UNIT 2
THE BASIC ACCOUNTING CYCLE
In Unit 1 we learned about the
different accounting careers and three
forms of business organizations.
In Unit 2 we will analyze transactions
and prepare financial records for a
business
EFFECTIVE READING SKILLS
Needed even in accounting
 Without these skills accountants wouldn’t be able
to analyze important financial documents, make
important financial recommendations or stay upto-date on current events and changes in laws
that affect the accounting field.

CHAPTER 3: BUSINESS TRANSACTIONS
AND THE ACCOUNTING EQUATION
Big Idea
 To understand the financial condition of any
business, you must first understand the
accounting equation.
Main Idea
 Any item of property has at least one financial
claim against it. Accounts are used to analyze
business transactions. Owner’s equity is changed
by revenues, expenses and withdrawals.
REAL WORLD CONNECTION






Hulu lets you watch TV shows, clips and movies online—
anytime
Can use Hulu to embed video on your blog or Web page, or just
email a clip to your friends
Hulu was founded in 2007 and have become very successful
Within the first year it was oneof the top five online video sites
in the US
Hulu employs about 150 people, which is a much smaller staff
that companies that generate similar revenues, and so is able
to keep its payroll costs to a minimum. Lower operating cost
is a big advantage in business because it helps increase
profitability
Hulu’s main assets are virtual in the world of streaming
online video, but producing its “product” requires technological
equipment and real space in which staff develops Hulu’s
innovative media distribution
3-1 PROPERTY AND FINANCIAL CLAIMS
We will look at basic accounting and concepts and
terminology
 UPS (United Parcel Service), a corporation the
provides global delivery services, uses accounting
reports to communicate with its managers,
employees and investors
 Financial reports identify the property used in
the business such as airplanes, trucks and
computers.
 They also show how the property was obtained,
either from loans or from funds provided by
investors

WHAT IS PROPERTY?
It is anything of value that a person or business
owns and therefore controls
 You have a legal right to that property
 Businesses own property
 Financial claim: a legal right to property
 One of the purposes of accounting is to provide
financial information about property and
financial claims to that property
 When you buy property with cash you acquire all
the financial claims to that property and the time
of the purchase

EXAMPLE
For example, if you pay $600 for a mountain bike
then you own that bike. Had you rented it for the
weekend then you would pay less but only have it
for a limited amount of time
 Since you paid cash, you have ownership and a
financial claim of $600

Property (Cost)
=
Financial Claims
Bike
=
Your Claim to the Bike
$600
=
$600
BUYING ON CREDIT
CREDIT - when you buy something and agree to
pay for it later
 CREDITOR - the business or person selling the
item on credit, can be any person/business you
owe money to
 When buying on credit, you do not have the only
financial claim to the property. You share the
financial claim with the creditor

EXAMPLE – BUYING ON CREDIT
If you purchase the bike by paying cash for $100
of it and sign agreement to pay the remaining
$500 over the next 5 months then you share the
financial claim
 Two or more people/businesses can have financial
claims to the same property, although only the
owner has control of the property
 If you don’t make payments the property can
exercise its legal claim and take it back

Property (Cost) =
Financial Claims
Bike =
Creditor’s Financial
Claim
Owner’s Financial
Claim
$600 =
$500
$100
ASSETS
ASSETS: property or items of value owned by a
business
 There are a variety of assets a business can have:

Cash
 Office Equipment
 Manufacturing Equipment
 Buildings


The accounting term for the financial claims to
assets is EQUITIES
EXAMPLE
Zip Delivery Service purchases a delivery truck
for $10,000 and puts a cash down payment of
$3,000 and a local bank loans the remaining
$7,000
 Both Zip Delivery and the bank have financial
claim to the truck

Property (Cost) =
Truck =
$10,000 =
Financial Claims
Creditor’s Financial
Claim
Owner’s Financial
Claim
$7,000
$3,000

Zip’s financial claim increases as the loan is
repaid
Property (Cost) =
Truck =
$10,000 =

Financial Claims
Creditor’s Financial
Claim
Owner’s Financial
Claim
$3,500
$6,500
Once the loan is paid in full Zip will have total
financial claim and the bank will have none
Property (Cost) =
Truck =
$10,000 =
Financial Claims
Creditor’s Financial
Claim
Owner’s Financial
Claim
$0
$10,000
ACCOUNTING EQUATION
In accounting there are separate terms for
owner’s claims and creditor’s claims
 Owner’s Equity is the owner’s claims to the
assets of a business
 Liabilities is the creditor’s claims to the assets of
a business
 Accounting Equation:

3-2 TRANSACTIONS THAT AFFECT OWNER’S
INVESTMENT, CASH, AND CREDIT
Business transaction – an economic event that
causes a change – either increase or decrease – in
assets, liabilities or owner’s equity
 When a business buys a computer with cash, its
cash decreases, but its computer equipment
increases
 Account – a subdivision under assets, liabilities,
or owner’s equity

ACCOUNTS
Each business sets up its accounts to meet its
needs
 The number of accounts needed varies
 Every account must be classified as an asset,
liability or owner’s equity
 Accounts Receivable: the total amount of money
owed to a business, an asset
 Accounts Payable: the total amount of money
owed to creditors, a liability

Assets
Cash
Accounts Receivable
Computer Equipment
Office Equipment
Delivery Equipment
=
Liabilities
Accounts Payable
+
Owner’s Equity
Capital
TRANSACTIONS AND THE ACCOUNTING
EQUATION

Analyzing a business transaction
1.
2.
3.
4.
Identify the accounts affected
Classify the account affected
Determine the amount of increase or decrease for
each account affected
Make sure the accounting equation remains in
balance
Every business transaction causes a change in
assets, liabilities or owner’s equity
 Analyzing each transaction to see how it affects
the accounting equation keeps everything in
balance

TYPES OF TRANSACTIONS
Investments by the owner – money or property
paid out in order to produce profit
 Cash transactions – any asset purchased for cash
 Credit transactions – any asset purchased on
account
 Revenue transactions
 Expense transactions
 Withdrawals by the owner

3-3 TRANSACTIONS THAT AFFECT REVENUE,
EXPENSE, AND WITHDRAWALS BY THE OWNER
UPS has thousands of shareholders who expect a
return on their investment in the business. The
most common way for a business to provide a
return is by selling goods or providing services.
UPS earns revenue by providing a global delivery
service. To provide the delivery service, UPS
incurs expenses like salaries, transportation, and
insurance.
WHAT ARE REVENUES AND EXPENSES?
Revenue is income earned from the sale of good
or services
 Revenue increases owner’s equity because it
increase the assets of the business
 To generate revenue most businesses must incur
expenses by buying goods, materials and services
 Expense is the cost of products or services used to
operate a business
 Expenses include: rent, utilities, advertising
 Expenses decrease owner’s equity because they
decrease the assets of the business or increase
liabilities

EFFECTS OF REVENUE AND EXPENSES
Revenue increase assets and increase owner’s
equity
 Expenses decrease assets and decrease owner’s
equity OR increase liabilities and decrease
owner’s equity

THINK ABOUT IT….

What is the difference between revenue and
investments by the owner?
WHAT IS A WITHDRAWAL?
Withdrawal: the owner takes cash or other assets
from the business for personal use
 A withdrawal decreases both assets and owner’s
equity
 Not the same as an expense

REVIEW

Describe the relationship between property and
financial claims:
REVIEW

List and define each part of the accounting
equation:
REVIEW

Use the following steps to analyze a business
transaction: