, or for incorrect
amounts. But a trial balance with uneven totals is certainly wrong.
5) Financial statements from the trial balance: we will learn in the future about additional
adjustments that are required to produce a set of financial statements. But, for now, we can
see that a tentative set of financial statements could be prepared based on the trial
balance. The basic process is to transfer amounts from the general ledger to the trial balance,
then into the financial statements.
Required: Prepare the balance sheet and the income statement as of January 31, 2023, for
our entity (after completion of the transactions above):
Income statement
as of January 31, 2023
Balance sheet
as of January 31, 2023
Total A
Prof.univ.dr. Catalin Albu, ASE Bucharest
Total OE & L
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