2-1 Chapter 2 Analyzing Business Transactions

Section 1: Property and Financial Interest Section Objectives

1. Record in equation form the financial effects of a business transaction.

2. Define, identify, and understand the relationship between asset, liability, and owner’s equity accounts.

McGraw-Hill © 2009 The McGraw-Hill Companies, Inc. All rights reserved. Meet JT’s Consulting Services.

JT’s Consulting

 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.  Every month the firm bills clients for the services provided that month.  Customers can also pay in cash when the services are provided.

2-3 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

2-4 Objective 1 Record in equation form the financial effects of a business transaction 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.

Analysis:

(a) The business received $90,000 of property in the form of cash.

(b) Taylor had an $90,000 financial interest in the business.

2-5 The owner invested cash into the business.

Property = Financial Interest

Cash = Jason Taylor, Capital

(a) Invested cash + $90,000

(b) Increased equity + $90,000

New balances $90,000 = $90,000

Jason Taylor now has $90,000 equity in JT’s Consulting Services.

2-6 The company buys equipment for $10,000 cash.

Property = Financial Interest

Cash + Equipment = Jason Taylor, Capital

Previous balances $90,000 = $90,000

(c) Purchased equip. + $10,000

(d) Paid cash - 10,000

New balances $80,000 + $10,000 = $90,000

$90,000 = $90,000

2-7 The company buys $12,000 of equipment on account.

Property = Financial Interest Accounts Jason Taylor, Cash + Equipment = Payable + Capital Previous balances $80,000 + $10,000 = $90,000

(e) Purchased equipment +12,000

(f) Incurred debt +$12,000

New balances $80,000 + $22,000 = $12,000 + $90,000

$102,000 = $102,000

Notice the new claim against the firm’s property – the creditor’s claim of $12,000.

2-8 The firm purchases supplies for $3,000 cash.

Property = Financial Interest

Accounts Jason Taylor,

Cash + Supplies + Equipment = Payable + Capital Previous balances $80,000 + $22,000 = $12,000 + $90,000 (g) Purchased supplies $3,000 (h) Paid cash -3,000 New balances $77,000 + $3,000 + $22,000 = $12,000 + $90,000

$102,000 = $102,000

2-9 The firm makes a payment of $5,000 on account.

Property = Financial Interest

Accounts Jason Taylor,

Cash + Supplies + Equipment = Payable + Capital Previous balances $77,000 + $3,000 + $22,000 = $12,000 + $90,000 (i) Paid cash -5,000 (j) Decreased debt -$5,000

New balances $72,000 + $3,000 + $22,000 = $7,000 + $90,000

$97,000 = $97,000

2-10 The firm makes a payment of $7,000 rent in advance.

Property = Financial Interest

Cash + Supplies + Prepaid + Equipment Accounts Jason Taylor, Rent = Payable + Capital Previous balances $72,000 + $3,000 + $22,000 = $7,000 + $90,000 (k) Paid -7,000 cash (l) Prepaid rent +$7,000

New balances $65,000 + $3,000 + $7,000 + $22,000 = $7,000 + $90,000

$97,000 = $97,000

2-11 Objective 2 Define, identify, and understand the relationship between asset, liability, and owner’s equity accounts

Assets, Liabilities, and Owner’s Equity

QUESTION:

What are assets?

ANSWER:

Assets are property owned by a business.

2-12 Liabilities and Equity

QUESTION: What are liabilities? ANSWER:

Liabilities are debts or obligations of a business.

QUESTION: What is owner’s equity? ANSWER:

Owner’s equity is the term used for sole proprietorships. It is the financial interest of an owner of a business. It is also called proprietorship or net worth. 2-13 QUESTION:

What is a Balance Sheet?

ANSWER:

A balance sheet is a formal report of a business’s financial condition on a certain date. It reports the assets, liabilities, and owner’s equity of the business.

2-14 JT’s Consulting Services Balance Sheet November 30, 2010

Assets Liabilities

Cash 65,000.00 Accounts Payable 7,000.00 Supplies 3,000.00 Prepaid Rent 7,000.00 Owner’s Equity Equipment 22,000.00 Jason Taylor, Capital 90,000.00 Total Assets 97,000.00 Total Liabilities and Owner’s Equity 97,000.00

 Assets – the amount and types of property owned by the business  Liabilities – the amount owed to the creditors  Equity – the owner’s interest

2-15 Liabilities + FinancialOwner’s PropertyAssets InterestEquity

Property equals Financial Interest

2-16 Chapter 2 Analyzing Business Transactions

Section 2: The Accounting Equation and Financial Statements Section Objectives

3. Analyze the effects of business transactions on a firm’s assets, liabilities, and owner’s equity and record these effects in accounting equation form. 4. Prepare an income statement. 5. Prepare a statement of owner’s equity and a balance sheet.

McGraw-Hill © 2009 The McGraw-Hill Companies, Inc. All rights reserved. QUESTION:

What is the fundamental accounting equation? ANSWER:

The fundamental accounting equation is the relationship between assets and liabilities plus owner’s equity.

2-18 The Fundamental Accounting Equation

 In accounting terms the firm’s assets must equal the total of its liabilities and owner’s equity.  This equality can be expressed in equation form as:

Assets = Liabilities + Owner’s Equity

 The entire accounting process of analyzing, recording and reporting business transactions is based on the fundamental accounting equation

 If any two parts of the equation are known, the third part can be determined.

2-19 Objective 3 Analyze the effects of business transactions on a firm’s assets, liabilities, and owner’s equity and record these effects in accounting equation form.

2-20 QUESTION:

What is revenue?

ANSWER:

A revenue is an inflow of money or other assets that results from the sales of goods or services or from the use of money or property. It is also called income.

2-21 QUESTION:

What is an expense?

ANSWER:

An expense is an outflow of cash, use of other assets, or incurring of a liability.

2-22 The firm receives $26,000 in cash for services provided to clients.

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 (m) Recd. cash +26,000 (n) 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

2-23 The company performs services on account for $9,000.

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 + 22,000 = $7,000 + $90,000 + $26,000

(o) Received new asset + $9,000 (p) 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

2-24 Collection of $4,000 from customers on account.

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 (q) Recd. cash +4,000

(r) 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

2-25 The firm pays $7,000 in salaries expense for the month.

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

(s) Paid cash -7,000 (t) 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

2-26 The firm pays $500 for utilities expenses.

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 - 7,000

(u) Paid cash -500

(v) 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

2-27 The firm records a withdrawal by the owner of $4,000.

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 (w) Withdrew cash -4,000

(x) 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

2-28 Objective 4 Prepare An Income Statement

QUESTION: What is an income statement?

ANSWER: An income statement is a formal report of business operations covering a specific period of time. It is also called a profit and loss statement or a statement of income and expenses.

2-29 The income statement has The third line shows that the report covers a three-line heading. operations over a period of time.

JT’s Consulting Services Income Statement Month Ended December 31, 2010

Revenue Fees Income $35,000.00

Expenses Salaries Expense $7,000.00 Utilities Expense 500.00 Total Expenses 7,500.00

Net Income $ 27,500.00

2-30 The income statement reports revenue.

JT’s Consulting Services Income Statement Month Ended December 31, 2010

Revenue Fees Income $35,000.00

Expenses Salaries Expense 7,000.00 Utilities Expense 500.00 Total Expenses 7,500.00

Net Income $ 27,500.00

2-31 The income statement also reports expenses.

JT’s Consulting Services Income Statement Month Ended December 31, 2010

Revenue Fees Income $35,000.00

Expenses Salaries Expense 7,000.00 Utilities Expense 500.00 Total Expenses 7,500.00

Net Income $27,500.00

2-32 The result is net income or net loss for the period.

JT’s Consulting Services Income Statement Month Ended December 31, 2010

Revenue Fees Income $35,000.00

Expenses Salaries Expense 7,000.00 Utilities Expense 500.00 Total Expenses 7,500.00

Net Income $27,500.00

2-33 Objective 5 Prepare a Statement of Owner’s Equity and Balance Sheet A Statement of Owner’s Equity

JT’s Consulting Services Statement of Owner’s Equity Month Ended December 31, 2010

Jason Taylor, Capital, December 1, 2010 $90,000.00 Net Income for December $27,500.00 Less Withdrawals for December 4,000.00 Increase in Capital 23,500.00 Jason Taylor, Capital, December 31, 2010 37 $113,500.00

2-34 The Balance Sheet

JT’s Consulting Services Balance Sheet December 31, 2010

Assets Liabilities

Cash 83,500.00 Accounts Payable 7,000.00 Accounts Receivable 5,000.00 Supplies 3,000.00 Prepaid Rent 7,000.00 Owner’s Equity Equipment 22,000.00 Jason Taylor, Capital 113,500.00 Total Assets 120,500.00 Total Liabilities and Owner’s Equity 120,500.00

 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.

2-35 The Importance of Financial Statements

Business managers and owners use the balance sheet and the income statement to control current operations and plan for the future.

Creditors, prospective investors, governmental agencies, and others are interested in the profits of the business and in the asset and equity structure.

2-36 Financial statements are prepared in a specific order:

1st Income Statement

2nd Statement of Owner’s equity

3rd Balance Sheet

2-37 JT’s Consulting Services Statement of Owner’s Equity Month Ended December 31, 2010

Jason Taylor, Capital, December 1, 2010 80,000.00 Net Income for December 22,400.00 Less Withdrawals for December 3,000.00 Increase in Capital 19,400.00 Jason Taylor, Capital, December 31, 2010 113,500.00

JT’s Consulting Services Balance Sheet December 31, 2010 Assets Liabilities Cash $83,500.00 Accounts Payable $7,000.00 Accounts Receivable 5,000.00 Supplies 3,000.00 Prepaid Rent 7,000.00 Owner’s Equity Equipment 22,000.00 Jason Taylor, Capital 113,500.00 Total Assets $ 120,500.00 Total Liabilities and Owner’s Equity $ 120,500.00

2-38 Thank You for using

College Accounting, 12th Edition

Price • Haddock • Farina

2-39