2-1 Skyline College Chapter 2

2-2 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.

2-3 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.

2-4 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

2-5 Meet JT’s Consulting Services. 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. JT’s Consulting

2-6 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. (a) The business received $90,000 of property in the form of cash. Analysis: (a) Taylor had an $90,000 financial interest in the business.

2-7 Property = Financial Interest Cash = Jason Taylor, Capital (a) Increased equity (a) Invested cash New balances $90,000 = $90,000 + $90,000 The equation remains in balance. Jason Taylor now has $90,000 equity in JT’s Consulting Services.

2-8 Business Transaction 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. Purchasing Equipment for Cash

2-9 Cash + Equipment = Jason Taylor, Capital Previous balances $90,000 = $90,000 (b) Purchased equip. + (b) Paid cash New balances $80,000 + $10,000 = $90,000 Property = Financial Interest - 10,000 $10,000 The equation remains in balance. $90,000 = $90,000

2-10 Buying on account is an arrangement to allow payment at a later date. It is also called a charge account or open- account credit. Accounts payable are the amounts a business must pay in the future. Accounts Payable

2-11 Business Transaction JT’s Consulting Services purchased additional office equipment on account from Office Plus for $12,000. (c) The firm purchased new equipment that cost $12,000. (c) The firm owes $12,000 to Office Plus. Analysis:

2-12 Accounts = Payable (c) Purchased equipment (c) Incurred debt New balances $80,000 + $22,000 = $12,000 + $90,000 Property = Financial Interest Cash + Equipment Previous balances $80,000 + $10,000 = $90,000 Jason Taylor, + Capital +12,000 +$12,000 The equation remains in balance. $102,000 = $102,000 Notice the new claim against the firm’s property – the creditor’s claim of $12,000.

2-13 Business Transaction JT’s Consulting Services issued a check for $3,000 to Office Warehouse Inc. to purchase office supplies. (d) The firm purchased office supplies that cost $3,000. (d) The firm paid $3,000 in cash. Analysis: Purchasing Supplies

2-14 Accounts = Payable (d) Purchased supplies (d) Paid cash New balances $77,000 + $3,000 + $22,000 = $12,000 + $90,000 Property = Financial Interest Cash + Supplies + Equipment Previous balances $80,000 + $22,000 = $12,000 + $90,000 Jason Taylor, + Capital +$3,000 -3,000 The equation remains in balance. $102,000 = $102,000

2-15 Business Transaction In order to reduce its debt, JT’s Consulting Services issued a check for $5,000 to Office Plus. (e) The firm paid $5,000 in cash. (e) The claim of Office Plus against the firm decreased by $5,000. Analysis: Paying a Creditor

2-16 Accounts = Payable (e) Paid cash New balances $72,000 + $3,000 + $22,000 = $7,000 + $90,000 Property = Financial Interest Cash + Supplies + Equipment Previous balances $77,000 + $3,000 + $22,000 = $12,000 + $90,000 Jason Taylor, + Capital (e) Decreased debt -5,000 -$5,000 The equation remains in balance. $97,000 = $97,000

2-17 Business Transaction JT’s Consulting Services issued a check for $7,000 to pay for rent for the months of December and January. (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. Analysis: Paying for Services

2-18 Accounts = Payable (f) Paid cash New balances $65,000 + $3,000 + $7,000 + $22,000 = $7,000 + $90,000 Property = Financial Interest Cash + Supplies + Prepaid + Equipment Rent Previous balances $72,000 + $3,000 + $22,000 = $7,000 + $90,000 Jason Taylor, + Capital (f) Prepaid rent -7,000 +$7,000 The equation remains in balance. $97,000 = $97,000

2-19 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.

2-20 In accounting terms the firm’s assets must equal the total of its liabilities and owner’s equity. Assets = Liabilities + Owner’s Equity The Fundamental Accounting Equation 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.

2-21 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.

2-22 JT’s Consulting Services Balance Sheet November 30, 2007 Liabilities – the amount owed to the creditors Assets – the amount and types of property owned by the business Equity – the owner’s interest Assets Cash $65,000 Supplies 3,000 Prepaid Rent 7,000 Equipment 22,000 Total Assets $97,000 Liabilities Accounts Payable $ 7,000 Jason Taylor, Capital 90,000 Total Liabilities and Owner’s Equity $ 97,000 Owner’s Equity

2-23 Assets Property equals Financial Interest Liabilities + Owner’s Equity Property Financial Interest

2-24 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. Revenues

2-25 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. Expenses

2-26 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. Selling Services for Cash Business Transaction

An increase in revenue is an increase in owner’s equity. Revenue $26,000 Owner’s Equity $26,000

2-28 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 +26,000 (g) Increased owner's equity + 26,000 New balances $91,000 + $3,000 + $7,000 + $22,000 = $7,000 + $90,000 + $26,000 $123,000 = $123,000 The fundamental accounting equation remains in balance.

Recording Revenue Amounts Why are revenue amounts recorded in a separate column under the Owner’s Equity section? REVIEW QUESTION: Firms can easily calculate total revenue while preparing financial statements. ANSWER:

2-30 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. Accounts Receivable

2-31 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. 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. Selling Services on Credit Business Transaction

2-32 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 = $7,000 + $90,000 + $26,000 _______ ______ _____ ______ ______ _____ ______ ______ (h) Received new asset + $9,000 (h) Increased owner’s equity + 9,000 New bal. $91,000 + $9,000 + $3,000 + $7,000 + $22,000 = $7,000 + $90,000 + $35,000 $132,000 = $132,000 The fundamental accounting equation remains in balance.

2-33 Analysis: (i) The firm received $4,000 in cash. (i) Accounts receivable decreased by $4,000. 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. Collecting Receivables Business Transaction

2-34 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 The fundamental accounting equation remains in balance.

Collecting Receivables The revenue was already recorded when the original sale took place. Why didn’t revenue increase when money was received from charge account clients?

2-36 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. 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. Paying Employees’ Salaries Business Transaction

An increase in expense is a decrease in owner’s equity. Expense $5,000 Owner’s Equity $5,000

2-38 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 The fundamental accounting equation remains in balance.

2-39 Analysis: (k) The firm decreased its cash balance by $500. (k) The firm paid utilities expense of $500, which decreased owner’s equity. JT’s Consulting Services issued a check for $500 to pay the utilities bill. The effect of this transaction is analyzed below. Paying Utilities Expenses Business Transaction

2-40 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 ______ ______ _______ _______ _______ ________ _______ _______ ______ (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 The fundamental accounting equation remains in balance.

2-41 Analysis: (l) The firm decreased its cash balance by $4,000. (l) Owner’s equity decreased by $4,000. At the end of December, Jason Taylor withdrew $4,000 in cash for personal use. The effect of this transaction is analyzed below. Effect of Owner’s Withdrawals Business Transaction

2-42 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 The fundamental accounting equation remains in balance.

2-43 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. The Income Statement Revenues – Expenses = Net Income

2-44 Revenue Fees Income $35,000 Expenses Salaries Expense $7,000 Utilities Expense 500 Total Expenses Net Income $ 27,500 JT’s Consulting Services Income Statement Month Ended December 31, 2007 The income statement has a three-line heading. The third line shows that the report covers operations over a period of time.

2-45 Revenue Fees Income $35,000 Expenses Salaries Expense 7,000 Utilities Expense 500 Total Expenses Net Income $ 27,500 JT’s Consulting Services Income Statement Month Ended December 31, 2007 The income statement reports revenue.

2-46 Revenue Fees Income $35,000 Expenses Salaries Expense 7,000 Utilities Expense 500 Total Expenses Net Income $27,500 JT’s Consulting Services Income Statement Month Ended December 31, 2007 The income statement also reports expenses.

2-47 Revenue Fees Income $35,000 Expenses Salaries Expense 7,000 Utilities Expense 500 Total Expenses Net Income $27,500 JT’s Consulting Services Income Statement Month Ended December 31, 2007 The result is net income or net loss for the period.

2-48 A statement of owner’s equity is a formal report of changes that occurred in the owner’s financial interest during a reporting period. The Statement of Owner’s Equity

Jason Taylor, Capital, December 1, 2007 Net Income for December Less Withdrawals for December Increase in Capital Jason Taylor, Capital, December 31, 2007 $27,500 $90,000 23,500 $113,500 JT’s Consulting Services Statement of Owner’s Equity Month Ended December 31, 2007 The statement of owner’s equity has a three-line heading.

Jason Taylor, Capital, December 1, 2007 Net Income for December Less Withdrawals for December Increase in Capital Jason Taylor, Capital, December 31, 2007 $27,500 $90,000 23,500 $113,500 JT’s Consulting Services Statement of Owner’s Equity Month Ended December 31, 2007 The statement of owner’s equity shows the capital at the beginning of the period.

Jason Taylor, Capital, December 1, 2007 Net Income for December Less Withdrawals for December Increase in Capital Jason Taylor, Capital, December 31, ,500 $90,000 23,500 $113,500 JT’s Consulting Services Statement of Owner’s Equity Month Ended December 31, 2007 Net income or net loss for the period is included.

Jason Taylor, Capital, December 1, 2007 Net Income for December Less Withdrawals for December Increase in Capital Jason Taylor, Capital, December 31, ,500 $90,000 23,500 $113,500 JT’s Consulting Services Statement of Owner’s Equity Month Ended December 31, 2007 The withdrawals and additional investments for the period are shown.

Jason Taylor, Capital, December 1, 2007 Net Income for December Less Withdrawals for December Increase in Capital Jason Taylor, Capital, December 31, ,500 $90,000 23,500 $113,500 JT’s Consulting Services Statement of Owner’s Equity Month Ended December 31, 2007 The increase or decrease in capital for the period is reported.

Jason Taylor, Capital, December 1, 2007 Net Income for December Less Withdrawals for December Increase in Capital Jason Taylor, Capital, December 31, ,500 $90,000 23,500 $113,500 JT’s Consulting Services Statement of Owner’s Equity Month Ended December 31, 2007 The result is the capital balance at the end of the period.

2-55 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. Additional Investments

2-56 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 JT’s Consulting Services Balance Sheet December 31, 2007 The balance sheet has a three-line heading. 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.

2-57 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??

2-58  Business managers and owners use the balance sheet and the income statement to control current operations and plan for the future. The Importance of Financial Statements  Creditors, prospective investors, governmental agencies, and others are interested in the profits of the business and in the asset and equity structure.

st Income Statement 2 nd Statement of Owner’s equity 3 rd Balance Sheet Financial statements are prepared in a specific order:

2-60 JT’s Consulting Services Income Statement Month Ended December 31, 2007 Revenue Fees Income $35,000 Expenses Salaries Expense7,000 Utilities Expense 500 Total Expenses Net Income $27, 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, ,500 $90,000 23,500 $113,500

2-61 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, ,400 3,000 80,000 19, ,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