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Lecture 2: Study Week 2

The Accounting Equation & the Double Entry System

Objectives for today
1. Analyzing transactions using the Accounting Equation 2. Next Week: How do firms actually measure Income?: Accrual vs. Cash Accounting g 3. Next Week: Determine when a company should record revenues and Expenses: The Matching Principle

The Operating Cycle
Start with cash and end with more cash

Collect cash from customers

Purchase inventory

Make sales to customers

The Recording Process


The sequence of five steps in recording and reporting transactions is as follows:

Transactions Documentation

Journal

Ledger

Trial Balance

Financial Statements



Source documents are the original records of any transaction

Consider the following activities
• • • • • • • • April 1: issued 1,000 shares of common stock for cash $40,000 April 2: issued 500 shares of common stock for equipment, $20,000 April 10: Borrowed cash, signing a note payable for $35,000 April 12: Purchased equipment for cash, $30,000 April 15: Purchased office furniture on account, $10,000 April 18: Disbursed cash on account (to reduce account payable) $ 4,000 April 25: Sold Equipment for cash $8,000 April 26: Discovered that the most prominent competitor in the area was bankrupt and was closing its doors on at the end of April!!

We shall consider each transaction and see how it affects the balance sheet on a particular date 5 of 49

Transaction 1 & 2
• April 1: issued 1,000 shares of common stock for cash $40,000 Assets Cash + $40,000 = = Liabilities + Owners’ Equity Capital +$40,000

• A il 2 i April 2: issued 500 shares of common stock f equipment, d h f t k for i t $20,000 Assets Cash + $40,000 + $20,000 Total Assets $60,000 Equipment = = = Total Liabilities + OE = Liabilities + Owners’ Equity Capital +$40,000 +$20,000 $60,000

Transaction 3
• April 10: Borrowed cash, signing a note payable for $35,000 Assets Cash + $40,000 + $20,000 + $35,000 Total Assets $95,000 Equipment = = = = +$35,000 Total Liabilities + OE $95,000 = Liabilities Note Payable + Owners’ Equity Capital +$40,000 +$20,000

Defining Assets
• Assets – Economic resources owned or ‘controlled’ by the company for the purpose of generating future Cash Inflows or preventing future cash Outflows.

• Current Assets – assets the company plans to turn into cash or use to generate revenue in the next fiscal year.

• Noncurrent/Long-term Assets – assets that will last for more than one year.

Defining a Liability
• Liabilities – amounts that the business owes; claims of creditors. • Liabilities are obligations of the company to outsiders or claims against its assets that may result into future cash outflows outflows. • Current Liabilities – liabilities the company will settle – pay off- in the next fiscal year. • Noncurrent/long-term Liabilities – liabilities that will take more than one year to settle.

Transaction 4
• April 12: Purchased equipment for cash, $30,000
Assets Cash + $40,000 + $20,000 + $35,000 -$30,000 Total Assets +30,000 $95,000 Equipment = = = = = Total Liabilities + OE $95,000 +$35,000 = Liabilities Note Payable + Owners’ Equity Capital +$40,000 +$20,000

• One asset (Cash) has been exchanged for another (Equipment)

Transaction 5
• April 15: Purchased office furniture on account, $10,000 Assets
Cash Equipment Furniture

=

Liabilities
Acc. Pay. Note Payable

+

Owners’ Equity
Capital

+ $40,000 + $20,000 + $35,000 -$30,000 +30,000

= = = = +10,000 = +$10,000 +$35,000

+$40,000 +$20,000

Total Assets

$105,000 =

Total Liabilities + OE

$105,000

• Assets have increased because of the purchased furniture!!

Transaction 6
• April 18: Disbursed cash on account (to reduce account payable) $ 4,000 Assets
Cash Equipment Furniture

=

Liabilities
Acc. Pay. Note Payable

+

Owners’ Equity
Capital

+ $40,000 + $20,000 + $35,000 -$30,000 +30,000

= = = = +10,000 = +$10,000 +$35,000...
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