Accounting 10
Module 1
Lesson 3
Accounting 10
1
Lesson 3
Accounting 10
2
Lesson 3
Lesson Three - Analyzing An Expanded
Equation
Read pages 33 to 53 in the textbook.
Topics:
•
Introduction
•
Analyzing an Expanded Equation
•
Analyzing the Income Statement and the Balance Sheet
•
Remember These Important Points
•
Do You Understand?
•
Conclusion
•
Self Test
•
Answers for Self Test
•
Assignment 3
Accounting 10
3
Lesson 3
After studying Lesson 3, the student should be able to
•
rearrange an accounting equation to show the matching of revenues and expenses
for a given accounting period.
•
analyze and correctly record business transactions on an expanded accounting
equation form; rearrange the equation to report the net income or net loss for the
accounting period.
•
prepare an income statement in good form from given information to report
revenues and expenses for a specific accounting period.
•
classify accounting data on an expanded accounting equation form; then prepare an
income statement and a balance sheet.
•
prepare in good form an income statement and related balance sheet from
accounting data but without the aid of an expanded accounting equation.
•
identify how GAAPs affect the preparation of financial statements.
Introduction
The business transactions you analyzed so far have affected assets, liabilities, and the
claim of the owner through her/his investment (capital). While these transactions occur
from time to time, they do not show the main reason for operating any business.
Simply stated, the main reason for operating a business is to make money. You will also
learn the realization of a profit will increase the Owner's Equity for a definite period of
time.
In the language of accounting, the financial events directly related to the accounting of a
business profit (or loss) are known as revenue and expense transactions. These
transactions will affect the fundamental elements by expanding the Owner's Equity
portion (right side) of the accounting equation.
Accounting 10
4
Lesson 3
Analyzing an Expanded Equation
Analyzing Revenue Transactions
Revenue usually results from the performance of services and/or the sale of goods. For
instance, the income for a hairdresser is the fee charged to customers for having their hair
done. The commissions earned by a real estate salesperson would be considered as income
for the salesperson.
You will analyze two transactions that affect Stacom Travel Agency by causing the
Owner's Equity section of the accounting equation to expand.
In each transaction in this lesson, the balance (B), the transaction (T) and the new balance
(N) will be given.
Transaction 1 - As of October 31, Stacom Travel has received $2 000 cash from the sale of
services during October.
Assets
Accts.
Cash
Rec.
B $25 800 + 0 +
T +2 000
N $27 800 + 0 +
$48 800
=
Liabilities
+ Owner's Eq uity
Office
Bank Loan Accts.
R. Ireland, R. Ireland,
Equip.
Furn.
Payable
Pay.
Capital
Drawing Revenue
$10 000 + $11 000 = $10 000 + $7 000 + $31 800 - $2 000
+ 2 000
$10 000 + $11 000 = $10 000 + $7 000 + $31 800 - $2 000
+ 2 000
=
$17 000 + $31 800
Analysis: The asset Cash and total assets (left side of the equation) have increased as a
result of this transaction. The right side of the equation must also be increased by the
same amount. Liabilities refer to the debts of the business so it is not affected by the sales
transaction. Therefore, Owner's Equity must be increased by $2 000 as a result of the
cash sales of services. Rob Ireland, Capital represents the claim of the owner through his
investment. Rob Ireland, Drawing shows a decrease to owner's equity resulting from an
owner's withdrawal of assets for personal use. Therefore, neither of these accounts can be
used to record this transaction. A special account--Revenue--is added to owner's equity.
This account represents such items as commissions or in this case, for sale of services.
Accounting 10
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Lesson 3
Transaction 2 - As of October 31 Stacom Travel sells services on credit to Terry Thomson
for $600, to Janet Brown for $1 000, to Black’s Shoe Co. for $2 000 and to J. McCain for
$400. All customers were given 30 days in which to make payment to the firm.
Assets
Accts.
Cash
Rec.
B $27 800 + 0 +
T
+ 4 000
N $27 800 +4 000 +
$52 800
=
Liabilities
+ Owner's Equity
Office
Bank Loan Accts.
Equip.
Furn.
Payable
Pay.
$10 000 + $11 000 = $10 000 + $7 000 +
$10 000 + $11 000 = $10 000 +
=
R. Ireland, R. Ireland,
Capital Drawing Revenue
$31 800 - $2 000 +
2 000
+
4 000
$7 000 + $31 800 - $2 000 +
6 000
$17 000 + $35 800
Analysis: The sale of services increase the assets of the business. A new account-Accounts Receivable--is added to the equation. This account is an asset representing
amounts due from customers. This asset increases by $4 000 because the business now
has claims on the property of four customers until their debts are paid. On the right side
of the equation, the increase is shown under Revenue.
Revenue for a given period is equal to the inflow of assets (cash and accounts receivable)
during that period from the selling of goods or services.
When Is Revenue Recognized?
The Generally Accepted Accounting Principle (GAAP)--the revenue principle--is stated as
follows: Revenue must be recognized at the time of the sale of goods or at the time of the
rendering of services.
Revenue is always recorded when the sale occurs. Even if the sale is on credit (accounts
receivable), the revenue must be recorded when the transaction takes place (even though
payment for the sale will not be received until a future date).
Analyzing Expense Transactions
All businesses have expenses, and for one reason only--to bring revenue into the business.
For example, money is spent on employee salaries, advertising, and the use of the
telephone to attract customers so that sales of services (or goods) can be made to obtain
revenue.
Accounting 10
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Lesson 3
In accounting terms, expenses are the costs of the goods or services used up by a business
to earn revenue.
•
Salaries and wages are dollars used up by the business to pay employees who work
in revenue-making activities.
•
The amount of the rent will be accounted for as an expense because the rented office
space will be used to bring customers to the place of business and it will house the
employees who are used to earn revenue.
•
A telephone bill received by a business will be accounted for as an amount used up
by the business to support revenue-making activities.
Transaction 3: To obtain revenue, Stacom Travel paid cash totalling $3 400 as of
October 31 for the following expenses: Rent, $540; Salaries, $2 750 and Utilities, $110.
Assets
Accts.
Cash
Rec.
B $27 800 + $4 000 +
T -3 400
N $24 400 + $4 000 +
$49 400
=
Liabilities
+ Owner's Equity
Other
Bank Loan Accts.
R. Ireland, R. Ireland,
Assets
Payable
Pay.
Capital Drawing Revenue Expenses
$21 000 = $10 000 + $7 000 + $31 800 - $2 000 + $6 000
- 3 400
$21 000 = $10 000 + $7 000 + $31 800 - $2 000 + $6 000
- 3 400
=
$17 000 + $32 400
Note: to conserve space, Office Equipment and Furniture were added together under the
heading "Other Assets".
Analysis: When a business has expenses and pays cash for them, the left side of the
equation is decreased because Cash is decreased. The right side of the equation must also
be decreased by the same amount. Since Liabilities are not affected by the cash
transaction, then Expenses under Owner's Equity causes the third element in the
equation to decrease. The minus sign is used opposite Expenses simply to show this item
causes a decrease to OE in the accounting equation.
Accounting 10
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Lesson 3
Transaction 4: On October 31, Stacom Travel receives a bill for $600 from the Leader
Post, a local newspaper, for running three large advertisements during October. The bill
allows StacomTravel a period of 30 days in which to pay for the advertising.
Assets
Accts.
Cash
Rec.
B $24 400 + $4 000 +
T
N $24 400 + $4 000 +
$49 400
=
Liabilities
+ Owner's Equity
Other
Bank Loan Accts.
R. Ireland,
Assets
Payable
Pay.
Capital
$21 000 = $10 000 + $7 000 + $31 800 +
600
$21 000 = $10 000 + $7 600 + $31 800 =
$17 600 + $31 800
R. Ireland,
Drawing
Revenue Expenses
$2 000 + $6 000 - $3 400
-600
$2 000 + $6 000 - $4 000
Analysis: The left side of the equation is not affected because no asset is involved. Stacom
Travel is given 30 days to pay for the advertising and the liability Accounts Payable must
be increased to record the new claim of creditors against the total assets of the business.
At the same time, the expense incurred must be shown as a second minus sign under OE
because Expenses cause a decrease to Owner's Equity in the equation.
The analysis of Transaction 4 introduces a second GAAP--the expense principle for
recognizing expenses. Just as revenue was recognized as at a point of sale, the expense
principle for recognizing expenses is:
Expenses must be recognized and recorded when they are incurred while making
revenue.
Read over and study the section "Matching Revenues and Expenses" on page 40 of the
textbook. Remember that the matching principle states that in reporting the net profit or
net loss of a business for a financial period, revenues must be matched with those
expenses within the same time period.
Applying the Matching Principle to the Accounting Equation
To apply the matching principle, you must rearrange the expanded section--revenue and
expenses--of the accounting equation by:
•
placing total expenses under total revenue.
•
calculating the difference between the amounts and listing this as a net income or
net loss.
Accounting 10
8
Lesson 3
Examine the rearranged equation on page 43 of your text for J. Emery Estate and study
the analysis.
Remember: revenue is the positive or plus part in calculating net income. Expenses are
the negative or minus part in calculating income. The difference between the two will
determine whether the owner's equity increases (net income) or decreases (net loss) as a
result of the business transactions for a certain period of time.
Net Income is the excess of revenue when matched with related expenses of the same time
period. Revenue is greater than expenses.
Net Loss is the excess of expenses when matched with related revenue for the same time
period. Expenses are greater than revenue.
Analyzing the Income Statement and the Balance Sheet
You just learned how revenue and expense transactions were matched under an expanded
accounting equation so the net income or net loss may be calculated for a certain period of
time. The details of this expanded equation may now be reported into two accounting
statements:
•
the income statement, which summarizes the revenue and related expenses to
report the net income or net loss for the accounting period; and
•
a balance sheet to report the position of assets, liabilities, and the total owner's
equity as at the end of the accounting period.
Analyzing an Income Statement
The basic form of an income statement is based upon the expanded part of the accounting
equation. Study carefully pages 47, 48, 49 and 50 in the textbook. Pay careful attention
to how an income statement is completed from the equation.
Accounting 10
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Lesson 3
Assets
=
Liabilities
+ Owner's Equity
Accts.
Office
Bank Loan Accts.
Cash
Rec.
Equip.
Furn.
Payable
Pay.
B $24 400 + $4 000 + $10 000 + $11 000 = $10 000 + $7 600 +
$49 400
=
$17 600 +
R. Ireland, + 6 000 Revenue
Capital
- 4 000 Expenses
$29 800 + 2 000 Net Income
$31 800
On accounting paper, the completed Income Statement would look like this:
Stacom Travel
Income Statement
For the Month Ended October 31, 20__
Revenue:
Sales
$6 000.00
Expenses:
Rent Expense
Salaries Expense
Utilities Expense
Telephone Expense
Advertising Expense
$ 500.00
2 750.00
110.00
40.00
600.00
Total Expenses
4 000.00
Net Income
Accounting 10
$2 000.00
10
Lesson 3
Preparing a Balance Sheet
Net income is the amount remaining after revenues and expenses have been matched for
an accounting period. Certain balance sheet items must be changed during the accounting
period. Either or both assets and liabilities can change as a result of revenue and expense
transactions.
A new point must be learned in preparing the owner's equity section of the balance sheet.
The net income under Owner's Equity must be added to the owner's capital. The Owner's
Equity section now shows two items of claims: the Capital (investment) and Net Income
(the difference between the revenue and expenses).
Study carefully pages 50, 51, 52 and 53 in the textbook concerning the balance sheet.
To show you another example of how the balance sheet is completed, here is the expanded
accounting equation for Stacom Travel.
Assets
=
Liabilities
+ Owner's Equity
Accts.
Office
Bank Loan Accts.
R. Ireland, + 6 000 Revenue
Cash
Rec.
Equip.
Furn.
Payable
Pay.
Capital
- 4 000 Expenses
B $24 400 + $4 000 + $10 000 + $11 000 = $10 000 + $17 600 + $29 800
+ 2 000 Net Income
$49 400
=
$17 600 + $31 800
Accounting 10
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Lesson 3
On accounting paper, the completed balance sheet would look like this: (We will again
categorize Office Equipment and Furniture separately instead of using "Other Assets".)
Stacom Travel
Balance Sheet
as at October 31, 20__
Cash
Accounts Receivable:
Terry Thompson
Janet Brown
Black’s Shoe Co.
J. McCain
Office Equipment
Furniture
$24 400.00
$ 600.00
1 000.00
2 000.00
400.00
4 000.00
10 000.00
11 000.00
Bank Loan Payable
Account Payable:
A&B Furniture Co.
The City Record
Nelson Equipment Co.
$49 400.00
$6 000.00
600.00
1 000.00
Total Liabilities
Owner’s Equity
Rob Ireland, Capital
Add Net Income
Less Drawing
Total Owner’s Equity
Total Assets
$10 000.00
7 600.00
$17 600.00
$31 800.00
2 000.00
2 000.00
Total Liabilities and
Owner’s Equity
31 800.00
$49 400.00
Remember These Important Points
Sources of increases in capital result from
•
the generation of revenue by the business.
•
additional investments by the owner of the business.
Sources of decreases in capital result from
•
expense transactions.
•
withdrawals made by the owner.
•
All revenue transactions will cause Assets and the Owner's Equity in the
accounting equation to increase by the amount of the sale of services.
Accounting 10
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Lesson 3
•
All expense transactions will cause OE in the accounting equation to decrease. To
balance the accounting equation, either Assets will decrease by the amount of the
expense, or Liabilities will increase by the amount of the expense.
•
When revenues are greater than related expenses for the same time period, a net
income results.
•
When expenses are greater than related revenues for the same time period, a net
loss results.
•
Net income always increases Owner's Equity. Net loss always decreases Owner's
Equity.
•
The net income or net loss for a specific accounting period is reported in a financial
statement called the income statement.
•
The body of the income statement reports the details of matching revenues and
related expenses to the net income or net loss for the accounting period.
•
The income statement is always prepared before the related balance sheet because
the net income (or net loss) reported by the income statement must be reported in
the balance sheet at the end of the accounting period.
•
A new balance sheet is prepared at the end of the accounting period because assets,
liabilities, and the owner's equity have changed.
•
The net income for the accounting period is added to the owner's Capital less
Drawings under the Owner's Equity section of the related balance sheet, to report
the total claim of the owner against total assets as at the end of the accounting
period.
•
A net loss would be deducted from Capital less Drawings in the Owner's Equity
section of the balance sheet.
•
The total Owner's Equity in the balance sheet at the end of the accounting period
will be made up of three parts: the owner's Capital (investment), the owner's
Drawing, and the net income or net loss as reported by the income statement.
Accounting 10
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Lesson 3
Do You Understand?
Revenue and expense transactions - financial events that determine the profit (or loss) of
a business.
Commissions - the fees a business charges for buying or selling goods; i.e. - real estate for
clients.
Accounts receivable - an asset representing amounts due from customers.
Revenue - an inflow of assets resulting from the sale of goods or services.
Revenue principle - revenue must be recognized at the time of the sale of goods or at the
time of the rendering of services.
Expenses - costs incurred by a business in earning revenue.
Expense principle - expenses must be recognized and recorded when they are incurred.
Matching principle - revenues and expenses must be correlated to report the net income
(or net loss) for an accounting period.
Net income - the excess of revenue over expenses.
Net loss - the excess of expenses over revenue.
Sales - the main source of revenue for firms that sell goods.
Fees earned - the main source of revenue for professionals such as doctors or lawyers.
Income statement - a financial report of the results of matching revenues with related
expenses for a definite accounting period.
Conclusion
You have seen how business transactions can be recorded by increasing and decreasing
the items in the Accounting Equation. This equation has been expanded to record revenue
and expense items under Owner's Equity. You have also seen how a balance sheet is
expanded in the Owner's Equity section.
Accounting 10
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Lesson 3
Self Test
4.
1.
Problem 2-4, page 43 of the text
2.
Problem 2-5, page 44 of the text
3.
MC 2-4, page 46 of the text
Problem 2-7, page 54 of the text
P 2-4 a, b
Cash
+
$__________
Accts.
+
Rec.
$__________
Equip=
Accts.
+ H. Chan
ment
Pay.
Capital
$___________ $__________ $__________
$_________Revenue
$_________Expenses
$__________
$__________
Did the matching of revenue against related expenses produce a net income or a net loss
for the period? Explain your answer.
________________________________________________________________________________
________________________________________________________________________________
________________________________________________________________________________
________________________________________________________________________________
________________________________________________________________________________
________________________________________________________________________________
________________________________________________________________________________
________________________________________________________________________________
Accounting 10
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Lesson 3
P 2-5a
Assets
Cash
+
$__________
Accts.
+
Rec.
$__________
=
Liabilities + Owner's Equity
Equip=
Accts. + D. Bojkovsky,
ment
Pay.
Capital
$___________ $__________ $__________
$_________Revenue
$_________Expenses
$_________
$__________
Did the matching of revenue against related expenses produce a net income or a net loss
for the period? Explain your answer.
________________________________________________________________________________
________________________________________________________________________________
________________________________________________________________________________
________________________________________________________________________________
________________________________________________________________________________
________________________________________________________________________________
________________________________________________________________________________
________________________________________________________________________________
Key Figure to Check: Final Cash Balance is $1 650.
Accounting 10
16
Lesson 3
P 2-5b
(ix)
Accounting 10
17
Lesson 3
P 2-7
Accounting 10
18
Lesson 3
Answers for Self Test
Assets
Cash
$2 510
+
+
$10 000
Accts.
Rec.
$1 090
=
+
+
Equip
=
ment
$6 400 =
Liabilities +
Accts.
Pay.
$1 000
$1 000
Owner's Equity
+
+
H Chan,
Capital
$5 000
$9 000
$+8 000 Revenue
$-4 000 Expenses
+4 000 (Net Income)
P 2-4b
The matching of revenue and expenses produced a net income because there was excess
revenues over expenses by $4 000.
P 2-5a
Cash
+
$1 650
Accts.
Rec.
$2 650
+
Equip
=
ment
$3 800
=
Accts. + D. Bojkovsky, $4 900 Revenue
Pay.
Capital
$-3 850 Expenses
$850
$6 200
$1 050
The revenue matched against the expenses for June for Bojkovsky Tree Service produced a
net income. A net income results because the total revenues exceed the total expenses for
the same time period.
Accounting 10
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Lesson 3
Accounting 10
20
Lesson 3
MC 2-4a
Revenue recognition
MC 2-4b
Service was performed on April 3. Revenue is recognized when the service is performed,
not when the cash is received.
MC 2-4c
The elements are assets and owner's equity. Both elements increase. Assets increase
because there is an increase in the amount of receivables the business expects to collect.
Owner's equity increases because service revenue causes the increase when the service
has been performed. The accounts affected are Accounts Receivable and Fees Earned.
P 2-7a
Diamond Theatre
Income Statement
For the Year Ended December 31, 20__
Revenues:
Admissions Revenue ........................................ $202 000
Parking Fees Earned .......................................
23 570
Concessions Revenue .......................................
37 500
Total Revenues...............................................
Expenses:
Salaries Expense ..............................................
Telephone Expense ..........................................
Advertising Expense ........................................
Insurance Expense ...........................................
Miscellaneous Expense ....................................
Building Rental Expense .................................
Utilities Expense..............................................
Film Rental Expense .......................................
Projection Rental Expense ..............................
Total Expenses .................................................
Net Income (Loss).......................................................
Accounting 10
21
$96 300
112
6 000
1 500
56
18 000
3 000
52 175
4 800
$263 070
181 943
$ 81 127
Lesson 3