Chapter
2
Skyline College
2-1

Business Transactions
The accounting process starts with the analysis of business transactions.
A business transaction is a financial event that changes the resources of a firm.
2-2

 A business transaction is analyzed to see how it affects this equation:
Property = Financial Interest
 In a free enterprise system, all property is owned by someone.
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Use these steps to analyze the effect of a business transaction.
1. Describe the financial event.



Identify the property.
Identify who owns the property.
Determine the amount of increase or decrease.
2. Make sure the equation is in balance.
Property = Financial Interest
2-4

JT’s Consulting
 JT’s Consulting Services is a firm that provides a wide range of accounting and consulting services.
 Jason Taylor is the sole proprietor of the firm.
 Tennille Brisbane is the office manager of the firm.
 The firm bills clients monthly for the services provided that month.
 Or customers can also pay in cash when the services are provided.
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Business Transaction
Jason Taylor withdrew $90,000 from personal savings and deposited it in a new checking account in the name of
JT’s Consulting Services.
Analysis:
(a) The business received $90,000 of property in the form of cash.
(a) Taylor had an $90,000 financial interest in the business.
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The equation remains in balance.
Property = Financial Interest
= Jason Taylor, Capital Cash
+ $90,000 (a) Invested cash
(a) Increased equity + $90,000
New balances $90,000 = $90,000
Jason Taylor now has $90,000 equity in JT’s
Consulting Services.
2-7

Business Transaction
JT’s Consulting Services issued a $10,000 check to purchase a computer and other equipment.
(b) The firm purchased new equipment for $10,000.
(b) The firm paid out $10,000 in cash.
2-8

The equation remains in balance.
Property = Financial Interest
Cash + Equipment = Jason Taylor, Capital
Previous balances $90,000 = $90,000
(b) Purchased equip. +
(b) Paid cash - 10,000
$10,000
New balances $80,000 + $10,000 = $90,000
$90,000 = $90,000
2-9

Accounts Payable
Buying on account is an arrangement to allow payment at a later date. It is also called a charge account or openaccount credit.
Accounts payable are the amounts a business must pay in the future.
2-10

Business
JT’s Consulting Services purchased additional office equipment on account from Office Plus for
$12,000.
Analysis:
(c) The firm purchased new equipment that cost $12,000.
(c) The firm owes $12,000 to Office Plus.
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The equation remains in balance.
Property = Financial Interest
Cash + Equipment
Accounts
= Payable
Jason Taylor,
+ Capital
Previous balances $80,000 + $10,000 = $90,000
(c) Purchased equipment
+12,000
(c) Incurred debt
+$12,000
New balances $80,000 + $22,000 = $12,000 + $90,000
$102,000 = $102,000
Notice the new claim against the firm’s property – the creditor’s claim of $12,000.
2-12

Business Transaction
JT’s Consulting Services issued a check for $3,000 to Office Warehouse Inc. to purchase office supplies.
Analysis:
(d) The firm purchased office supplies that cost $3,000.
(d) The firm paid $3,000 in cash.
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The equation remains in balance.
Property = Financial Interest
Cash + Supplies + Equipment
Accounts
= Payable
Jason Taylor,
+ Capital
Previous balances $80,000 + $22,000 = $12,000 + $90,000
(d) Purchased supplies +$3,000
(d) Paid cash -3,000
New balances $77,000 + $3,000 + $22,000 = $12,000 + $90,000
$102,000 = $102,000
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In order to reduce its debt, JT’s Consulting Services issued a check for $5,000 to Office Plus.
Analysis:
(e) The firm paid $5,000 in cash.
(e) The claim of Office Plus against the firm decreased by
$5,000.
2-15

The equation remains in balance.
Property = Financial Interest
Cash + Supplies + Equipment
Accounts
= Payable
Jason Taylor,
+ Capital
Previous balances $77,000 + $3,000 + $22,000 = $12,000 + $90,000
(e) Paid cash
(e) Decreased debt
-5,000
-$5,000
New balances $72,000 + $3,000 + $22,000 = $7,000 + $90,000
$97,000 = $97,000
2-16

Business Transaction
JT’s Consulting Services issued a check for $7,000 to pay for rent for the months of December and January.
Analysis:
(f) The firm prepaid the rent for the next two months in the amount of $7,000.
(f) The firm decreased its cash balance by $7,000.
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The equation remains in balance.
Property = Financial Interest
Cash + Supplies + Prepaid + Equipment
Rent
Accounts
= Payable
Jason Taylor,
+ Capital
Previous balances $72,000 + $3,000 + $22,000 = $7,000 + $90,000
(f) Paid cash
-7,000
(f) Prepaid rent +$7,000
New balances $65,000 + $3,000 + $7,000 + $22,000 = $7,000 + $90,000
$97,000 = $97,000
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Assets are property owned by a business.
Liabilities are debts or obligations of a business.
Owner’s equity is the term used for sole proprietorships. It is the financial interest of an owner of a business.
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Assets = Liabilities + Owner’s Equity
 In accounting terms the firm’s assets must equal the total of its liabilities and owner’s equity.
 The entire accounting process is based on the fundamental accounting equation
 If any two parts of the equation are known, the third part can be determined.
2-20

At regular intervals a Balance Sheet is prepared for
JT’s Consulting Services.
A balance sheet is a formal report of a firm’s financial condition on a certain date. It reports the assets, liabilities, and owner’s equity of the business.
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JT’s Consulting Services
Balance Sheet
November 30, 2007
Assets Liabilities
Cash $65,000 Accounts Payable $ 7,000
Supplies 3,000
Prepaid Rent 7,000
Equipment 22,000
Total Assets $97,000
Owner’s Equity
Jason Taylor, Capital 90,000
Total Liabilities and Owner’s Equity
$
97,000
 Assets – the amount and types of property owned by the business
 Liabilities – the amount owed to the creditors
 Equity – the owner’s interest
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Liabilities +
Property equals Financial Interest
2-23

Revenue is earned at the time the service is performed regardless when the customer pays the firm.
It is an inflow of money (cash) or other assets (accounts receivable) that results from the sales of goods or services.
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Expenses are recognized in the period that they help create revenue.
An expense is an outflow of cash, use of other assets, or incurring of a liability.
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Business Transaction
During the month of December, JT’s Consulting
Services earned a total of $26,000 in revenue from clients. The total effect of these transactions is analyzed below.
Analysis:
(g) The firm received $26,000 in cash for services provided to clients.
(g) Revenues increased by $26,000, which results in a
$26,000 increase in owner’s equity.
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Revenue
Owner’s Equity
$26,000
$26,000

The fundamental accounting equation remains in balance.
Assets = Liab. + Owner ’s Equity
Prepaid Accounts J. Taylor,
Cash + Supplies + Rent + Equip. = Payable + Capital + Revenue
Previous balances $65,000 + $3,000 + $7,000 + $22,000 = $7,000 + $90,000
(g) Recd. cash +26,000
(g) Increased owner's equity + 26,000
New balances $91,000 + $3,000 + $7,000 + $22,000 = $7,000 + $90,000 + $26,000
$123,000 = $123,000
2-28

REVIEW QUESTION:
Why are revenue amounts recorded in a separate column under the Owner’s Equity section?
ANSWER:
Firms can easily calculate total revenue while preparing financial statements.

Accounts Receivable
Accounts receivable arise when the firm performs a service for a customer but they don’t pay at that time.
They are claims for future collection from customers.
2-30

Business Transaction
During December JT’s Consulting Services earned
$9,000 of revenue from charge account clients. The effect of these transactions in the month is analyzed below.
Analysis:
(h) The firm acquired a new asset, accounts receivable, of $9,000.
(h) Revenue increases by $9,000, which results in a $9,000 increase in owner’s equity.
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The fundamental accounting equation remains in balance.
Assets = Liab. + Owner's Equity
Accts. Prepaid Accts. J. Taylor,
Cash + Rec. + Supplies + Rent + Equip. = Pay. + Capital + Rev.
Previous balances $91,000 + $3,000 + $7,000 + 22,000 = $7,000 + $90,000 + $26,000
(h) Received new asset
(h) Increased owner’s equity
+ $9,000
+ 9,000
_______ ______ _____ ______ ______ _____ ______ ______
New bal. $91,000 + $9,000 + $3,000 + $7,000 + $22,000 = $7,000 + $90,000 + $35,000
$132,000 = $132,000
2-32

Business Transaction
During December JT’s Consulting Services received
$4,000 on account from clients who owed money for services previously billed. The effect of these transactions is analyzed below.
Analysis:
(i) The firm received $4,000 in cash.
(i) Accounts receivable decreased by $4,000.
2-33

The fundamental accounting equation remains in balance.
Assets = Liab. + Owner's Equity
Accts. Prepaid Accts. J. Taylor,
Cash + Rec. + Supplies + Rent + Equip. = Pay. + Capital + Rev.
Previous
Balances $91,000 + $9,000 + $3,000 + $7,000 + $22,000 = $7,000 + $90,000 + $35,000
(i) Recd.
cash +4,000
(i) Decreased accts. rec. - 4,000
_______ ______ ______ ______ ______ ______ ______ ______
New bal. $95,000 + $5,000 + $3,000 + $7,000 + $22,000 = $7,000 + $90,000 + $35,000
$132,000 = $132,000
2-34

Why didn’t revenue increase when money was received from charge account clients?
The revenue was already recorded when the original sale took place.

Business Transaction
In December JT’s Consulting Services paid $7,000 in salaries for the accounting clerk and the office manager. The effect of this transaction is analyzed below.
Analysis:
(j) The firm decreased its cash balance by $7,000.
(j) The firm paid salaries expense in the amount of $7,000, which decreased owner’s equity.
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Expense $5,000
Owner’s Equity $5,000

The fundamental accounting equation remains in balance.
Assets = Liab. + Owner's Equity
Accts. Prepaid Accts. J. Taylor,
Cash + Rec. + Supplies + Rent + Equip. = Pay. + Capital + Rev. - Exp.
Previous balances $95,000 + $5,000 + $3,000 + $7,000 + $22,000 = $7,000 + $90,000 + $35,000
(j) Paid cash -7,000
(j) Decreased owner’s equity - 7,000
______ ______ ______ ______ ______ ______ ______ ______ _____
New bal. $88,000 + $5,000 + $3,000 + $7,000 + $22,000 = $7,000 + $90,000 + $35,000 - $7,000
$125,000 = $125,000
2-38

Business Transaction
JT’s Consulting Services issued a check for $500 to pay the utilities bill. The effect of this transaction is analyzed below.
Analysis:
(k) The firm decreased its cash balance by $500.
(k) The firm paid utilities expense of $500, which decreased owner’s equity.
2-39

The fundamental accounting equation remains in balance.
Assets = Liab. + Owner's Equity
Accts. Prepaid Accts. J. Taylor,
Cash + Rec. + Supplies + Rent + Equip. = Pay. + Capital + Rev. - Exp.
Previous balances $88,000 + $5,000 + $3,000 + $7,000 + $22,000 = $7,000 + $90,000 + $35,000 - 7,000
(k) Paid cash -500
(k) Decreased owner’s equity -500
______ ______ _______ _______ _______ ________ _______ _______ ______
New bal. $87,500 + $5,000 + $3,000 + $7,000 + $22,000 = $7,000 + $90,000 + $35,000 -$7,500
$124,500 = $124,500
2-40

Business Transaction
At the end of December, Jason Taylor withdrew
$4,000 in cash for personal use. The effect of this
transaction is analyzed below.
Analysis:
(l) The firm decreased its cash balance by $4,000.
(l) Owner’s equity decreased by $4,000.
2-41

The fundamental accounting equation remains in balance.
Assets = Liab. + Owner’s Equity
Accts. Prepaid Accts. J. Taylor,
Cash + Rec. + Supp. + Rent + Equip. = Pay. + Capital + Rev. - Exp.
Previous balances $87,500 + $5,000 + $3,000 + $7,000 + $22,000 = $7,000 + $90,000 + $35,000 - $7,500
(l) Withdrew cash -4,000
(l) Decreased owner's equity -4,000
______ _____ _____ ______ ______ ______ ______ ______ ______
New bal. $83,500 + $5,000 + $3,000 + $7,000 + $22,000 = $7,000 + $86,000 + $35,000 - $7,500
$120,500 = $120,500
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An income statement is a formal report of business operations
(revenues minus expenses)covering a specific period of time. It is also called a profit and loss statement.
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The income statement has a three-line heading.
The third line shows that the report covers operations over a period of time.
JT’s Consulting Services
Income Statement
Month Ended December 31, 2007
Revenue
Fees Income
Expenses
Salaries Expense
Utilities Expense
Total Expenses
Net Income
$7,000
500
$35,000
<7,500>
$ 27,500
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The income statement reports revenue.
JT’s Consulting Services
Income Statement
Month Ended December 31, 2007
Revenue
Fees Income
Expenses
Salaries Expense
Utilities Expense
Total Expenses
Net Income
7,000
500
$35,000
<7,500>
$ 27,500
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The income statement also reports expenses.
JT’s Consulting Services
Income Statement
Month Ended December 31, 2007
Revenue
Fees Income
Expenses
Salaries Expense
Utilities Expense
Total Expenses
Net Income
7,000
500
$35,000
<7,500>
$27,500
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The result is net income or net loss for the period.
JT’s Consulting Services
Income Statement
Month Ended December 31, 2007
Revenue
Fees Income
Expenses
Salaries Expense
Utilities Expense
Total Expenses
Net Income
7,000
500
$35,000
<7,500>
$27,500
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A statement of owner’s equity is a formal report of changes that occurred in the owner’s financial interest during a reporting period.
2-48

The statement of owner’s equity has a three-line heading.
JT’s Consulting Services
Statement of Owner’s Equity
Month Ended December 31, 2007
Jason Taylor, Capital, December 1, 2007
Net Income for December
Less Withdrawals for December
Increase in Capital
Jason Taylor, Capital, December 31, 2007
37
$27,500
<4,000>
$90,000
23,500
$113,500
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The statement of owner’s equity shows the capital at the beginning of the period.
JT’s Consulting Services
Statement of Owner’s Equity
Month Ended December 31, 2007
Jason Taylor, Capital, December 1, 2007
Net Income for December
Less Withdrawals for December
Increase in Capital
$27,500
<4,000>
$90,000
23,500
$113,500
2-50

Net income or net loss for the period is included.
JT’s Consulting Services
Statement of Owner’s Equity
Month Ended December 31, 2007
Jason Taylor, Capital, December 1, 2007
Net Income for December
Less Withdrawals for December
Increase in Capital
Jason Taylor, Capital, December 31, 2007
37
$90,000
27,500
<4,000>
23,500
$113,500
2-51

The withdrawals and additional investments for the period are shown.
JT’s Consulting Services
Statement of Owner’s Equity
Month Ended December 31, 2007
Jason Taylor, Capital, December 1, 2007
Net Income for December
Less Withdrawals for December
Increase in Capital
Jason Taylor, Capital, December 31, 2007
37
$90,000
27,500
<4,000>
23,500
$113,500
2-52

The increase or decrease in capital for the period is reported.
JT’s Consulting Services
Statement of Owner’s Equity
Month Ended December 31, 2007
Jason Taylor, Capital, December 1, 2007
Net Income for December
Less Withdrawals for December
Increase in Capital
Jason Taylor, Capital, December 31, 2007
37
$90,000
27,500
<4,000>
23,500
$113,500
2-53

The result is the capital balance at the end of the period.
JT’s Consulting Services
Statement of Owner’s Equity
Month Ended December 31, 2007
Jason Taylor, Capital, December 1, 2007
Net Income for December
Less Withdrawals for December
Increase in Capital
Jason Taylor, Capital, December 31, 2007
37
$90,000
27,500
<4,000>
23,500
$113,500
2-54

 Note that Jason Taylor did not make any additional investments in
December.
 Additional investments such as cash or equipment would appear in a new line in the statement of owner’s equity.
 An investment made in a form other than cash is recorded at its fair market value.
2-55

The balance sheet has a three-line heading.
JT’s Consulting Services
Balance Sheet
December 31, 2007
Assets Liabilities
Cash 83,500
Accounts Receivable 5,000
Supplies 3,000
Prepaid Rent 7,000
Equipment 22,000
Total Assets 120,500
Accounts Payable 7,000
Owner’s Equity
Jason Taylor, Capital 113,500
Total Liabilities and Owner’s Equity 120,500
 A single line shows that the amounts above it are being added or subtracted. A double line indicates final amounts for the column or section of a report.
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JT’s Consulting Services
Income Statement
Month Ended December 31, 2007
JT’s Consulting Services
Statement of Owner’s Equity
Month Ended December 31, 2007
JT’s Consulting Services
Balance Sheet
December 31, 2007
Notice any difference in the date line??
2-57

 Business managers and owners use the balance sheet and the income statement to control current operations and plan for the future.
 Creditors, prospective investors, governmental agencies, and others are interested in the profits of the business and in the asset and equity structure.
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1 st Income Statement
2 nd Statement of Owner’s equity
3 rd Balance Sheet
2-59

JT’s Consulting Services
Income Statement
Month Ended December 31, 2007
Revenue
Fees Income
Expenses
Salaries Expense
Utilities Expense
Total Expenses
Net Income
7,000
500
$35,000
<7,500>
$27,500
JT’s Consulting Services
Statement of Owner’s Equity
Month Ended December 31, 2007
Jason Taylor, Capital, December 1, 2007
Net Income for December
Less Withdrawals for December
Increase in Capital
Jason Taylor, Capital, December 31, 2007
37
2-60
27,500
<4,000>
$90,000
23,500
$113,500

JT’s Consulting Services
Statement of Owner’s Equity
Month Ended December 31, 2007
Jason Taylor, Capital, December 1, 2007
Net Income for December
Less Withdrawals for December
Increase in Capital
Jason Taylor, Capital, December 31, 2007
22,400
3,000
80,000
19,400
113,500
JT’s Consulting Services
Balance Sheet
December 31, 2007
Assets
Cash $ 83,500
Accounts Receivable 5,000
Supplies 3,000
Prepaid Rent 7,000.
Equipment 22,000
Total Assets $ 120,500
Liabilities
Accounts Payable $7,000
Owner’s Equity
Jason Taylor, Capital 113,500
Total Liabilities and Owner’s Equity $ 120,500
2-61