# Business Transactions and the Accounting Equation

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2 Working in the Real World APPLYING YOUR ACCOUNTING KNOWLEDGE Every business has assets, liabilities, and owner s equity the elements in the basic accounting equation that you will study in this chapter. A television studio s assets include cameras and computers. Its liabilities may include unpaid bills to videotape suppliers. The owner s equity of a business is what the business is worth. Personal Connection 1. In your workplace what types of assets does the business have? 2. What types of debts or liabilities would you imagine the business to have? Online Connection Go to glencoeaccounting.glencoe.com and click on Student Center. Click on Working in the Real World and select Chapter 3. glencoeaccounting.glencoe.com 49

6 SECTION 1 Assessment AFTER YOU READ Reinforce the Main Idea Use a diagram like this one to describe the financial claims of creditors and owners. Do the Math Owner s equity can be expressed as a fraction of the total equities. It can also be expressed as a decimal. Consider the following example: Assets Liabilities Owner s Equity \$10,000 \$9,000 \$1,000 Owner s equity is equal to 1/10, or 10 percent, of the total equities: Owner s Equity Total Equities \$1,000 \$10,000 1/ Convert the following fractions into decimals Convert the following decimals into fractions Problem 3 1 Balancing the Accounting Equation Instructions Determine the missing dollar amount indicated by the question mark in each equation. Write each missing amount in your working papers. ASSETS LIABILITIES OWNER S EQUITY 1. \$17,000 \$ 7,000? 2.? \$ 6,000 \$20, \$10,000? \$ 7,000 4.? \$ 9,000 \$17, \$ 8,000 \$ 2,000? 6. \$20,000 \$ 7,000? 7.? \$12,000 \$ 4, \$30,000? \$22, \$22,000 \$ 1,000? 10. \$25,000 \$ 5,000? 11.? \$10,000 \$25, \$ 7,500? \$ 3,000 Section 1 Property and Financial Claims 53

11 Business Transaction 6 Roadrunner issued a check for \$350 in partial payment of the amount owed to its creditor, North Shore Auto. ANALYSIS Identify Classify / Balance 1. The payment decreased the total amount owed to the creditor, so Accounts Payable is affected. Payment was made by check, so the account Cash in Bank is affected. 2. Accounts Payable is a liability account. Cash in Bank is an asset account. 3. Accounts Payable is decreased by \$350. Cash in Bank is also decreased by \$ The accounting equation remains in balance. Assets Liabilities Owner s Equity Cash Accounts Computer Office Delivery Accounts Maria Sanchez, in Bank Receivable Equipment Equipment Equipment Payable Capital Prev. Bal. \$22,000 \$200 \$3,000 \$200 \$12,000 \$12,000 \$25,400 Trans Balance \$21,650 \$200 \$3,000 \$200 \$12,000 \$11,650 \$25,400 Business Transaction 7 Roadrunner received and deposited a check for \$200 from Green Co. The check received is full payment for the telephone sold on account in Transaction 5. ANALYSIS Identify Classify / Balance 1. The check decreases the amount owed to Roadrunner, so Accounts Receivable is affected. A check is given in payment, so Cash in Bank is affected. 2. Accounts Receivable and Cash in Bank are asset accounts. 3. Accounts Receivable is decreased by \$200. Cash in Bank is increased by \$ The accounting equation remains in balance. Assets Liabilities Owner s Equity Cash Accounts Computer Office Delivery Accounts Maria Sanchez, in Bank Receivable Equipment Equipment Equipment Payable Capital Prev. Bal. \$21,650 \$200 \$3,000 \$200 \$12,000 \$11,650 \$25,400 Trans Balance \$21,850 \$0 \$3,000 \$200 \$12,000 \$11,650 \$25,400 As you can see, each business transaction causes a change in assets, liabilities, or owner s equity. Analyzing each transaction to see how it affects the accounting equation keeps everything in balance. 58 Chapter 3 Business Transactions and the Accounting Equation

12 SECTION 2 Assessment AFTER YOU READ Reinforce the Main Idea Create a diagram like the one shown here. For the boxes marked?, fill in the correct labels and give one example of a related account for each category. Do the Math The basic accounting equation is in the form of A L OE 1. What is the algebra equation to find L? 2. What is the algebra equation to find OE? Using the rules of algebra, determine the missing dollar amount in each equation. Assets Liabilities Owner s Equity? \$9,000 \$21,000 \$25,000? \$11,000 \$10,000 \$2,000? Problem 3 2 Determining the Effects of Transactions on the Accounting Equation Instructions Use these accounts to analyze the business transactions of WordService. Assets Liabilities Owner s Equity Cash in Bank Accounts Receivable Computer Equipment Office Furniture Accounts Payable Jan Swift, Capital On the form provided in your working papers, identify the accounts affected by each transaction and the amount of increase or decrease in each account. Make sure the accounting equation is in balance after each transaction. 1. Jan Swift, owner, deposited \$30,000 in the business checking account. 2. The owner transferred to the business a desk and chair valued at \$ WordService issued a check for \$4,000 for the purchase of a computer. 4. The business bought office furniture on account for \$5,000 from Eastern Furniture. 5. The desk and chair previously transferred to the business by the owner were sold on account for \$ WordService wrote a check for \$2,000 in partial payment of the amount owed to Eastern Furniture Company. Section 2 Transactions That Affect Owner s Investment, Cash, and Credit 59

15 AS READ YOU In Your Own Words Withdrawal Explain how a withdrawal decreases owner s equity. withdrawal. Withdrawals and investments have opposite effects. A withdrawal decreases both assets and owner s equity. A withdrawal is not the same as an expense. Both decrease owner s equity, but each represents a different transaction. An expense is the price paid for goods and services used to operate a business. For example, a gardening service purchases fertilizer and lawncare supplies to conduct daily operations. Withdrawals by the owner are cash or other assets taken from the business for the owner s personal use. Transaction 10 illustrates the impact of a withdrawal on the accounting equation. Business Transaction 10 Maria Sanchez withdrew \$500 from the business for her personal use. ANALYSIS Identify Classify / Balance 1. A withdrawal decreases the owner s claim to the assets of the business, so Maria Sanchez, Capital is affected. Cash is paid out, so the Cash in Bank account is affected. 2. Maria Sanchez, Capital is an owner s equity account. Cash in Bank is an asset account. 3. Maria Sanchez, Capital is decreased by \$500. Cash in Bank is decreased by \$ The accounting equation remains in balance. Assets Liabilities Owner s Equity Cash Accounts Computer Office Delivery Accounts Maria Sanchez, in Bank Receivable Equipment Equipment Equipment Payable Capital Prev. Bal. \$22,350 \$0 \$3,000 \$200 \$12,000 \$11,650 \$25,900 Trans Balance \$21,850 \$0 \$3,000 \$200 \$12,000 \$11,650 \$25,400 The following summarizes the transactions of this chapter. Can you describe what is happening in each line? Cash Accounts Computer Office Delivery Accounts Owner s in Bank Receivable Equipment Equipment Equipment Payable Equity Prev. Bal Trans. 1 25,000 25,000 Trans Trans. 3 3,000 3,000 Trans. 4 12,000 12,000 Trans Trans Trans Trans. 8 1,200 1,200 Trans Trans Balance \$21,850 \$0 \$3,000 \$200 \$12,000 \$11,650 \$25, Chapter 3 Business Transactions and the Accounting Equation

16 SECTION 3 Assessment AFTER YOU READ Reinforce the Main Idea Use a table like the one shown here to describe four transactions of a home decorating business. Indicate how each transaction affects owner s equity. Do the Math Determine the Cash in Bank balance for Wiemack Landscape Designs after the third transaction that follows. All three transactions occurred on the same day. The Cash in Bank balance before the first transaction was \$10, John Wiemack, the owner, withdrew \$1,000 from personal savings and deposited that amount in the business checking account. 2. Purchased computer equipment for \$5,000; issued a check for 20 percent of the price and agreed to pay the balance at a later date. 3. Issued a check for \$100 to buy tools. Problem 3 3 Determining the Effect of Transactions on the Accounting Equation Instructions Use the accounts of WordService to analyze these business transactions. The beginning balance for each account is shown following the account name. Assets Liabilities Owner s Equity Cash in Bank, \$24,000 Accounts Receivable, \$700 Computer Equipment, \$4,000 Office Equipment, \$5,000 Accounts Payable \$3,000 Jan Swift, Capital \$30,700 On the form provided in your working papers, identify the accounts affected by each transaction and the amount of the increase or decrease for each account. Make sure the accounting equation is in balance after each transaction. 1. Paid \$50 for advertising in the local newspaper. 2. Received \$1,000 as payment for preparing a report. 3. Wrote a \$600 check for the month s rent. 4. Jan Swift withdrew \$800 for her personal use. 5. Received \$200 on account from the person who had purchased the old office furniture. Section 3 Transactions That Affect Revenue, Expense, and Withdrawals by the Owner 63

17 CHAPTER 3 Summary Key Concepts 1. Property is anything of value that a person or business owns and therefore controls. Property is measured in dollars. In accounting, property appears in the records at the amount it cost the owner. Financial claims are the legal rights to property and are also measured in dollars. The relationship between property and financial claims is shown in the following equation: PROPERTY FINANCIAL CLAIMS 2. As it is used in accounting, the term equities refers to the financial claims on assets (property). The two types of equities in a business are creditors financial claims, called liabilities, and the owner s financial claims, called owner s equity. 3. The accounting equation is ASSETS LIABILITIES OWNER S EQUITY Property Financial Claims ASSETS LIABILITIES OWNER S EQUITY Items of value owned by the business Financial claims of creditors Financial claims of owners 4. A business transaction is an economic event that causes a change either an increase or a decrease in assets, liabilities, or owner s equity. The accounting equation remains in balance after each transaction: Assets Liabilities Owner s Equity Cash in Bank Computer Equipment Office Equipment Serge Toblek, Capital Trans. 1 \$15, \$15,000 Trans. 2 \$600 \$600 Balance \$15,000 0 \$600 0 \$15,600 Trans. 3 \$3,000 \$3,000 Balance \$15,000 \$3,000 \$600 \$3,000 \$15,600 \$18,600 \$18, Chapter 3 Summary

18 Summary CHAPTER 3 The following table shows the effects of typical business transactions on the parts of the accounting equation. Transaction Assets Effects On: Liabilities Owner s Equity Investment of cash by owner Investment of property Cash payment for office equipment Purchase of an asset on account Sale of office equipment on account Make a payment on account Record revenue from a cash sale Record a cash payment for an expense Record a cash withdrawal by the owner,, 5. Use the following steps to analyze a business transaction: ANALYSIS Identify Classify / Balance 1. Identify the accounts affected. 2. Classify the accounts affected. 3. Determine the amount of increase or decrease for each account affected. 4. Make sure the accounting equation remains in balance. Key Terms account (p. 54) accounting equation (p. 52) accounts payable (p. 55) accounts receivable (p. 54) assets (p. 51) business transaction (p. 54) credit (p. 51) creditor (p. 51) equities (p. 52) expense (p. 60) financial claim (p. 50) investment (p. 55) liabilities (p. 52) on account (p. 57) owner s equity (p. 52) property (p. 50) revenue (p. 60) withdrawal (p. 62) Chapter 3 Summary 65

19 CHAPTER 3 Review and Activities AFTER YOU READ Check Your Understanding 1. Property and Financial Claims a. Define the terms property and financial claim. b. What is the relationship between property and financial claims? 2. Equities a. Describe the relationship between assets and equities. b. Name the two types of equities in a business, and give an example of an account that is used for each type. 3. The Accounting Equation a. What is the accounting equation? b. Give an example of an account for each part of the accounting equation. 4. Effects of Transactions a. What is a business transaction? b. How does each of the following transactions affect the three parts of the accounting equation? Trans. 1: Owner transferred cash from personal savings account to the business. Trans. 2: Owner withdrew cash from the business for personal use. Trans. 3: Purchased equipment for cash. Trans. 4: Purchased equipment on credit. Trans. 5: Issued a check for the first monthly payment for equipment purchased in Transaction 4. Trans. 6: Received payment on the date of service for design consulting. Trans. 7: Issued a check to pay the telephone bill. 5. Accounting Equation in Balance a. At least how many accounts must be affected by each business transaction? Why? b. Describe the four-step process described in this chapter used to analyze business transactions. Apply Key Terms Which of the following terms can be considered assets? Which terms relate to liabilities? Which terms do not fall easily into either category? accounts payable accounts receivable credit creditor expense investment on account property revenue withdrawal 66 Chapter 3 Review and Activities

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