MGMT 101 - Chapter 2 Analyzing Transactions - The Accounting Equation

What is the input phase all about?

Business transactions (i.e., economic events that have a direct impact on the business) provide the necessary input for the accounting information system

What are some examples of business transactions?

Buying goods, paying for services, selling goods, providing services, buying and selling assets, lending and borrowing money

Why is the financial statement named the balance sheet?

Called the balance sheet because it confirms that the accounting equation is in balance

What are liabilities?

Debts or obligations of the business that can be paid with cash, goods, or services (i.e., something that is owed to another business entity with the amount being owed representing the probable future outflow of assets as a result of a past event or transaction)

What happens when there is the payment of a loan?

Decrease in Asset offset by a decrease in Liability

Paid rent for a month in cash

EXP ↓A & ↓OE

Paid telephone bill for a month in cash

EXP ↓A & ↓OE

Payment of employee wages in cash

EXP ↓A & ↓OE

When analyzing business transactions what is always increased or decreased?

Each business transaction always increases or decreases specific asset, liability, or owner's equity accounts

When analyzing business transactions what holds true concerning the number of accounts affected?

Each transaction affects at least two accounts and one or more of the three basic accounting elements (i.e. assets, liabilities, owner's equity)

What is a business transaction?

Economic event that has a direct impact on the business

Concerning the output phase, what equation is used on the statement of owner's equity

Ending Capital = Beginning Capital + Investments + Net Income - Withdrawals

During the output phase which total (i.e., indicated with a double rule) moves from the statement of owner's equity to the balance sheet?

Ending capital

When are expenses incurred?

Expenses are incurred as assets are consumed (i.e., supplies) or services are provided (i.e. by the employees for the business)

What affect do expenses have on assets and liabilities?

Expenses can cause a reduction in assets or an increase in liabilities (i.e. wages earned by employees if paid, the expense reduces owner's equity and an asset, cash, if not paid, then expense reduces owner's equity and increases a liability, wages payable either way owner's equity is reduced)

What are expenses?

Expenses represent the decrease in assets (or increase in liabilities) as a result of a company's efforts to produce revenues (i.e., rent, salaries, supplies consumed , and taxes)

What are some of the separate accounts used to recognize different types of revenue?

Fees (either consulting, delivery, etc.), rent revenue (if the business rents space to others), interest revenue (for interest earned on bank deposits), and sales (for sales of merchandise to customers)

What are the steps in analyzing a business transaction?

First understand the economic substance of events, then determine how that information is entered into the accounting system

On the income statement, how do some companies list their expenses?

From highest to lowest dollar amount (with miscellaneous expenses listed last)

On the balance sheet how are liabilities listed?

From most current to least current

On the balance sheet how are assets listed?

From most liquid to least liquid (i.e., liquidity measures the ease with which the asset will be converted to cash

What do single rules (single underlines) and double rules (double underlines) indicate when used on financial statements?

Single rules indicate that the numbers above the line have been added or subtracted and double rules indicate a total

Withdrawal of assets from company in cash

WITH ↓A & ↓OE

What three basic questions must be answered when analyzing the effect of a business transaction on the accounting equation?

What happened, which accounts are affected, how is the accounting equation affected

When do most businesses recognize revenues?

When earned even if cash has not yet been received (important to remember that revenues do not always increase cash right away and expenses do not always reduce cash right away)

What are withdrawals?

Withdrawals (aka drawing) represent the result of the owner taking cash or other assets out of the business for personal use (since earnings are expected to offset withdrawals, this reduction is viewed as temporary)

Delivery revenues earned on account

↑A(accounts receivable) & ↑OE(revenues)

Delivery revenues made in cash and on account

↑A(cash) & ↑A(accounts receivable) ↑OE(revenues)

Cash receipts from prior sales on account

↑A(cash) & ↓A(accounts receivable)

Purchase of an asset (making a partial payment) on account

↓A(cash) & ↑A(equipment) & ↑L(accounts payable)

Payment of insurance premium in cash

↓A(cash) & ↑A(prepaid insurance)

Purchase of supplies in cash

↓A(cash) & ↑A(supplies)

Concerning the output phase, what equation is used on the balance sheet?

Assets = Liabilities + Owner's Equity

What are the three elements of accounting?

Assets, liabilities, and owner's equity

What are three key accounting elements of every business entity?

Assets, liabilities, and owner's equity

What are some characteristics of a business transaction?

Almost always requires an exchange between the business and another outside entity and must be able to measure the exchange in dollars

What happens when there is an investment by the owner of a company?

An increase in Asset if offset by an increase in Owner's Equity

What happens when there is the purchase of an asset for cash?

An increase in Asset offset by a Decrease in another Asset (i.e., cash)

What happens when there is the purchase of an asset on account (aka credit)?

An increase in Asset offset by an increase in a Liability

What does net loss have to do with revenues and expenses?

If total expenses are greater than total revenues for the period, the excess is a net loss for the period

What does net income have to do with revenues and expenses?

If total revenues are greater than total expenses for the period the excess is the net income (aka net profit) for the period

What are three financial statements commonly prepared by a business entity?

Income statement, statement of owner's equity, balance sheet

What are the three basic phases of the accounting process?

Input, processing, output

What are assets?

Items that are owned by a business and will provide future benefits such as cash, merchandise, furniture, fixtures, machinery, buildings, land, and accounts receivable (which represents the amount of money owed to the business by its customers as a result of making sales on credit meaning that the customers will pay sometime in the future

Concerning the output phase, what equation is used on the income statement?

Net Income = Revenues - Expenses

What is the most important number on the income statement that has a double rule underneath it and is located at the bottom of the income statement?

Net income (aka the "Bottom Line")

During the output phase which total (i.e., indicated with a double rule) moves from the income statement to the statement of owner's equity?

Net income (or net loss)

Delivery revenues earned in cash

REV ↑A & ↑OE

What is the processing phase all about?

Recognizing the effect of business transactions on the assets, liabilities, owner's equity, revenues and expenses of a business (i.e., identify accounts, classify accounts, determine whether increase or decrease, enter transaction and verify balance)

What is the balance sheet?

Report of assets, liabilities, and owner's equity on a specific date

What is the statement of owner's equity?

Report of the beginning capital plus net income less withdrawals to compute ending capital

What is the income statement?

Report of the profitability of business operations for a specific period of time

What affect do revenues have on the accounting equation?

Revenues increase both assets and owner's equity

How do revenues, expenses, and withdrawals affect owner's equity in the accounting equation?

Revenues increase owner's equity, expenses and withdrawals reduce owner's equity

What are revenues?

Revenues represent the amount a business charges customers for products sold or services performed (customers generally pay with cash or a credit card, or they promise to pay at a later date)

What are three additional accounting elements needed to be examined in addition to assets, liabilities, and owners' equity in order to expand the accounting equation?

Revenues, expenses, and withdrawals

What is a simple way to remember the accounting equation?

The acronym ALOE (i.e., Assets = Liabilities + Owner's Equity)

What is owner's equity?

The amount by which the business assets exceed the business liabilities (i.e., if there are no business liabilities, then owner's equity (aka net work or capital) is equal to the total assets

What is the accounting period concept?

The concept that income determination can be made on a periodic basis (i.e., the owner can determine the time period used in the measurement of net income or net loss, it may be a month, a quarter (three months), a year, or some other time period)

What does the accounting equation reflect?

The fact that both outsiders and insiders have an interest in the assets of a business (i.e., liabilities represent the outside interests of creditors and owner's equity represents the inside interests of owners)

What is the output phase all about?

The financial statements (i.e. income statement, statement of owner's equity, and balance sheet) are the output of the accounting information system and are prepared primarily for users not associated with the company and therefore follow a standard form with attention to placement, spacing, and indentations

What is different about the dates in the financial statement header for income statement, statement of owner's equity and balance sheet?

The income statement and statement of owner's equity provide information concerning events over a period of time (i.e., "For Month Ended June 30, 2016") while the balance sheet offers a picture of the business on a specific date (i.e., "June 30, 2016")

What do the left-hand side and right-hand side of the accounting equation represent?

The left-hand side represents the assets of the company, the right-hand side shows where the money came from to purchase the assets

What is the accounting equation?

The relationship between the three basic accounting elements (assets, liabilities, and owner's equity) expressed in the form of a simple equation

What information is used to prepare the financial statements?

The transaction information gathered and summarized in the accounting equation (i.e., a summary of the specific revenue and expense transactions and the ending totals for the asset, liability, capital, and drawing accounts from the accounting equation)

Do transactions always have to affect both sides of the accounting equation?

There are times when transactions only affect one side of the accounting equation, however two accounts will always be affected by any transaction

How do business transactions affect the accounting equation?

Through specific accounts (a separate record used to summarize changes in each asset, liability, and owner's equity of a business)

What are the two main purposes of recognizing an expense?

To keep track of the amount and types of expenses incurred and to show the reduction in owner's equity

What is required information that must be included in the header of financial statements?

name of company, title of statement, time period covered (or the date of the statement)