Mr. Yiianis Papamichael - c.d.a. College Larnaka
ANALYZING CHANGES IN FINANCIAL POSITION
Business Transactions
A business transaction is a financial event that causes a change in a company’s financial position (A =
L + OE).
In other words, a business transaction is an event that causes a change in the value of a company’s
asset, liability or equity accounts.
Two examples of business transactions are (a) the cash sale/purchase of goods or services to a
customer and (b) the purchase/sale of supplies on credit/on account.
(a) Cash sale = sell now, collect now
.....Cash purchase = buy now, pay now
(b) Purchase on credit/on account = buy now, pay later
.....Sale on credit/on account = sell now, collect later
However, when a business owner purchases an item for personal use or a customer merely thinks about
purchasing an item but ultimately chooses not to, the financial position of the business is not affected and
so a business transaction has not occurred.
You may have noticed that when one of the accounts of a business is affected by a business
transaction, at least one other account must also be affected. Why is this so? This is because the
fundamental accounting equation (A = L + OE) must remain true at all times and after each transaction.
Accordingly, it is perhaps even more accurate to state that a business transaction is a financial event
that affects (changes) the values of at least two accounts of the business.
Source Documents
A source document is a piece of paper evidencing a business transaction. It is the original record of the
financial event used by the accounting department to record the transaction in the company’s books.
More specifically, a source document provides the accounting department with sufficient information to
record the specific accounts and dollar values involved in each transaction.
Most source documents provide proof of purchase and/or payment.
By law, source documents must be kept on file for several years for future reference.
Examples of source documents include bills, receipts, invoices, cheque copies or stubs, cash register
tapes and credit card slips.
Proper source documents should contain the following information: date of transaction, parties to
transaction, description of items sold/services provided, sale price plus taxes, and terms of sale (if sale is
made on credit/on account).
Source Documents & GAAP - Objectivity Principle
The GAAP known as the Objectivity Principle states that accounting entries must be recorded on the
basis of objective or unbiased evidence and not in response to subjective or personal opinions/feelings.
This means that business transactions should be recorded on the basis of facts that are accurate,
impartial and easily verifiable.
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Mr. Yiianis Papamichael - c.d.a. College Larnaka
In most cases then, source documents are the best available evidence of the details of a business
transaction.
Section 3.2 - Equation Analysis Sheet (EAS)
As business transactions take place daily, the values of certain asset, liability and owner's equity
accounts will increase or decrease accordingly.
These daily changes in value are not recorded on the balance sheet, however, as to do so would be very
messy and inconvenient indeed.
Instead, for now these changes will be recorded on an informal (unofficial) business document known as
an Equation Analysis Sheet (EAS) which is a much more efficient means of recording changes to the
values of various accounts as a result of business transactions.
An example of an EAS is found below.
The beginning or opening balance in each account on the EAS is taken from the most recently prepared
balance sheet. Notice how each account on the EAS is listed in the same order, left to right, as found on
the balance sheet under the subheadings of assets, liabilities and owner's equity.
Thereafter, notice how each transaction is recorded separately on the Transaction line before updated
balances for each account are calculated on the New Balances line.
And most importantly, notice how each transaction affects or changes at least two accounts on the EAS.
This is to ensure that the fundamental accounting equation (A=L+OE) remains true after each transaction.
Finally, notice how assets, liabilities and owner's equity are totalled at the bottom of the EAS once all
business transactions have been recorded in order to once again ensure that the fundamental accounting
equation (A = L + OE) remains true.
Equation Analysis Sheet Example
Transaction 1: Cash purchase of equipment, $200
Transaction 2: Partial payment of outstanding debt to creditor supplier B. Late, $500
Assets
Liabilities
Bank A/R
Equipment A/P
B. Smith B. Wright
Beginning balances 1,000 500
Transaction 1
-200
New Balances
800 500
Transaction 2
-500
500
Owner's Equity
Bank Loan B. Gold,Capital
B. Late
23,000
4,000 18,000
3,000
4,000 18,000
3,000
+200
500
23,200
-500
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Mr. Yiianis Papamichael - c.d.a. College Larnaka
New Balances
300 500
500
23,200
3,500 18,000
3,000
...................................$24,500..................................... = .........$21,500 + $3,000
Analyzing Transactions using the Equation Analysis Sheet
Don't forget that for each business transaction:
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at least two account values (A, L, OE) must change (increase or decrease)
at least one asset value always changes
an asset only changes when the business owns more or less of that asset
a liability only changes when the business owes more or less money to its creditors
capital only changes when the overall value of the business increases or decreases
generally speaking, capital increases when: goods or services are sold for cash or on account in
the ordinary course of operations, the owner invests cash or another asset into the business, or a
company asset is sold for a gain in an extraordinary transaction
generally speaking, capital decreases when: the company pays for routine business costs/expenses or a
bill is received for same, the owner withdraws cash or another asset from the business, or a company
asset is sold for a loss in an extraordinary transaction
Summary of Transactions Affecting the Capital Account
The Capital account is only affected (increased or decreased) when one of the following business
transactions takes place:
(1) goods or services are sold by the business to its customers in the ordinary course of
operations (whether for cash or on account)
e.g. goods or services sold for cash -- Bank (increase) -- Capital (increase)
e.g. goods or services sold on account -- A/R (increase) -- Capital (increase)
(2) money is paid out or a bill is received concerning routine business costs/expenses (e.g., rent,
advertising, wages)
e.g. paid wages to company employees -- Capital (decrease) -- Bank (decrease)
e.g. received bill from Toronto Star re: September advertising -- Capital (decrease) -- A/P (increase)
(3) money or other assets are either invested into or withdrawn from the business by the owner
e.g. owner invests personal vehicle into the business -- Automobile (increase) -- Capital (increase)
e.g. owner withdraws cash from the business -- Capital (decrease) -- Bank (decrease)
(4) a business asset (e.g., automobile, equipment, furniture) is sold for a gain or a loss in
an extraordinary transaction, i.e., not in the ordinary course of operations
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Mr. Yiianis Papamichael - c.d.a. College Larnaka
e.g. company vehicle listed at $6000 sold at a loss for $4000 -- Bank (increase $4000) - Capital (decrease $2000) -- Automobile (decrease $6000)
e.g. company equipment listed at $8000 sold at a gain for $9000 -- Bank (increase $9000) -- Equipment
(decrease $8000) -- Capital (increase $1000)
Notice how each of the above transactions affects the overall value of the business - that is why
the Capital account must be increased or decreased in each scenario.
And please note that later on in this course, once we have learned about revenue, expense and
drawings accounts, this lesson will become much clearer in terms of understanding the concept
of equity.
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