1
2
Unit 2
The Equation
1.
2.
3.
4.
Learning Objectives
Describe and use the fundamental
accounting equation.
Identify five basic classes of
accounts
Explain five essential accounting
concepts
Analysis: Percentage of sales
(common size income statements)
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2
Objective 2.1:
The accounting equation
The following slides use Jack &
Jill Enterprises to demonstrate
the fundamental accounting
equation
O2.1
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Jack and Jill Enterprises
3
Hey Jill!
Lets fetch
water and
make some
money
You fetch
I’ll
supervise
O2.1
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4
Jack and Jill Enterprises
We receive
$1 for each
pail of
water we
fetch
O2.1
And we pay
$1 to
replace each
shoe we
wear out
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5
Assets
First, we can
list all of J &
J’s assets in
a blue box.
Cash
3
Pails
2
Total
O2.1
5
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6
Assets
Liabilities
Cash
3
Mom payable
Pails
2
The red box
has two
parts,
creditors
and owners.
Next, list all
the claims
against the
assets in a
red box.
Equity
Jack & Jill, Capital
Total
O2.1
5
2
Total
3
5
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Assets
Liabilities
Cash
3
Pails
2
The most important thing
to remember is the total
in the blue box must
always equal the total in
the red box. A = L + E
Mom payable
Equity
Jack & Jill, Capital
Total
O2.1
5
2
Total
3
5
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This is the BALANCE SHEET
8
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9
Now lets see how this
system works for J & J
Enterprises. (Remember,
Assets must always equal
Liabilities Plus Owner’s
Equity.
O2.1
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Jack and Jill Enterprises
Assets
Liabilities
3
4
6
7
5
8
7
2
Cash
Pails
Fetch
Fetch12
Fetch
1
Pail
Buy
23
Pails
Fetch
Pail
Buy 1
Shoes
Pails
Shoe
Mom payable
O2.1
10
5
9
6
78
9
2
Equity
J&J, Capital
Total assets
10
Total Liab. + Equity
3
4
8
6
7
7
5
5
10
89
9
7
6
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11
We increased Equity with each
sale
We decreased Equity for
each expense.
The system stayed in balance
O2.1
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12
So what are the total sales
earned by Jack and Jill so far?
Answer: With this simplified system,
you would have have to memorize
the total sales.
Sales
?
O2.1
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Jack and Jill Enterprises
Assets
Cash
Pails
I wish I
could
remember
what our
sales
were.
13
Liabilities
3
4
6
7
5
8
7
2
Mom payable
2
Equity
J&J, Capital
Total assets
O2.1
10
5
9
6
78
9
Total Liab. + Equity
3
4
8
6
7
7
5
5
10
89
9
7
6
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14
We need a better method to
keep track of
sales and expenses
for each time period
BALANCE SHEET
INCOME STATEMENT
Solution:
The Income Statement
O2.1
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15
To keep track of sales and expenses
for any given period.
BALANCE
SHEET
INCOME
STATEMENT
Income Statement
A separate
“temporary” list of
Sales and Expenses
O2.1
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The Sales and Expenses are collected
on the Income Statement
BALANCE
SHEET
Assets
INCOME
STATEMENT
Liabilities
Equity
O2.1
Sales
Expenses
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The resulting Profit or Loss
is calculated
BALANCE
SHEET
Assets
17
INCOME
STATEMENT
Liabilities
Equity
Sales
Expenses
Profit
Loss
O2.1
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18
At the end of the time period
The Profit or Loss is moved to Equity
BALANCE
SHEET
Assets
INCOME
STATEMENT
Liabilities
Equity
O2.1
Let’s
try
it
Sales
Expenses
Profit
Loss
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Jack and Jill Enterprises
Balance Sheet
Assets
Cash
Pails
Income Statement
Liabilities + Equity
8
3
4
6
5
7
Mom payable
2
Revenue
J&J, Capital
10
97
5
6
8
9
Total Liab & Equity
Fetch 1
Fetch
21
Fetch
Pail
Buy
23
Pails
Fetch
Pail
Buy 1
Shoes
Pails
Shoe
O2.1
1
3
4
7
2
Shoe Expense
Total assets
19
3
3
0
2
5
14
3
2
5
OR
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This is a big improvement.
The Income Statement
allows us to tell at a glance
what the sales and expense
totals are.
20
The Income Statement is used to collect
sales and expenses for a given time period
-for example a month or a year.
O2.1
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Jack and Jill Enterprises
Balance Sheet
Assets
Cash
Pails
Income Statement
Liabilities + Equity
8
3
4
6
5
7
Mom payable
2
Revenue
J&J, Capital
O2.1
1
3
4
7
2
Shoe Expense
Total assets
21
10
97
5
6
8
9
Total Liab & Equity
The systems stays
balanced –you
must consider the
change in J&J
Capital that is
being recorded in
the Income
Statement
3
3
0
2
5
14
3
2
5
OR
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22
Following are exercises
using the fundamental
accounting equation
Assets = Liabilities + Equity + Revenues - Expenses
O2.1
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23
Assets
Liabilities
What is
Total
Equity?
78
Total Liabilities
Equity
Total Assets
O2.1
150
Total Equity
72
?
Total Liab & Equity
150
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24
Assets
What are
Total
Liabilities?
Liabilities
Total Liabilities
1092
?
Equity
Total Equity
Total Assets
O2.1
1750
658
Total Liab & Equity 1750
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25
Assets
What are
Total
Assets?
Liabilities
Total Liabilities
6,420
Equity
Total Equity
Total Assets
O2.1
9,850
?
3,430
Total Liab & Equity 9,850
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26
Balance Sheet
Assets
Income Statement
Liabilities + Equity
Revenue
Total Liabilities
870
Expenses
Owner, Capital
(Beginning)
Total assets
1,275
10
5
8
6
9
7
Total Liab
& Equity
What is the
total Owner,
Capital?
O2.1
1
3
4
0
405
?
0
2
1,275
10
3
4
2
5
OR
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27
Balance Sheet
Assets
Income Statement
Liabilities + Equity
Revenue
Total Liabilities
870
Expenses
Owner, Capital
(Beginning)
Total assets
O2.1
1,350
10
5
8
6
9
7
1
1003
4
405
?
25
0
2
Total Liab
& Equity
Beg.
Owner
What
is theCapital
total 405
plus
Revenue
100 minus
Owner,
Capital?
Expenses
25 = the
480 Ending
(consider
Owner,
Capital
Income
Statement
also)
75
15
3
4
2
OR
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28
Objective 2.2:
Account Classification
The following slides offer an
expanded Balance Sheet and
Income Statement to help
understand the 5 classes of
accounts
O2.2
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Balance Sheet
Assets
Cash
Accounts Receivable
Supplies
Inventory
Land
Buildings
Equipment
Copyrights
1.
Assets
29
Income Statement
Liabilities + Equity
Accounts Payable
Wages Payable
Taxes Payable
Unearned Revenue
Notes Payable
2.
Liabilities
Owner’s, Capital
3.
Equity
There are 5
basic classes of
accounts
Revenue
4.
Revenue
Cost of Goods Sold
Wages Expense
Taxes Expense
Rent Expense
Utilities Expense
Interest expense
5.
Expenses
Profit
OR
Loss
O2.2
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30
There are a number of
words used in account
descriptions that help us
identify the classification.
Note the words on the following slide
and the classification they indicate
O2.2
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BALANCE SHEET
Asset s
Liabilit ies
INCOME STATEMENT
Remember
where
these
words
belong!
Revenue
Expenses
Equit y
Pro fit
or
Lo ss
O2.2
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Where does this account belong?
BALANCE SHEET
Asset s
Liabilit ies
32
INCOME STATEMENT
Revenue
Expenses
Equit y
Pro fit
O2.2
or
Lo©CourseCollege.com
ss
Where does this account belong?
BALANCE SHEET
Asset s
Liabilit ies
33
INCOME STATEMENT
Revenue
Expenses
Equit y
Pro fit
O2.2
or
Lo©CourseCollege.com
ss
Where does this account belong?
BALANCE SHEET
Asset s
Liabilit ies
34
INCOME STATEMENT
Revenue
Expenses
Equit y
Pro fit
O2.2
or
Lo©CourseCollege.com
ss
Where does this account belong?
BALANCE SHEET
Asset s
Liabilit ies
35
INCOME STATEMENT
Revenue
Expenses
Equit y
Pro fit
O2.2
or
Lo©CourseCollege.com
ss
Where does this account belong?
BALANCE SHEET
Asset s
Liabilit ies
36
INCOME STATEMENT
Revenue
Expenses
Equit y
Pro fit
O2.2
or
Lo©CourseCollege.com
ss
Where does this account belong?
BALANCE SHEET
Asset s
Liabilit ies
37
INCOME STATEMENT
Revenue
Expenses
Equit y
Pro fit
O2.2
or
Lo©CourseCollege.com
ss
Where does this account belong?
BALANCE SHEET
Asset s
Liabilit ies
38
INCOME STATEMENT
Revenue
Expenses
Equit y
Pro fit
O2.2
or
Lo©CourseCollege.com
ss
Where does this account belong?
BALANCE SHEET
Asset s
Liabilit ies
39
INCOME STATEMENT
Revenue
Expenses
Equit y
Pro fit
O2.2
or
Lo©CourseCollege.com
ss
Where does this account belong?
BALANCE SHEET
Asset s
Liabilit ies
40
INCOME STATEMENT
Revenue
Expenses
Equit y
Pro fit
O2.2
or
Lo©CourseCollege.com
ss
Where does this account belong?
BALANCE SHEET
Asset s
Liabilit ies
41
INCOME STATEMENT
Revenue
Expenses
Equit y
Pro fit
O2.2
or
Lo©CourseCollege.com
ss
Where does this account belong?
BALANCE SHEET
Asset s
Liabilit ies
42
INCOME STATEMENT
Revenue
Expenses
Equit y
Pro fit
O2.2
or
Lo©CourseCollege.com
ss
Where does this account belong?
BALANCE SHEET
Asset s
Liabilit ies
43
INCOME STATEMENT
Revenue
Expenses
Equit y
Pro fit
O2.2
or
Lo©CourseCollege.com
ss
Where does this account belong?
BALANCE SHEET
Asset s
Liabilit ies
44
INCOME STATEMENT
Revenue
Expenses
Equit y
Pro fit
O2.2
or
Lo©CourseCollege.com
ss
Where does this account belong?
BALANCE SHEET
Asset s
Liabilit ies
45
INCOME STATEMENT
Revenue
Expenses
Equit y
Pro fit
O2.2
or
Lo©CourseCollege.com
ss
Where does this account belong?
BALANCE SHEET
Asset s
Liabilit ies
46
INCOME STATEMENT
Revenue
Expenses
Equit y
Pro fit
O2.2
or
Lo©CourseCollege.com
ss
Where does this account belong?
BALANCE SHEET
Asset s
Liabilit ies
47
INCOME STATEMENT
Revenue
Expenses
Equit y
Pro fit
O2.2
or
Lo©CourseCollege.com
ss
Where does this account belong?
BALANCE SHEET
Asset s
Liabilit ies
48
INCOME STATEMENT
Revenue
Expenses
Equit y
Pro fit
O2.2
or
Lo©CourseCollege.com
ss
49
Objective 2.3:
Concepts
The following slides present 6
important concepts that guide
many accounting practices and
decisions.
O2.3
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Concepts
Unit of Measure
(Monetary Unity)
Concept
Periodicity
Concept
O2.3
Matching
Concept
50
Objectivity
Concept
Cost Concept
Revenue Recognition
Concept
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51
Simply put, we must
express accounts in
monetary units such as
dollars.
Unit of Measure
(Monetary Unity)
Concept
The monetary unit
used is specific
to the country in
which business activity
is conducted.
O2.3
$
£
¥
DM
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52
Periodicity
Concept
Accounting information
should be separated into
regular time periods such
as months, quarters and
years.
Information collected in
time periods allows
comparisons that help
us track financial
progress.
O2.3
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53
Matching
Concept
For any accounting time
period, all expenses that
were incurred to earn
revenues for that period
must be matched
(recorded as an expense)
in that same time period.
This concept is one
that guides a great deal
of accounting activity
in the production of
accrual financial
statements
O2.3
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54
Cost
Concept
Historical cost is used to
record values in the
accounts (in most cases)
rather than current
market values or
replacement costs
This concept is part of the
conservative approach to
financial reporting that is
required by FASB
O2.3
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55
Objectivity
Concept
When recording values
where historical cost is
not relevant, objective
information is required
rather than (subjective)
values based on opinion
or educated guesses.
Objective information is provided
by reliable, unbiased third parties,
generally from market data
O2.3
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56
Revenue
Recognition
Concept
Revenue should be
recorded when it is
earned and receivable.
Record revenue when
the seller has completed
everything necessary to have
the right to receive payment
O2.3
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57
What concept is involved?
Tom buys 12 new kayaks to add to his inventory paying
$425 each from a dealer going out of business. Tom buys
the same kayak from the manufacturer for $675.
Cost
Concept
What value should be recorded in the accounts for this purchase?
12 @ $425 each
O2.3
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58
What concept is involved?
Thao wants to invest a 2 year old delivery van owned
personally into her florist business. She saw two identical
vans for sale at $36,000. She paid $47,000 for the van two
years ago. Current published values for the van indicate a
value of $31,000.
Objectivity
Concept
What value should be recorded in the accounts for this investment?
$31,000
O2.3
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59
What concept is involved?
It is important to express accounting information in a
common denominator of units that is simple, reliable,
universally available and understandable.
Unit of Measure
(Monetary Unity)
Concept
O2.3
$
£
¥
DM
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60
What concept is involved?
There would be limited value in accounting information
that continuously accumulated sales and expenses month
after month, year after year without interruption.
Periodicity
Concept
O2.3
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61
What concept is involved?
Tom sells a kayak for $950 and records the revenue. What
else should Tom record as a result of this sale?
Matching
Concept
Tom should record the expense (Cost of Goods Sold) for the cost
incurred to acquire this inventory item.
O2.3
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62
What concept is involved?
Mark’s Hydraulic Repair receives a repair job from a credit
customer on May 15, completes the job on May 18 and
bills the customer. The customer picks up the repair on
May 22. When can Mark’s record the revenue?
Revenue
Recognition
Concept
Mark’s can record the revenue on the day the work
was completed, May 18
O2.3
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63
Objective 2.4:
Common size income
statement
Useful information can be
obtained by expressing income
statement items in terms of
their percentage of sales.
O2.4
©CourseCollege Publishing
A standard common size 64
percentage calculated is
net profit as a percentage
of sales.
Tom's Kayaks
Income Statement
For the year ending 12/31/08
Revenue
%
Kayak sales
268,000
Expenses
%
Cost of Goods Sold
Rent expense
Wages expense
Utilities expense
147,400
13,200
45,000
16,000
Total expenses
221,600
Profit
O2.4
100%
55%
This allows
comparison from
one period to
the next
5%
17%
6%
46,400
17%
46,400/268,000
= 17%
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65
End of Unit 2
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