Asset, Liability, Owner’s Equity, Revenue, and Expense Accounts Chapter One Asset, Liability, Owner’s Equity, Revenue, and Expense Accounts

Fundamental Accounting Equation A = L + OE Assets = Liabilities + Owner’s Equity Items owned Amounts owed to creditors Owner’s investment Copyright © Houghton Mifflin Company. All rights reserved.

Copyright © Houghton Mifflin Company. All rights reserved. Define Asset Asset Cash, properties, and other things of value owned by an economic unit or business entity Copyright © Houghton Mifflin Company. All rights reserved.

Copyright © Houghton Mifflin Company. All rights reserved. Identify Assets Examples of assets: Cash Trucks Buildings Shoes in a shoe store Kites in a kite store Accounts Receivable The amount owed to you or the business Copyright © Houghton Mifflin Company. All rights reserved.

Define Accounts Receivable An account used or record of the amounts owed by charge customers (legal claims against charge customers) Look for the words: “Sold on account” Copyright © Houghton Mifflin Company. All rights reserved.

Copyright © Houghton Mifflin Company. All rights reserved. Define Liability Liability Debts or amounts owed to creditors In one word: Debt Copyright © Houghton Mifflin Company. All rights reserved.

Copyright © Houghton Mifflin Company. All rights reserved. Identify Liabilities Examples of Debts/Liabilities Loans (borrowing money) Accounts Payable account Buy goods/services on credit Receive a bill, but don’t pay until later Buy supplies from a store, but pay for them later Copyright © Houghton Mifflin Company. All rights reserved.

Define Accounts Payable A liability account used for short-term liabilities or charge accounts, usually due within thirty days Look for the words: “Bought/purchased on account” Copyright © Houghton Mifflin Company. All rights reserved.

Copyright © Houghton Mifflin Company. All rights reserved. Define Owner’s Equity The owner’s right to or investment in the business A – L = OE Copyright © Houghton Mifflin Company. All rights reserved.

Identify Owner’s Equity What is left over for the owner after all the debts have been paid Remember: Creditors must be paid before the owners are paid The Capital account Copyright © Houghton Mifflin Company. All rights reserved.

Fundamental Accounting Equation A = L + OE Assets = Liabilities + Owner’s Equity The equals sign means that one side must always equal the other side We’ll use this equation later to determine whether we have recorded our business transactions correctly Copyright © Houghton Mifflin Company. All rights reserved.

Fundamental Accounting Equation Suppose the total value of the assets is $26,000 and the business entity does not owe any amount against the assets. Assets = Liabilities + Owner’s Equity $26,000 $0 Copyright © Houghton Mifflin Company. All rights reserved.

Fundamental Accounting Equation Suppose the total value of the assets consists of a truck that costs $23,000. The owner invested $11,000 in the truck and borrowed 12,000 from the bank. Assets = Liabilities + Owner’s Equity $23,000 $12,000 $11,000 Copyright © Houghton Mifflin Company. All rights reserved.

Determine Owner’s Equity Ms. Burns has $9,000 invested in her travel agency, and the agency owes creditors $2,000. Assets = Liabilities + Owner’s Equity ? $2,000 $9,000 $2,000 Liabilities + 9,000 Owner’s Equity = 11,000 Assets Assets = Liabilities + Owner’s Equity $11,000 $2,000 $9,000 Copyright © Houghton Mifflin Company. All rights reserved.

Determine Owner’s Equity Mr. Shea owns an auto lube shop. His business has assets of $36,000 and it owes creditors $5,000. Assets = Liabilities + Owner’s Equity $36,000 $5,000 ? $36,000 Assets - 5,000 Liabilities = 31,000 Owner’s Equity Assets = Liabilities + Owner’s Equity $36,000 $5,000 $31,000 Copyright © Houghton Mifflin Company. All rights reserved.

Determine Owner’s Equity Mr. Stan’s insurance agency has assets of $32,000; his investment (his equity) amounts to $20,000. Assets = Liabilities + Owner’s Equity $32,000 ? $20,000 $32,000 Assets - 20,000 Owner’s Equity = 12,000 Liabilities Assets = Liabilities + Owner’s Equity $32,000 $12,000 $20,000 Copyright © Houghton Mifflin Company. All rights reserved.

Recording Business Transactions We will be recording business transactions for a company with the following details: Owner’s name: L.P. Arch Business name: Arch Copy Co. Business type: Sole Proprietorship (one-person business) Copyright © Houghton Mifflin Company. All rights reserved.

Copyright © Houghton Mifflin Company. All rights reserved. Some Definitions Sole proprietorship A one-owner business Separate entity concept The concept by which a business is treated as a separate economic or accounting entity The business stands by itself, separate from its owners, creditors, and customers Copyright © Houghton Mifflin Company. All rights reserved.

Copyright © Houghton Mifflin Company. All rights reserved. Some Definitions Accounts The categories under the Assets, Liabilities, and Owner’s Equity headings Double-entry accounting The system by which each business transaction is recorded in at least two accounts and the accounting equation is kept in balance Copyright © Houghton Mifflin Company. All rights reserved.

Copyright © Houghton Mifflin Company. All rights reserved. Some Definitions Fair market value The present worth of an asset or the amount that would be received if the asset were sold to an outsider on the open market Withdrawal The taking of cash or other assets out of a business by the owner for his or her own use (also referred to as drawing) Treated as a temporary decrease in owner’s equity Copyright © Houghton Mifflin Company. All rights reserved.

Steps in Recording a Business Transaction What accounts are involved? What are the classifications of the accounts involved? Are the accounts increased or decreased? Is the equation in balance after the transaction has been recorded? Remember: each business transaction must affect at least two accounts Copyright © Houghton Mifflin Company. All rights reserved.

Recording Transactions Transaction (a): Arch deposited $70,000 in a bank account in the name of business. Copyright © Houghton Mifflin Company. All rights reserved.

Recording Transactions Transaction (b): Bought equipment, paying cash, $33,000. Copyright © Houghton Mifflin Company. All rights reserved.

Recording Transactions Assets = Liabilities + Owner's Equity Cash + Equip. = Accounts Payable + L. P. Arch, Capital Prev. Bal. 37,000 + 33,000 = + 70,000 (c) + 7,000 + 7,000 New Bal. 37,000 + 40,000 = 7,000 + 70,000 77,000 = 77,000 Transaction (c): Bought equipment on account from Melton Office Supply, $7,000. Copyright © Houghton Mifflin Company. All rights reserved.

Recording Transactions Transaction (d): Paid Melton Office Supply, a creditor, $2,000. Copyright © Houghton Mifflin Company. All rights reserved.

Recording Transactions Transaction (e): Arch invested her own personal data processing equipment in Arch Copy Co. having a fair market value of $6,200. Copyright © Houghton Mifflin Company. All rights reserved.

Copyright © Houghton Mifflin Company. All rights reserved. Define Revenues The amounts a business earns Examples Fees earned for performing services Sales of merchandise Rent income, and interest income May take the form of cash, credit card receipts, or accounts receivable (charge accounts) Copyright © Houghton Mifflin Company. All rights reserved.

Identify Revenue Accounts Fees Earned for performing services Sales Income from selling merchandise Rent Income for the use of property Interest Income for lending money Credit Sales where cash will be received at a later time Example: Home Depot sells lumber to a customer and lets the customer pay later Copyright © Houghton Mifflin Company. All rights reserved.

Copyright © Houghton Mifflin Company. All rights reserved. Define Expenses The costs that relate to earning revenue (the costs of doing business) Examples Wages Rent Interest Advertising May be paid in cash, immediately or at a future time (accounts payable) Copyright © Houghton Mifflin Company. All rights reserved.

Identify Expense Accounts Wages Expense for labor performed Rent Expense for the use of property Interest Expense for the use of money Advertising Expense Expense incurred but not paid Example: Received a bill for a newspaper ad you took out last week Cash will be paid at a later time Copyright © Houghton Mifflin Company. All rights reserved.

Copyright © Houghton Mifflin Company. All rights reserved. Owner’s Equity Revenues and expenses are under the umbrella of owner’s equity Revenue  Add to Capital account Expenses  Subtract from Capital account Copyright © Houghton Mifflin Company. All rights reserved.

Define Chart of Accounts The official list of account titles to be used to record the transactions of a business , Capital , Drawing Copyright © Houghton Mifflin Company. All rights reserved.

Recording Transactions Transaction (f): Arch Copy Co. sold services for cash, $2,520. Copyright © Houghton Mifflin Company. All rights reserved.

Recording Transactions - Transaction (g): Paid rent for the month, $700. Copyright © Houghton Mifflin Company. All rights reserved.

Recording Transactions - Transaction (h): Arch Copy Co. bought supplies (toner and paper) on credit. These supplies are used immediately; therefore, they are recorded as an expense. Copyright © Houghton Mifflin Company. All rights reserved.

Recording Transactions Transaction (i): Arch Copy Co. paid $360 for a one-year liability insurance policy. Copyright © Houghton Mifflin Company. All rights reserved.

Recording Transactions Transaction (j): Arch Copy Co. received a bill for an expense. Copyright © Houghton Mifflin Company. All rights reserved.

Recording Transactions Transaction (k): Arch Copy Co. completed a printing job and billed Walker Company $1,050 for services performed. Copyright © Houghton Mifflin Company. All rights reserved.

Recording Transactions Transaction (l): Arch Copy Co. paid $1,800 to Melton Office Supply, its creditor, as part payment on account Copyright © Houghton Mifflin Company. All rights reserved.

Recording Transactions Assets = Liabilities + Owner's Equity Cash + Equip. + Ppd. Ins. + Accts. Rec. = A/P + L. P. Arch, Capital + Revenue - Expenses Prev. Bal. 34,660 + 46,200 + 360 + 1,050 = 4,000 + 76,200 + 3,570 - 1,500 (m) - 160 + 160 (Utilities Expense) New Bal. 34,500 + 46,200 + 360 + 1,050 = 4,000 + 76,200 + 3,570 - 1,660 82,110 = 82,110 Transaction (m): Arch Copy Co. received and paid a bill from Regional Power, Inc., for $160. Copyright © Houghton Mifflin Company. All rights reserved.

Recording Transactions Transaction (n): Arch Copy Co. pays on account $200 to the City News for advertising. Copyright © Houghton Mifflin Company. All rights reserved.

Recording Transactions Transaction (o): Arch Copy Co. pays wages for a part-time employee, $2,130. Copyright © Houghton Mifflin Company. All rights reserved.

Recording Transactions Transaction (p): Arch Copy Co. buys additional equipment from Melton Office Supply for $3,520, paying $620 down, with the remaining $2,900 on account Copyright © Houghton Mifflin Company. All rights reserved.

Recording Transactions Transaction (q): Arch Copy Co. receives $850 cash on account from a credit customer. Copyright © Houghton Mifflin Company. All rights reserved.

Recording Transactions Transaction (r): Arch Copy Co. receives revenue from cash customers for the rest of the month, $4,220 Copyright © Houghton Mifflin Company. All rights reserved.

Recording Transactions Assets = Liabilities + Owner's Equity Cash + Equip. + Ppd. Ins. + Accts. Rec. = A/P + L. P. Arch, Capital + Revenue - Expenses Prev. Bal. 36,620 + 49,720 + 360 + 200 = 6,700 + 76,200 + 7,790 - 3,790 (s) - 2,500 -2,500 (Drawing) New Bal. 34,120 + 49,720 + 360 + 200 = 6,700 + 73,700 + 7,790 - 3,790 84,400 = 84,400 Transaction (s): Arch withdraws $2,500 in cash from the business for her personal living costs Copyright © Houghton Mifflin Company. All rights reserved.

Recording Transactions Assets = Liabilities + Owner's Equity Cash + Equip. + Ppd. Ins. + Accts. Rec. = A/P + L. P. Arch, Capital 73,700 + Revenue 7,790 - Expenses 3,790 34,120 + 49,720 + 360 + 200 = 6,700 + Left Side of Equals Sign = Right Side of Equals Sign Cash $34,120 Accts. Pay. $ 6,700 Equip. 49,720 L. P. Arch, Capital 73,700 Ppd. Ins. 360 Revenue 7,790 Accts. Rec. 200 $88,190 $84,400 Expenses - 3,790 $84,400 Copyright © Houghton Mifflin Company. All rights reserved.

Demonstration Problem We will be recording business transactions for a company with the following details: Owner name: Mai Lee Business name: Lee Attorneys Business type: Sole proprietorship (one-person business) Copyright © Houghton Mifflin Company. All rights reserved.

Demonstration Problem + + (a) Deposited $5,000 in a bank account in the name of the business Copyright © Houghton Mifflin Company. All rights reserved.

Demonstration Problem Assets = Liabilities + Owner's Equity Cash + Supplies + Law Library + Equip. = A/P + M. Lee, Capital + Revenue - Expenses (a) 5,000 5,000 (b) -700 +700 (Rent Expense) Bal. 4,300 = 5,000 - 700 4,300 = 4,300 (b) Paid rent for the month, $700 (Rent Expense) Copyright © Houghton Mifflin Company. All rights reserved.

Demonstration Problem Assets = Liabilities + Owner's Equity Cash + Supplies + Law Library + Equip. = A/P + M. Lee, Capital + Revenue - Expenses (a) 5,000 5,000 (b) -700 700 (Rent Expense) (c) +2,000 +2,000 Bal. 4,300 + 2,000 = 2,000 + 5,000 - 700 6,300 = 6,300 (c) Bought office equipment on credit, $2,000 Copyright © Houghton Mifflin Company. All rights reserved.

Demonstration Problem Assets = Liabilities + Owner's Equity Cash + Supplies + Law Library + Equip. = A/P + M. Lee, Capital + Revenue - Expenses (a) 5,000 5,000 (b) -700 700 (Rent Expense) (c) 2,000 2,000 (d) +3,000 +3,000 (Income from Services) Bal. 7,300 + 2,000 = 2,000 + 5,000 + 3,000 - 700 9,300 = 9,300 (d) Sold services for cash, $3,000 Copyright © Houghton Mifflin Company. All rights reserved.

Demonstration Problem Assets = Liabilities + Owner's Equity Cash + Supplies + Law Library + Equip. = A/P + M. Lee, Capital + Revenue - Expenses (a) 5,000 5,000 (b) -700 700 (Rent Expense) (c) 2,000 2,000 (d) 3,000 3,000 (Income from Services) (e) +4,000 +4,000 Bal. 7,300 + 4,000 + 2,000 = 2,000 + 9,000 + 3,000 - 700 13,300 = 13,300 (e) Mai Lee invested her personal law library with a fair market value of $4,000 Copyright © Houghton Mifflin Company. All rights reserved.

Demonstration Problem Assets = Liabilities + Owner's Equity Cash + Supplies + Law Library + Equip. = A/P + M. Lee, Capital + Revenue - Expenses (a) 5,000 5,000 (b) -700 700 (Rent Expense) (c) 2,000 2,000 (d) 3,000 3,000 (Income from Services) (e) 4,000 4,000 (f) -1,000 -1,000 Bal. 6,300 + 4,000 + 2,000 = 2,000 + 8,000 + 3,000 - 700 12,300 = 12,300 (f) Mai Lee withdraws $1,000 cash for personal use Copyright © Houghton Mifflin Company. All rights reserved.

Demonstration Problem Assets = Liabilities + Owner's Equity Cash + Supplies + Law Library + Equip. = A/P + M. Lee, Capital + Revenue - Expenses (a) 5,000 5,000 (b) -700 700 (Rent Expense) (c) 2,000 2,000 (d) 3,000 3,000 (Income from Services) (e) 4,000 4,000 (f) -1,000 -1,000 (g) +200 +200 Bal. 6,300 + 200 + 4,000 + 2,000 = 2,200 + 8,000 + 3,000 - 700 12,500 = 12,500 (g) Purchased supplies on credit for $200 Copyright © Houghton Mifflin Company. All rights reserved.