Use the accounting equation to analyze business transactions'

1

• Use the accounting equation to analyze business
  transactions.

2
Accounting for Business Transactions

• What is a transaction?
• It is any event that both affects the financial
  position of the business and can be reliably
  recorded.

3
Accounting for Business Transactions

• Gay Gillen invests 30,000 to begin Gay Gillen
  eTravel.
• Gillen purchases an office location, paying
  20,000 in cash.
• She buys office supplies, agreeing to pay 500 in
  30 days.
• She earns and collects 5,500 revenues.

4
Accounting for Business Transactions

• Gillen performs services, and the client agrees
  to pay 3,000 within one month.
• During the month, she pays 3,100 for expenses
  incurred.
• Gillen pays 300 to the store from which she
  purchased 500 worth of supplies.
• What is the effect of these transactions on the
  accounting equation?

5
Accounting for Business Transactions
Owners Assets
Liabilities Equity
1) Cash 30,000 30,000 2) Cash
20,000 Land 20,000 3) Supplies
500 500 4) Cash 5,500
5,500 5) Receivable 3,000
3,000 6) Cash 3,100
3,100 7) Cash 300 300
Totals 35,600 200 35,400
6
Accounting for Business Transactions

• Notice that the equation always stays in balance.
• Each transaction affects at least two accounts,
  sometimes more.
• Some transactions affect only one side of the
  equation some affect both sides.

7
Accounting for Business Transactions

• Other transactions that took place were as
  follows
• The business collected 1,000 from the client.
• She sold some land at cost for 9,000.
• She withdrew 2,100 from the business.

8

• Prepare and use
• financial statements.

9
Financial Statements...
are the final product of the accounting
process.
tell how the business is performing and where
it stands.
10
Financial Statements

• income statement
• statement of owners equity or retained earnings
• balance sheet
• statement of cash flows

11

• Evaluate the performance
• of business.

12
Relationships Among the StatementsIncome
Statement

• Revenue
• Fees earned 8,500
• Expenses
• Salary expense 1,200
• Utilities and telephone expense 400
• Equipment rental expense 400
• Office rent expense 1,100 3,100
• Net income 5,400

13
Relationships Among the StatementsStatement of
Owners Equity
G. Gillen, capital, April 1, 20xx
0 Contribution of capital 30,000 Net
income 5,400 Cash distributions
2,100 G. Gillen, capital, April 30,
20xx 33,300
14
Relationships Among the StatementsBalance Sheet
Assets Cash
20,000 Accounts receivable
2,000 Supplies 500 Land
11,000 Total assets 33,500
Liabilities Accounts payable
200 Owners equity, G. Gillen, capital
33,300 Total liabilities and owners
equity 33,500
15
Relationships Among the StatementsStatement Of
Cash Flows

• Cash flows from operating activities
• Cash receipts from services rendered 6,500
• Cash payments
• Supplies 300
• Operating expenses 3,100 3,400
• Net cash flows from
• Operating activities 3,100
• Cash flows from investing activities
• Purchase and sale of land (11,000)

16
Relationships Among the StatementsStatement Of
Cash Flows

• Cash Flows from Financing Activities
• Beginning Balance 0
• Investment by Owner 30,000
• Withdrawals 2,100
• Net Cash Flows from Financing Activities 27,900
• Cash at Beginning of Year 0
• Cash at End of the Year 20,000

17
VOILA !

• Congratulations !
• Easy or Difficult ?

18
Principle1 Revenue Recognition

• Revenue must be recorded when the four criteria
• has been satisfied
• Persuasive sales arrangement exists
• Delivery has/will eventually occur or services
  already rendered
• The sellers price to the buyer is fixed or
  determinable and
• Collectibility is reasonably assured

19
Basic Underlying Accounting Principles

• The Matching Concept
• Requires that revenue and expenses related to
  generating the corresponding revenue be recorded
  in the same period.
• As a sale is made, the appropriate charges for
  COGS or other expenses should be consistent from
  one accounting period to the next.

20
Basic Underlying Accounting Principles

• Historical Cost
• Is the proper basis for the recording of
• assets, expenses, equity, etc.
• Full Disclosure
• The financial statements of a firm must
• include all information necessary for the
• formation of valid decisions by the users.

21
Basic Underlying Accounting Principles

• Consistency
• Firms must employ consistent accounting
  procedures from period to period.
• Variations or changes in accounting policy
• and procedures must be justifiable.
• Standards used to value inventory, depreciate
  assets, or accrue expenses must be consistent
  from one accounting period to the next.

22
Basic Underlying Accounting Principles

• Objectivity
• Accounting records must be designed and kept on
  objective rather than subjective evidence.
• Underlying verifiability must exist for the
  information contained in the financials.
• The historical cost must be verifiable through
  legitimate proof of purchase.

23
Basic Underlying Accounting Principles

• Separate Entity Assumption
• Economic activity of an entity must be kept
  separate from other personal or business entities

24
Basic Underlying Accounting Principles

• Going Concern Continuity Assumption
• There is an assumption that the life of an entity
  will be long enough to fulfill its financial and
  legal obligations.
• Any evidence to the contrary must be reported in
  the financial statements of an entity.

25
Basic Underlying Accounting Principles

• Unit of Measure
• All financial reports are based on the monetary
  unit of the firms home country.
• Adjustments for inflationary trends are not shown
  in the financial statements of the entity.

26
Basic Underlying Accounting Principles

• Periodicity Time Period Assumption
• The life of an entity is divided into short
  economic time periods on which reporting
  statements are fashioned

27
Departures from GAAPModifying Conventions

• Variations from GAAP are sometimes required.
  The following modifying conventions give guidance
  and must be considered when departing from what
  is generally acceptable.

28
Modifying Conventions

• Conservatism
• When considering an accounting matter in which
  there are two alternatives that equally satisfy
  conceptual and implementation principles for a
  transaction the accountant must take the
  conservative approach, and follow the alternative
  that will have the least favorable impact on the
  net income of the entity.

29
Modifying Conventions

• Industry Practices Peculiarities
• The peculiarities and practices of an industry
• (such as banking, investment, insurance etc)
• May warrant selective exceptions to
• accounting principles . Some differences in
• Accounting also occur in response to legal
• requirements.

30
Modifying Conventions

• Substance over form
• The economic substance of a transaction
• determines the accounting treatment , even
• when the legal aspects of the transaction
• indicate otherwise.
• Example lease contract

31
Modifying Conventions

• Application of Judgment
• An accountant may depart from GAAP if the
• results of departure appear reasonable
• under the circumstances, especially when
• the strict adherence to GAAP will produce
• unreasonable results.

32
Modifying Conventions

• Materiality
• The amount of an item is material if its
• omission would affect the judgment of a
• Reasonable person who is relying on the
• financial statements.