1. 2 The Equation 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)
Unit 2

2. Objective 2.1: The accounting equation
The following slides use Jack & Jill Enterprises to demonstrate the fundamental accounting equation
O2.1

3. Jack and Jill Enterprises
Hey Jill!
Lets fetch water and make some money
You fetch
I’ll supervise
O2.1

4. Jack and Jill Enterprises
We receive $1 for each pail of water we fetch
And we pay $1 to replace each shoe we wear out
O2.1

5. First, we can list all of J & J’s assets in a blue box.
Cash 3
Pails 2
Total 5
O2.1

6. Assets Liabilities Equity
Cash 3
Mom payable 2
The red box has two parts, creditors and owners.
Pails 2
Next, list all the claims against the assets in a red box.
Equity
Jack & Jill, Capital 3
Total 5
Total 5
O2.1

7. Assets Liabilities Equity
Cash 3
Mom payable 2
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
Equity
Jack & Jill, Capital 3
Total 5
Total 5
O2.1

8. This is the BALANCE SHEET
Assets
Liabilities
Equity

9. Now lets see how this system works for J & J Enterprises
Now lets see how this system works for J & J Enterprises. (Remember, Assets must always equal Liabilities Plus Owner’s Equity.
O2.1

10. Jack and Jill Enterprises
Assets
Liabilities
Mom payable 2 3 4
Cash 6 7 5 8 7
Pails 2
Fetch 1 Pail
Fetch 2 Pails
Fetch 1 Pail
Buy 2 Shoes
Fetch 3 Pails
Buy 1 Shoe
Equity 4 3 8 7 6 5 7
J&J, Capital 9 5 10 6 8 5
Total assets 7 9
Total Liab. + Equity 8 9 7 6 10 9
O2.1

11. The system stayed in balance
We increased Equity with each sale
We decreased Equity for each expense.
The system stayed in balance
Assets
Liabilities
Equity
O2.1

12. Answer: With this simplified system, you would have have to memorize
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

13. Jack and Jill Enterprises I wish I could remember what our sales were.
Assets
Liabilities
Mom payable 2 3
I wish I could remember what our sales were. 4
Cash 6 7 5 8 7
Pails 2
Equity 4 3 8 6 7 7 5
J&J, Capital 5 10 9 8 6 5
Total assets 7 9
Total Liab. + Equity 7 8 9 10 9 6
O2.1

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

15. To keep track of sales and expenses
for any given period.
Income Statement
A separate
“temporary” list of
Sales and Expenses
BALANCE SHEET
INCOME STATEMENT
O2.1

16. The Sales and Expenses are collected on the Income Statement
BALANCE SHEET
INCOME STATEMENT
Sales
Assets
Liabilities
Equity
Expenses
O2.1

17. The resulting Profit or Loss
is calculated
BALANCE SHEET
INCOME STATEMENT
Sales
Assets
Liabilities
Equity
Expenses
Profit
Loss
O2.1

18. At the end of the time period The Profit or Loss is moved to Equity
BALANCE SHEET
INCOME STATEMENT
Sales
Assets
Liabilities
Equity
Expenses
Let’s
try it
Profit
Loss
O2.1

19. Jack and Jill Enterprises
Balance Sheet
Income Statement
Assets
Liabilities + Equity
Cash
Pails
Total assets
Mom payable
J&J, Capital
Total Liab & Equity
Revenue 3 6 8 4 2 1 7 7 5 3 7 4 2
Shoe Expense 3 2 3 5 9 10 7 9 5 8 6
Fetch 1 Pail
Fetch 2 Pails
Fetch 1 Pail
Buy 2 Shoes 1 3 2 4 4 5
Fetch 3 Pails
Buy 1 Shoe OR
O2.1

20. This is a big improvement
This is a big improvement. The Income Statement allows us to tell at a glance what the sales and expense totals are.
The Income Statement is used to collect
sales and expenses for a given time period
-for example a month or a year.
O2.1

21. Jack and Jill Enterprises
Balance Sheet
Income Statement
Assets
Liabilities + Equity
Cash
Pails
Total assets
Mom payable
J&J, Capital
Total Liab & Equity
Revenue 4 8 6 3 2 1 7 5 7 3 4 7 2
Shoe Expense 3 2 3 5 9 10 7 9 6 5 8
The systems stays balanced –you must consider the change in J&J Capital that is being recorded in the Income Statement 3 1 4 5 4 2 OR
O2.1

22. Assets = Liabilities + Equity + Revenues - Expenses
Following are exercises using the fundamental accounting equation
Assets = Liabilities + Equity + Revenues - Expenses
O2.1

23. Assets Liabilities Equity
What is Total Equity? 78
Total Liabilities
Equity ?
Total Equity 72
Total Assets
150
Total Liab & Equity
150
O2.1

24. What are Total Liabilities?
Assets
Liabilities
What are Total Liabilities? ?
1092
Total Liabilities
Equity
Total Equity
658
Total Assets
1750
Total Liab & Equity
1750
O2.1

25. Assets Liabilities Equity
What are Total Assets?
Total Liabilities
6,420
Equity
Total Equity
3,430 ?
Total Assets
9,850
Total Liab & Equity
9,850
O2.1

26. What is the total Owner, Capital?
Balance Sheet
Income Statement
Assets
Liabilities + Equity
Total assets
Total Liabilities
Owner, Capital
(Beginning)
Total Liab
& Equity
Revenue 1 3 4
870
Expenses 2
405 ?
1,275 10 7 9 8 5 6
1,275 3 1 4 2 5
What is the total Owner, Capital? OR
O2.1

27. What is the total Owner, Capital? (consider the Income Statement also)
Balance Sheet
Income Statement
Assets
Liabilities + Equity
Total assets
Total Liabilities
Owner, Capital
(Beginning)
Total Liab
& Equity
Revenue 1 3
100 4
870
Expenses 25 2
405 ?
1,350 10 7 9 5 8 6
Beg. Owner Capital 405 plus Revenue 100 minus Expenses 25 = 480 Ending Owner, Capital
What is the total Owner, Capital? (consider the Income Statement also) 75 3 1 4 2 5 OR
O2.1

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

29. There are 5 basic classes of accounts
Balance Sheet
Income Statement
Assets
Liabilities + Equity 4.
Revenue
Cash
Accounts Receivable
Supplies
Inventory
Land
Buildings
Equipment
Copyrights
Accounts Payable
Wages Payable
Taxes Payable
Unearned Revenue
Notes Payable
Owner’s, Capital 2.
Liabilities
Revenue 1.
Assets
Cost of Goods Sold
Wages Expense
Taxes Expense
Rent Expense
Utilities Expense
Interest expense 5.
Expenses 3.
Equity
There are 5 basic classes of accounts
Profit OR
Loss
O2.2

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

31. Remember where these words belong!
Earned
Income
Payable
Cash
Revenue
Sales
Receivable
Unearned
Prepaids
Expense
Capital
Equipment
Withdrawals
O2.2

32. Where does this account belong?
Accounts Receivable
Accounts Receivable
O2.2

33. Where does this account belong?
Prepaid Insurance
Prepaid Insurance
O2.2

34. Where does this account belong?
Accounts Payable
Accounts Payable
O2.2

35. Where does this account belong?
Sales
Sales
O2.2

36. Where does this account belong?
Rent expense
Rent expense
O2.2

37. Where does this account belong?
Taxes payable
Taxes payable
O2.2

38. Where does this account belong?
J. Black, Capital
J. Black, Capital
O2.2

39. Where does this account belong?
Interest Income
Interest Income
O2.2

40. Where does this account belong?
Interest expense
Interest expense
O2.2

41. Where does this account belong?
Equipment
Equipment
O2.2

42. Where does this account belong?
Salary expense
Salary expense
O2.2

43. Where does this account belong?
Fee Income
Fee Income
O2.2

44. Where does this account belong?
J. Black, Drawing
J. Black, Drawing
O2.2

45. Where does this account belong?
Unearned Revenue
Unearned Revenue
O2.2

46. Where does this account belong?
Cost of Goods Sold
Cost of Goods Sold
O2.2

47. Where does this account belong?
Cash
Cash
O2.2

48. Where does this account belong?
Dividend Revenue
Dividend Revenue
O2.2

49. Objective 2.3: Concepts
The following slides present 6 important concepts that guide many accounting practices and decisions.
O2.3

50. (Monetary Unity) Concept Revenue Recognition Concept
Concepts
Objectivity Concept
Unit of Measure
(Monetary Unity) Concept
Matching Concept
Cost Concept
Periodicity Concept
Revenue Recognition Concept
O2.3

51. (Monetary Unity) Concept
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.
$ £ ¥ DM
O2.3

52. Information collected in
Accounting information should be separated into regular time periods such as months, quarters and years.
Periodicity Concept
Information collected in
time periods allows
comparisons that help
us track financial
progress.
O2.3

53. 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.
Matching Concept
This concept is one
that guides a great deal
of accounting activity
in the production of
accrual financial
statements
O2.3

54. Historical cost is used to record values in the accounts (in most cases) rather than current market values or replacement costs
Cost Concept
This concept is part of the
conservative approach to
financial reporting that is
required by FASB
O2.3

55. When recording values where historical cost is not relevant, objective information is required rather than (subjective) values based on opinion or educated guesses.
Objectivity Concept
Objective information is provided
by reliable, unbiased third parties,
generally from market data
O2.3

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

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?
$425 each
O2.3

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

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
$ £ ¥ DM
O2.3

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

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

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

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

64. A standard common size percentage calculated is net profit as a percentage of sales.
This allows
comparison from
one period to
the next
46,400/268,000
= 17%
O2.4

65. End of Unit 2