1. Introduction to Accounting and Business
LO 4 – Relating Business Transactions to the Accounting Equation

2. LO 4
Business Transaction
A business transaction is an economic event or condition that directly changes an entity’s financial condition or its results of operations.
A business transaction is an economic event that directly affects two or more of the elements of the accounting equation. Every time a business transaction occurs, its effect on the accounting equation must be recorded.

3. LO 4
Transaction A
On November 1, 2011, Chris Clark deposited $25,000 in a bank account in the name of NetSolutions in return for shares of stock in the corporation.
On November 1, 2011, Chris Clark begins a business that will be known as NetSolutions. This lecture will illustrate how transactions change the elements in the accounting equation. The first transaction is a deposit of $25,000 into the business bank account in exchange for shares of stock. This transaction will cause both the asset account Cash to increase, and the stockholder’s equity account Capital Stock to increase by $25,000. After recording each transaction, the accounting equation must still be in balance. The total of the assets must always equal the total of the liabilities plus stockholders’ equity.

4. Transaction A
Stock issued to owners (stockholders), such as Chris Clark, is referred to as capital stock. The owner’s equity in a corporation is called stockholders’ equity.

5. LO 4
Transaction B
On November 5, 2011, NetSolutions paid $20,000 for the purchase of land as a future building site.
In the next transaction, NetSolutions exchanged $20,000 for land. This transaction affects two different asset accounts. The asset account Cash is decreased by $20,000, and the asset account Land is increased by $20,000. The total assets are still equal to $25,000 although the composition of the total assets has changed. There is no effect upon the stockholder’s equity account Capital Stock because exchanging one asset for another has no effect upon the shareholder’s claim on assets. The shareholder’s claim on assets is $25,000 both before and after the land is bought by the business.
The new amounts are called balances.

6. LO 4
Transaction C
On November 10, 2011, NetSolutions purchased supplies for $1,350 and agreed to pay the supplier in the near future.
In this transaction, the business purchased supplies “on account,” therefore the asset account Supplies is increased by $1,350. The business will pay for these supplies in the future. Therefore, a liability account, Accounts Payable, which represents amounts the business owes to suppliers, is increased by $1,350 . This transaction causes the total assets of the business to increase by $1,350. At the same time, the liabilities of the business have increased by $1,350. This transaction has no effect upon the stockholders’ equity, because although there has been an increase in business assets, there has been a corresponding increase in creditors’ claims on assets.

7. LO 4
Transaction C
The liability created by a purchase on account is called an account payable.
Items such as supplies that will be used in the business in the future are called prepaid expenses, which are assets.

8. LO 4
Transaction D
On November 18, 2011, NetSolutions received cash of $7,500 for providing services to customers. A business earns money by selling goods or services to its customers. This amount is called revenue.
In this transaction, NetSolutions provides services to their customers, receiving $7,500 in cash. This transaction is recorded on the asset side by increasing cash by $7,500. The increase in assets is recorded with a corresponding increase in the stockholders’ equity account Fees Earned of $7,500. A transaction with a customer represents revenue, which increases stockholders’ equity in the assets of the business. Total Stockholders’ Equity is equal to $32,500, or $25,000 plus $7,500.

9. LO 4
Transaction D
Revenue from providing services is recorded as fees earned.
Revenue from the sale of merchandise is record as sales.
Other examples of revenue include rent, which is recorded as rent revenue, and interest, which is recorded as interest revenue.
An account receivable is a claim against a customer, which is an asset.
Different terms are used for the various types of revenues.

10. LO 4
Transaction E
During the month, NetSolutions spent cash or used up other assets in earning revenue. Assets used in this process of earning revenue are called expenses.
Expenses include supplies used and payments for employee wages, utilities, and other services.

11. LO 4
Transaction E
On November 30, 2011, NetSolutions paid the following expenses: wages, $2,125; rent, $800; utilities, $450; and miscellaneous, $275.
Expenses can be paid directly in cash, or payment might be made in the near future, called on account. For this transaction, NetSolutions paid a total of $3,650 in cash for four different expenses; therefore, the asset Cash is decreased by $3,650. On the right side of the equation, the payment of expenses is recorded by decreasing stockholders’ equity for each expense paid. Stockholders’ equity will decrease by $3,650 for the total expenses paid during the month.

12. LO 4
Transaction F
On November 30, 2011, NetSolutions paid creditors on account, $950.
In this transaction, NetSolutions pays $950 to its creditors in payment of the account payable that was set up when the supplies were purchased in Transaction C. This payment affects the asset account Cash, which is decreased by $950. On the right side of the equation, the liability Accounts Payable is decreased by $950. Paying off a debt reduces the creditors’ claims on the assets of the business.

13. LO 4
Transaction G
On November 30, 2011, Chris Clark determined that the cost of supplies on hand at the end of the period was $550; therefore, the amount of supplies used amounted to $800 ($1,350 – $550 = $800).
During the month, supplies needed in running the business were used. The business does not record the usage of supplies on a daily basis because it would be too time consuming. At the end of the month, the asset account Supplies must be updated to reflect the balance of the supplies that are still unused, or on hand. Therefore, they count up the amount of supplies that remain, in this case $550. Since they began the month with a purchase of supplies of $1,350 and only $550 of supplies remain by subtraction, $800 of supplies, or $1,350 minus $550, must have been used up during the month. The business records this transaction by subtracting $800 from Supplies, reducing the Supplies account balance to $550. On the right side of the accounting equation, the usage of supplies is recorded by subtracting $800 from stockholders’ equity. This is called Supplies Expense. It is an expense because supplies are used up in the process of generating revenue.

14. LO 4
Transaction H
On November 30, 2011, NetSolutions paid $2,000 to stockholders as dividends.
Dividends are distributions of earnings to stockholders.
When the stockholders receive distributions of earnings, the asset Cash is reduced by $2,000. On the right side of the equation, this distribution of cash paid to the stockholders from the business reduces the stockholders’ equity by $2,000.

15. LO 4
Summary
In the summary listed above, you should note the following points:
Every transaction is an increase or decrease in one or more of the accounting equation elements.
The two sides of the equation are ALWAYS equal.
Stockholders’ Equity increases with investments made by stockholders and decreases with dividends paid.
Stockholders’ Equity will also be increased by revenues earned and decreased by expenses incurred.

16. Types of Transactions Affecting Stockholders’ Equity
LO 4
Types of Transactions Affecting Stockholders’ Equity