Accounting Chapter 3
Teacher Notes
Chapter 3 Business Transactions and the Accounting Equation
Accounting Terms:
- Equities: Equity is what you own more than what you owe. Business equities are the financial rights to the business assets.
The Accounting Equation:
Assets = Liabilities + Owner’s Equity
- Assets = what
the business has or owns (equipment, supplies, cash, accounts receivable)
- Accounts
receivable is money the business will be paid by customers/clients for goods or
services
- Liabilities = what
the business owes to others (bank loan, accounts payable)
- Accounts
payable is money the business owes for things is purchased and has not yet paid
for
- Owner’s Equity (or capital) = what the owner owns (investment and business profit)
The left and right sides must ALWAYS be EQUAL.
The accounting equation can be expressed in 3 ways:
- Assets = Liabilities + Owners' Equity
- Liabilities = Assets - Owners' Equity
- Owners' Equity = Assets – Liabilities
Other terms:
- Transaction: any
business activity that changes assets, liabilities, or owner’s equity.
Include: sales, purchases, loans, bill and debt payments, etc.
- A transaction
that increases total assets must also increase total liabilities or owner's
equity.
- A transaction
that decreases total assets must also decrease total liabilities or owner's
equity.
- Some
transactions may increase one account and decrease another on the same side of
the equation i.e. one asset increases and another decreases.
- Account: a
record summarizing all the information about one item in the accounting equation; where transaction
are posted to in debits and credits
- Account balance:
the amount currently in the account, after all transactions have been posted
(recorded)
- Capital =
owner’s equity. The capital account = the owner’s equity account (same thing)
Other:
- Purchases of good and services for “cash” will only affect the assets side of the accounting equation. Purchases made for “credit” will increase the business’s liabilities, so they must be posted on the right side, too.
- Purchasing "on account" is the same as buying on credit; you pay for your purchase at a later date.
Changes that Affect Owner’s Equity
Revenue is an increase in owner's equity from the operation of a business.
- It is the profit that a business makes.
- Your income would be called wages, or salary. A business's income is called revenue.
Sales of goods and services can either be made for cash or “on account” (credit). Either way, they will increase owner's equity, the capital account on the right side.
- Sales for cash: cash account is increased on the left side
- Sales on account: accounts receivable is increased on the left side
Example: ABC Company sells $5000 in materials to ZYX Company. ZYX pays $2000 down,and puts the rest on account. The account postings for ABC Company would be:
| Assets |
Liabilities |
Cash |
+ $2000 |
Capital |
+ $5000 |
A/R ABC Company |
+ $3000 |
|
|
- Receiving cash on account (payment for sales made previously for credit)
- increase cash
- decrease A/R
Realization of revenue: applied when revenue is recorded at the time goods or services are sold.
Expense: decrease in owner's equity resulting from the operation of a business.
Business expenses include everything they need to do business ... rent, utilities, office supplies, raw materials and equipment, maintenance and repairs, etc.
- Expenses paid in cash
- decrease cash on the left
- decrease capital on the right
Owner withdrawals (usually cash but might be supplies) will decrease owner's equity.
- decrease cash on the left
- decrease capital on the right