The Basic Accounting Equation

 Assets = Liabilities + Stockholders’ Equity

 ASSETS: Probable future economic benefits obtained or controlled by entity, are

resources owned by a business.

 LIABILITIES: Probable future sacrifices of economic benefits arising from present

obligations of entity to transfer assets or provide services to other entities in the future as a
result of past transactions or events.

 STOCK Holder’s Equity: The ownership claim on total assets, It equal to total
assets minus total liabilities.

 INVESTMENTS BY OWNERS: Increases in net assets of enterprise resulting

from transfers By Owner.

 DISTRIBUTIONS TO OWNERS: Decreases in net assets of a particular

enterprise resulting from transferring assets by the enterprise to owners.

 REVENUES: the gross increases in stockholder’s equity that result from operating the
business.

 EXPENSES: the decreases in stockholders’ equity that result from operating the business.
 When revenues exceed expenses, net income results.
 When expenses exceed revenues, a net loss results.

 GAINS. Increases in equity (net assets) from peripheral or incidental transactions

 LOSSES. Decreases in equity (net assets) from peripheral or incidental transactions

6
Demonstration Problem:
¤ The following business transactions occur during Soft byte’s first month of operations.
TRANSACTION (1) Ray Neal starts a smart phone app development company which he names
Softbyte. On September 1, 2017, he invests $15,000 cash in the business.
TRANSACTION (2) Soft-byte purchases computer equipment for $7,000 cash.
TRANSACTION (3) Soft-byte purchases for $1,600 from Mobile Solutions headsets and other
computer accessories expected to last several months. Mobile Solutions agrees to allow Softbyte to
pay this bill in October.
TRANSACTION (4) Soft-byte receives $1,200 cash from customers for app development services
it has performed.
TRANSACTION (5) Soft-byte receives a bill for $250 from the Daily News for advertising on its
online website but postpones payment until a later date.
TRANSACTION (6) Soft-byte performs $3,500 of app development services for customers. The
company receives cash of $1,500 from customers, and it bills the balance of $2,000 on account.
TRANSACTION (7) Soft-byte pays the following expenses in cash for September: office rent
$600, salaries and wages of employees $900, and utilities $200.
TRANSACTION (8) Soft-byte pays its $250 Daily News bill in cash.
TRANSACTION (9) Soft-byte receives $600 in cash from customers who had been billed for
services [Transn (6)].
TRANSACTION (10) Ray Neal withdraws $1,300 in cash from the business for his personal use.

Required:
»Summarizes the September transactions of Soft-byte to show their cumulative effect on the
basic accounting equation.

7
 Cash AR Supplies Equipment AP Capital Drawing Revenue Expenses Notes
1 15000 0 0 0 0 15000 0 0 0 Initial
investment
2 -7000 0 0 7000 0 0 0 0 0
3 0 1,600 0 1600 0 0 0 0
4 1200 0 0 0 0 0 0 1200 0 Service
Revenue
5 0 0 0 0 250 0 0 0 -250 Advertisin
Expense
6 1500 2000 0 0 0 0 0 3500 0 Service
Revenue
7 -600 0 0 0 0 0 0 0 -600 Rent
Expense
-900 0 0 0 0 0 0 0 -900 Salaries
Wages
Expense
-200 0 0 0 0 0 0 0 -200 Utilities
Expense
8 -250 0 0 -250 0 -1300 0 0 Drawings

9 600 -600
1 1,300
0
8,050 1,400 1,600 7,000 1,600 15,000 -1,300 4,700 -1,950

18,050 18,050

8
 DO IT!
Transactions made by Virmari & Co., a public accounting firm, for the month of August are shown
below. Prepare a tabular analysis which shows the effects of these transactions on the expanded
accounting equation, similar to that shown in Illustration 1-8.
1. The owner invested $25,000 cash in the business.
2. The company purchased $7,000 of office equipment on credit.
3. The company received $8,000 cash in exchange for services performed.
4. The company paid $850 for this month’s rent.
5. The owner withdrew $1,000 cash for personal use.

9
 Questions:
Question: 1 Liabilities
A. are future economic benefits.
B. are existing debts and obligations.
C. possess service potential.
D. are things of value used by the business in its operation.
Question: 2 Liabilities of a company would not include
A. notes payable.
B. accounts payable.
C. salaries and wages payable.
D. cash.
Question: 3 Liabilities of a company are owed to
A. debtors.
B. benefactors.
C. creditors.
D. underwriters.
Question: 4 Owner's equity can be described as
A. creditorship claim on total assets.
B. ownership claim on total assets.
C. benefactor's claim on total assets.
D. debtor claim on total assets.
Question: 5 Revenues would not result from
A. sale of merchandise.
B. initial investment of cash by owner.
C. performance of services.
D. rental of property.
Question: 6 Sources of increases to owner's equity are
A. additional investments by owners.
B. purchases of merchandise.
C. withdrawals by the owner.
D. expenses.
Question: 7 Owner's equity is decreased by all of the following except
A. owner's investments.
B. owner's withdrawals.
C. expenses.
D. owner's drawings.

10
Question: 8 A net loss will result during a time period when
A. liabilities exceed assets.
B. drawings exceed investments.
C. expenses exceed revenues.
D. revenues exceed expenses
Question: 9 If total liabilities decreased by $40,000 and owner’s equity increased by $30,000
during a period of time, then total assets must change by what amount and direction during
that same period?
A. $50,000 decrease
B. $10,000 decrease
C. $10,000 increase
D. $50,000 increase
Question: 10 Collection of a $1,500 Accounts Receivable
A. increases an asset $1,500; decreases an asset $1,500.
B. increases an asset $1,500; decreases a liability $1,500.
C. decreases a liability $1,500; increases owner's equity $1,500.
D. decreases an asset $1,500; decreases a liability $1,500.
Question: 11 If services are rendered for credit, then
A. assets will decrease.
B. liabilities will increase.
C. owner's equity will increase.
D. liabilities will decrease.
Question: 12 If expenses are paid in cash, then
A. assets will increase.
B. liabilities will decrease.
C. owner's equity will increase.
D. assets will decrease

11
 The four financial statements and how they are prepared
1. An income statement presents the revenues and expenses and resulting net income or net loss for
a specific period
2. An owner’s equity statement summarizes the changes in owner’s equity for a specific period of time.
3. A balance sheet reports the assets, liabilities, and owner’s equity at a specific date.
4. A statement of cash flows summarizes information about the cash inflows (receipts) and
outflows (payments) for a specific period of time.
Softbyte INC
Income Statement
For the month ended of December 2020
Revenue
Service Revenue 4700
Expenses
Salaries and wages Expenses 900
Rent Expense 600
Advertising Expense 250
Utility Expense 200
Total Expenses (1,950)
Net Income 2,750

Softbyte INC
Statement Of Owners Equity
For the month ended of December 2020
Beg Capital 0
Add: Investment 15,000
Add: Net income 2,750
Less: Withdrawals (1,300)
Ending Capital 16,450

Softbyte INC
Statement of Financial Position
For the month ended of December 2020
Assets
Cash 8,050
AR 1,400
Supplies 1,600
Equipment 7,000
Total Assets 18,050
Liabilities
Accounts Payable 1,600
Total Liabilities 1,600
Owner’s Equity
Ending Capital 16,450
Total Liabilities and Equity 18,050
12
 Softbyte INC
Statement of Cash Flows
For the month ended of December 2020
Cash Flows from Operating Activities
Cash Receipts from Revenues 3,300
Cash Payments for Expenses (€1,950)
Net Cash Provided by Operating Activities 1,350

Cash Flows from Investing Activities

Purchase of Equipment (7,000)
Net Cash Provided by Investing Activities (7,000)

Cash Flows from Financing Activities

Investment by Owners 15,000
Withdrawals (1,300)
Net Cash Provided by Financing Activities 13,700

Net increase in Cash 8,050

Add: Beg balance of Cash 0
Cash at the End of The Period 8,050

13
Demonstration Problem:
Legal Services Company was incorporated on July 1, 2014. During the fi rst month of operations,
the following transactions occurred.
1. Shareholders invested NT$10,000,000 in cash in exchange for ordinary shares of Legal Services Company.
2. Paid NT$800,000 for July rent on office space.
3. Purchased office equipment on account NT$3,000,000.
4. Provided legal services to clients for cash NT$1,500,000.
5. Borrowed NT$700,000 cash from a bank on a note payable.
6. Performed legal services for client on account NT$2,000,000.
7. Paid monthly expenses: salaries NT$500,000, utilities NT$300,000, and advertising NT$100,000.
Instructions
(a) Prepare a tabular summary of the transactions.
(b) Prepare the income statement, Owner’s Equity statement, and statement of financial
position at July 31 for Legal Services Company.
Cash AR Equipment NP AP Capital Drawing Revenue Expenses
1 10,000 10,000
2 -800 -800
3 +3,000 +3,000
4 +1,500 +1,500
5 +700 +700
6 +2,000 +2,000
7 -500 -500
-300 -300
-100 -100
10,500 +2,000 +3,000 700 +3,000 +10,000 +3,500 -1,700

15,500 15,500

14
 Exercise: Accounting Equation for a Service Company
Company Name: Tech-Fix Services
Scenario: Below are the business transactions for Tech-Fix Services during its first month of operations. Use the
accounting equation (Assets = Liabilities + Owner's Equity) to record the impact of each transaction.

Transactions:

1. On January 1, 2025, the owner invested $20,000 cash into the business.
2. On January 3, 2025, Tech-Fix Services purchased office supplies for $1,500 on account.
3. On January 5, 2025, the company paid $1,200 for a six-month insurance policy.
4. On January 8, 2025, Tech-Fix Services earned $4,000 for services rendered and received cash immediately.
5. On January 12, 2025, the company performed services worth $2,500 on credit.
6. On January 15, 2025, the company paid $1,000 to settle part of the amount owed for office supplies.
7. On January 18, 2025, the owner withdrew $800 for personal use.
8. On January 20, 2025, Tech-Fix Services received $2,000 cash from the client for services performed on
January 12.
9. On January 25, 2025, the company purchased equipment worth $5,000 by paying $2,000 in cash and signing a
note payable for the balance.
10. On January 30, 2025, Tech-Fix Services incurred utility expenses of $300, paid in cash.

Accounting Equation Exercise Solution for Tech-Fix Services

Date Transaction Description Assets Liabilities and Owner's Equity
1/1/2025 Owner invests cash ($20,000). +$20,000 Cash +$20,000 Capital
1/3/2025 Purchased office supplies on account +$1,500 Supplies +$1,500 Accounts Payable
($1,500).
1/5/2025 Paid insurance ($1,200). -$1,200 Cash -$1,200 Prepaid Expense
1/8/2025 Earned service revenue ($4,000 cash). +$4,000 Cash +$4,000 Revenue
1/12/2025 Performed services on credit ($2,500). +$2,500 Accounts +$2,500 Revenue
Receivable
1/15/2025 Paid $1,000 for supplies purchased on -$1,000 Cash -$1,000 Accounts Payable
account.
1/18/2025 Owner withdrew $800 for personal use. -$800 Cash -$800 Owner’s Withdrawal
1/20/2025 Received $2,000 for services performed +$2,000 Cash, -
earlier. $2,000 Accounts
Receivable
1/25/2025 Purchased equipment ($5,000: $2,000 +$5,000 +$3,000 Notes Payable
cash, $3,000 payable). Equipment, -$2,000
Cash
1/30/2025 Paid utility expenses ($300). -$300 Cash -$300 Expense

15
 Financial Statements for Tech-Fix Services
Income Statement
Description Amount ($)
Revenues 6,500
Expenses -1,500
Net Income 5,000

Statement of Owner's Equity

Description Amount ($)
Owner's Capital, January 1, 2025 20,000
Add: Net Income 5,000
Less: Owner's Withdrawal -800
Owner's Equity, January 31, 2025 24,200

Balance Sheet
Category Description Amount ($)
Assets Cash 20,700
Assets Supplies 1,500
Assets Accounts Receivable 500
Assets Equipment 5,000
Liabilities Accounts Payable 500
Liabilities Notes Payable 3,000
Owner's Equity Total Owner's Equity 24,200

Cash Flow Statement for TechFix Services

Category Amount ($)
Cash Flows from Operating Activities
Cash received from services rendered 6,000
Cash paid for insurance -1,200
Cash paid for utilities -300
Cash paid to suppliers -1,000
Net Cash Flows from Operating Activities 3,500
Cash Flows from Investing Activities
Cash paid for equipment -2,000
Net Cash Flows from Investing Activities -2,000
Cash Flows from Financing Activities
Owner's investment 20,000
Owner's withdrawal -800
Net Cash Flows from Financing Activities 19,200
Net Increase in Cash 20,700
Cash at the Beginning of the Period 0
Cash at the End of the Period 20,700

16
 Test Your Self
Accounting Exercise: Comprehensive Case for a Service Company

Company Name: ProTech Services

Scenario: ProTech Services was established on January 1, 2025, with the purpose of providing IT support services.
The company recorded the following transactions during January 2025:

1. January 1: Owner invested $30,000 cash into the business.

2. January 3: Purchased office equipment for $7,000, paying $4,000 in cash and the remainder on account.
3. January 5: Paid $1,500 for a one-year insurance policy.
4. January 8: Performed services and received $5,500 in cash.
5. January 10: Performed services on credit for $3,200.
6. January 12: Paid $800 for office supplies.
7. January 15: Received $2,000 cash from credit customers.
8. January 18: Paid $1,500 for utilities.
9. January 22: Paid $1,500 on the outstanding balance for the office equipment purchased.
10. January 25: Owner withdrew $1,200 for personal use.

Required:

1. Record the above transactions using the accounting equation.

2. Prepare the following financial statements:
o Income Statement
o Statement of Owner’s Equity
o Balance Sheet
o Cash Flow Statement

17
 Questions:
Question: 1 A balance sheet shows
A. revenues, liabilities, and owner's equity.
B. expenses, drawings, and owner's equity.
C. revenues, expenses, and drawings.
D. assets, liabilities, and owner's equity.
Question: 2 An income statement
A. summarizes the changes in owner's equity for a specific period of time.
B. reports the changes in assets, liabilities, and owner's equity over a period of time.
C. reports the assets, liabilities, and owner's equity at a specific date.
D. presents the revenues and expenses for a specific period of time.
Question: 3 Eli’s Electronic Repair Shop started the year with total assets of $300,000 and
total liabilities of $200,000. During the year, the business recorded $400,000 in electronic
repair revenues, $300,000 in expenses, and Eli withdrew $50,000. Eli's Owner’s Capital
balance at the end of the year was
A.$200,000.
B.$100,000.
C.$150,000.
D.$350,000
Question: 4 The balance sheet is frequently referred to as
A. an operating statement.
B. the statement of financial position.
C. the statement of cash flows.
D. the statement of owner's equity.
Question: 5 All of the financial statements are for a period of time except the
A. income statement.
B. owner's equity statement.
C. balance sheet.
D. statement of cash flows.
Question: 6 Martha Innocenzi Ito began the Innocenzi Company by investing $75,000 of cash
in the business. The company recorded revenues of $555,000, expenses of $410,000, and had
owner drawings of $30,000. What was Innocenzi’s net income for the year?
A.$115,000.
B.$145,000.
C.$175,000.
D.$190,000

18
Question: 7 Foxes Service Shop started the year with total assets of $320,000 and total
liabilities of $240,000. During the year, the business recorded $630,000 in revenues, $450,000 in
expenses, and owner drawings of $60,000.Owner’s equity at the end of the year was
A. $80,000.
B. $200,000.
C. $310,000.
D. $370,000.
Question: 8 Mirah Company compiled the following financial information as of December 31,
2016:
Revenues $340,000
Owner’s Capital (1/1/16) 140,000
Equipment 80,000
Expenses 240,000
Cash 90,000
Owner’s Drawings 20,000
Supplies 20,000
Accounts payable 40,000
Accounts receivable 70,000
Mirah’s assets on December 31, 2016 are
A. $190,000.
B. $260,000.
C. $360,000.
D.$ 480,000.
Mirah’s owner’s equity on December 31, 2016 is
A. $100,000.
B. $140,000.
C. $220,000.
D. $260,000
Question: 9 International standards are developed by the
A. IFRS.
B. GAAP.
C. IASB.
D. FASB.
Question: 10 U.S. standards are developed by the
A. IFRS.
B. GAAP.
C. IASB.
D. FASB

19