Chapter 2 PPT

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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.

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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

Meet JT’s Consulting Services.

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

Purchasing Equipment for Cash

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.

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Business

Transaction

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

Purchasing Supplies

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

2-14

Business Transaction

Paying a Creditor

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.

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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

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Business Transaction

Paying for Services

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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The Fundamental Accounting Equation

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.

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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

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Revenues

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

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

Selling Services for Cash

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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An increase in revenue is an increase in owner’s equity.

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

(g) Increased owner's equity

+26,000

+ 26,000

New balances $91,000 + $3,000 + $7,000 + $22,000 = $7,000 + $90,000 + $26,000

$123,000 = $123,000

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Recording Revenue Amounts

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.

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Business Transaction

Selling Services on Credit

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

Collecting Receivables

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.

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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 + $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

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Collecting Receivables

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

Paying Employees’ Salaries

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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An increase in expense is a decrease in owner’s equity.

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

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Business Transaction

Paying Utilities Expenses

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.

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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. - 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

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Business Transaction

Effect of Owner’s Withdrawals

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.

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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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The Income Statement

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.

Revenues

– Expenses = Net Income

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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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The Statement of Owner’s Equity

A statement of owner’s equity is a formal report of changes that occurred in the owner’s financial interest during a reporting period.

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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

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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

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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

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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

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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

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Additional Investments

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.

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The balance sheet has a three-line heading.

JT’s Consulting Services

Balance Sheet

December 31, 2007

Assets Liabilities

Cash

Accounts Receivable

83,500

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??

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The Importance of Financial

Statements

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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Financial statements are prepared in a specific order:

1 st

Income Statement

2 nd

Statement of Owner’s equity

3 rd

Balance Sheet

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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

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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

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