Equity Transactions and
Accounting Principles
Equity Transactions and Accounting Principles
• We are going to start working more with transaction data for equity accounts.
• Revenues are credited
• Drawings and expenses are debited.
• Why do these make sense?
Let’s look at an example:
• Eve Boa, a lawyer, draws up a legal agreement for J. Basso, a client, and for
her services is paid a fee of $450 in cash.
• In the old way, what would changes would we make?
• What changes are made using the new way?
Let’s look at an example:
• Both “Fees Earned” transactions give more assets for the owner to claim.
• This increases equity (so we need credit entries).
• Fees Earned accounts will almost always have a credit balance. Debits to
these accounts are VERY rare.
The Revenue Recognition Principle
• Very simple. Revenue needs to be recorded in the accounts at the time the
transaction is completed.
• This means crediting the revenue account when the bill or invoice is sent to
the customer.
• The law says that sellers have the right to send the bill if the service or good
is provided.
• Where does the debit entry go that would balance the transaction?
Revenue Recognition Principle
• So, if the lawyer Eve Boa provides services to B. Singh for $700 (page 147) this
principle lets her credit Fees Earned. She does not have to wait for him to pay her.
• What if though…J. Basso pays her for a service that she promises to perform in
three months? Can she record it as revenue?
• NO. She still has a lot to do before she has earned that money.
• If she fails to do it…what happens?
• Let’s pretend though…that Eve does take his
money but the service is not due for three months.
• What do we do?
• What do we do when Eve performs the service?
Let’s analyse some expense transactions
• Eve Boa writes a $3300 cheque for the monthly rent payment.
• What do we do?
Let’s analyse some expense transactions
• Eve Boa receives the monthly utilities bill for $395 from Municipal
Gas. The bill is not paid immediately.
• What do we do this time?
Drawings Transactions
• Cash is the most common item withdrawn by an owner.
• Eve Boa, the owner of the business, withdraws $1975 for her personal
use.
• What do we do here?
Drawings Transactions
• Sometimes owners buy things for themselves THROUGH the business.
• Eve Boa buys a coffee maker for herself from Kitchen Plus for $85. She
buys it through her business and a bill arrives to the business for $85.
• What do we do?
Drawings Transactions
• Sometimes owners take other assets. Merchandise, computers, furniture, etc.
• Maybe the owner collects a debt and keeps the money. What would we do
here?
• There has to be evidence of this, and the accounting clerks
Fiscal Periods
• Knowing revenues is not that useful unless we know the timeline.
• Need to be 12 consecutive months.
• Does not have to match the calendar year.
• There is also Quarterly periods (usually for investors).
The Matching Principle
• This is another simple principle to remember.
• Expense items related to revenue earned have to be recorded in the same period as
the revenue that it helped earn.
• If this isn’t done, net income is not accurate.
• If a business buys $30,000 of advertising for a Boxing Day sale on December 26,
2014, and the bill does not get paid until January, what happens?
The Matching Principle
• What about if the sale lasted two weeks, starting on December 26, 2014 and
ending on January 10, 2015?
• The advertisement has helped the business earn money in two fiscal periods.
• This means that the expense has to be recorded in both periods.
REVIEW
• Why can you be almost certain that revenue accounts will have a credit
balance at the end of a period?
• Give me an example of when you debit a revenue account.
• When does the Revenue Recognition Principle require a transaction to be
recorded in the accounts of a business.?
• What must the seller do before sending an invoice to a customer?
• Explain how a seller can record a sale without actually delivering anything!
REVIEW
• When purchasing advertising on credit, why does equity decrease from the
debit to an expense account even though no assets have yet left the business?
• What is a fiscal period?
• When explaining the matching principle, a student said “Expenses give up
their lives for the sake of earning revenue.” How accurate is that statement?
Exercises
• Going over the following transactions, we have to figure out what is being
debited and what is being credited.
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1. Purchased $400 of supplies for future use and paid cash.
2. Reduced the bank loan by $1000.
3. Received $800 cash from J. Cheung, a debtor.
4. Sold services for $900 cash.
5. Sold services on credit to B. Hull, $1500.
Exercises
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6. Paid the utilities bill that arrived today, $125.
7. Mary Hartman, the owner, withdrew $750 cash for personal use
8. Paid an employee’s wages, $600.
9. Paid $20,000 cash for a new truck.
10. Mary Hartman, the owner, took supplies for personal use, $250.