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1 Accounting in Action

Learning Objectives

Analyze the effects of business transactions on the accounting

4 equation.

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LEARNING Analyze the effects of business transactions
OBJECTIVE
4
on the accounting equation.
Transactions (business transactions) are a business’s
economic events recorded by accountants.

❑ May be external or internal.

External transactions are economic events between the
company and some outside enterprise.

For example, Campus Pizza’s purchase of cooking

equipment from a supplier, payment of monthly rent to the
landlord, and sale of pizzas to customers are external
transactions.

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LEARNING Analyze the effects of business transactions
OBJECTIVE
4
on the accounting equation.

Internal transactions are economic events that occur

entirely within one company.

For Example, the use of cooking and cleaning supplies

are internal transactions for Campus Pizza.

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LEARNING Analyze the effects of business transactions
OBJECTIVE
4
on the accounting equation.

❑ Not all activities represent transactions.

Companies carry on many activities that do not represent
business transactions.

Examples are hiring employees, responding to e-mails, and

talking with customers.

The company must analyze each event to find out if it affects

the components of the accounting equation. If it does, the
company will record the transaction.

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 Transaction Analysis

Illustration: Are the following events recorded in the accounting

records?
Illustration 1-7
Discuss product
Purchase
Event design with Pay rent
computer
potential customer

Criterion Is the financial position (assets, liabilities, or

owner’s equity) of the company changed?

Record/
Don’t Record

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LEARNING Analyze the effects of business transactions
OBJECTIVE
4
on the accounting equation.

❑ Each transaction has a dual effect on the accounting

equation.

For example, if an asset is increased, there must be a

corresponding (1) decrease in another asset, (2) increase in
a specific liability, or (3) increase in owner’s equity.

Two or more items could be affected. For example, as one

asset is increased $10,000, another asset could decrease
$6,000 and a liability could increase $4,000.

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 Transaction Analysis

➢ Each transaction must be analyzed in terms of its effect

on the components of the basic accounting equation.

➢ The analysis must also identify the specific items

affected and the amount of the change in each item.

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 Transaction Analysis

When recording any transaction we must take care of the

following:
⚫ Don't record personal transactions of the owner or
transactions related to other businesses.
Example: the owner purchased a car for his personal use.

⚫Don't record any asset at the market value – only record

at historical cost (cost).

⚫Don't record non-monetary transactions.

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 Transaction Analysis

To demonstrate how to analyze transactions in terms of the

accounting equation, we will review the business activities of
Softbyte, a smartphone app development company. Softbyte is
the creation of Ray Neal, an entrepreneur who wants to create
focused apps that inspire and engage users of all ages. Ray was
encouraged to start his own business after the success of “Food
Alert,” a customizable app he developed that tracks the daily
location of local food trucks. The following business transactions
occur during Softbyte’s first month of operations.

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 Transaction Analysis

TRANSACTION 1. INVESTMENT BY OWNER Ray Neal decides to start

a smartphone app development company which he names Softbyte. On
September 1, 2017, he invests $15,000 cash in the business.
This transaction results in an equal increase in assets and owner’s equity.

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 TRANSACTION 2. PURCHASE OF EQUIPMENT FOR CASH Softbyte
Inc. purchases computer equipment for $7,000 cash.

4. +1,200 +1,200
5. +250 -250
6. +1,500 +2,000 +3,500
7. -1,700 -600
-900
-200
8. -250 -250
9. +600 -600
10. -1,300 -1,300
$8,050 + $1,400 + $1,600 + $7,000 = $1,600 + $15,000 + $4,700 - $1,950 - $1,300
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 TRANSACTION 3. PURCHASE OF SUPPLIES ON CREDIT
Softbyte Inc. purchases for $1,600 headsets and other
accessories expected to last several months. The supplier allows
Softbyte to pay this bill in October.
This transaction is a purchase on account (a credit purchase).
Assets increase because of the expected future benefits of using
the headsets and computer accessories, and liabilities increase
by the amount due to Mobile Solutions.

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 TRANSACTION 4. SERVICES PERFORMED FOR CASH
Softbyte Inc. receives $1,200 cash from customers for app
development services it has performed.
This transaction represents Softbyte’s principal revenue-
producing activity. Recall that revenue increases owner’s
equity.

4. +1,200 +1,200
5. +250 -250
6. +1,500 +2,000 +3,500
7. -1,700 -600
-900
-200
8. -250 -250
9. +600 -600
10. -1,300 -1,300
$8,050 + $1,400 + $1,600 + $7,000 = $1,600 + $15,000 + $4,700 - $1,950 - $1,300
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 TRANSACTION 5. PURCHASE OF ADVERTISING ON
CREDIT Softbyte Inc. receives a bill for $250 from the
Daily News for advertising on its online website but
postpones payment until a later date.
The cost of advertising is an expense (rather than an asset)
because the company has used the benefits.

4. +1,200 +1,200
5. +250 -250
6. +1,500 +2,000 +3,500
7. -1,700 -600
-900
-200
8. -250 -250
9. +600 -600
10. -1,300 -1,300
$8,050 + $1,400 + $1,600 + $7,000 = $1,600 + $15,000 + $4,700 - $1,950 - $1,300
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 TRANSACTION 6. SERVICES PERFORMED FOR CASH AND
CREDIT. Softbyte performs $3,500 of services. The company receives
cash of $1,500 from customers, and it bills the balance of $2,000 on
account.
Softbyte recognizes $3,500 in revenue when it performs the service. In
exchange for this service, it received $1,500 in Cash and Accounts
Receivable of $2,000. This Accounts Receivable represents customers’
promises to pay $2,000 to Softbyte in future.
4. +1,200 +1,200
5. +250 -250
6. +1,500 +2,000 +3,500
7. -1,700 -600
-900
-200
8. -250 -250
9. +600 -600
10. -1,300 -1,300
$8,050 + $1,400 + $1,600 + $7,000 = $1,600 + $15,000 + $4,700 - $1,950 - $1,300
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 TRANSACTION 7. PAYMENT OF EXPENSES Softbyte
Inc. pays the following expenses in cash for September:
office rent $600, salaries and wages of employees $900,
and utilities $200.

4. +1,200 +1,200
5. +250 -250
6. +1,500 +2,000 +3,500
7. -1,700 -600
-900
-200
8. -250 -250
9. +600 -600
10. -1,300 -1,300
$8,050 + $1,400 + $1,600 + $7,000 = $1,600 + $15,000 + $4,700 - $1,950 - $1,300
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 TRANSACTION 8. PAYMENT OF ACCOUNTS PAYABLE
Softbyte Inc. pays its $250 Daily News bill in cash.
The company previously (in Transaction 5) recorded the bill
as an increase in Accounts Payable.

4. +1,200 +1,200
5. +250 -250
6. +1,500 +2,000 +3,500
7. -1,700 -600
-900
-200
8. -250 -250
9. +600 -600
10. -1,300 -1,300
$8,050 + $1,400 + $1,600 + $7,000 = $1,600 + $15,000 + $4,700 - $1,950 - $1,300
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 TRANSACTION 9. RECEIPT OF CASH ON ACCOUNT
Softbyte Inc. receives $600 in cash from customers who
had been billed for services (in Transaction 6).
Transaction (9) does not change total assets, but it changes the
composition of those assets.

4. +1,200 +1,200
5. +250 -250
6. +1,500 +2,000 +3,500
7. -1,700 -600
-900
-200
8. -250 -250
9. +600 -600
10. -1,300 -1,300
$8,050 + $1,400 + $1,600 + $7,000 = $1,600 + $15,000 + $4,700 - $1,950 - $1,300
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 TRANSACTION 10. WITHDRAWAL OF CASH BY
OWNER Ray Neal withdraws $1,300 in cash from the
business for his personal use.
Owner’s drawings are not expenses. Expenses are incurred for the
purpose of earning revenue. Drawings do not generate revenue. They are
a disinvestment.

4. +1,200 +1,200
5. +250 -250
6. +1,500 +2,000 +3,500
7. -1,700 -600
-900
-200
8. -250 -250
9. +600 -600
10. -1,300 -1,300
$8,050 + $1,400 + $1,600 + $7,000 = $1,600 + $15,000 + $4,700 - $1,950 - $1,300
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 Transaction Analysis

A tabular summary may be prepared to show the cumulative

effect of transactions on the basic accounting equation. The
summary demonstrates that:
a. Each transaction must be analyzed in terms of its
effect on:
(1) the three components of the equation and
(2) specific types of items within each component.

b. The two sides of the equation must always be equal.

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 Notes

✓ If it is given in the transaction that the business billed the

client or submitted a bill, in this case service revenue will
increase and accounts receivables will increase.

✓ If it is given in the transaction that the business received a

bill, in this case accounts payables will increase, and an
expense will increase.

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 Notes

✓ Collected cash on account will increase cash and decrease

accounts receivable.

✓ Paid cash on account will decrease both cash and

accounts payables.

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 Notes

✓ Revenues are recorded when the service is rendered

whether cash received or not.

✓ Expenses are recorded when it is incurred whether cash

paid or not.

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 DO IT! 4 Tabular Analysis

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. The owner invested $25,000 cash in the business.
1. The company purchased $7,000 of office equipment on credit.
2. The company received $8,000 cash in exchange for services
performed.
3. The company paid $850 for this month’s rent.
4. The owner withdrew $1,000 cash for personal use.

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 DO IT! 4 Tabular Analysis

1. The owner invested $25,000 cash in the business.

Assets = Liabilities + Owner's Equity

Trans- Accounts Owner's Owner's
Cash + Equipment = + - + Rev. - Exp.
action Payable Capital Drawings
1. +25,000 +25,000

2. +7,000 +7,000

3. +8,000 +8,000

4. -850 -850

5. -1,000 -1,000

$31,150 + $7,000 = $7,000 + $25,000 + $8,000 - $850 - $1,000

$18,050 $18,050
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 DO IT! 4 Tabular Analysis

2. The company purchased $7,000 of office equipment on credit.

Assets = Liabilities + Owner's Equity

Trans- Accounts Owner's Owner's
Cash + Equipment = + - + Rev. - Exp.
action Payable Capital Drawings
1. +25,000 +25,000

2. +7,000 +7,000

3. +8,000 +8,000

4. -850 -850

5. -1,000 -1,000

$31,150 + $7,000 = $7,000 + $25,000 + $8,000 - $850 - $1,000

$18,050 $18,050
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 DO IT! 4 Tabular Analysis

3. The company received $8,000 cash in exchange for services

performed.
Assets = Liabilities + Owner's Equity
Trans- Accounts Owner's Owner's
Cash + Equipment = + - + Rev. - Exp.
action Payable Capital Drawings
1. +25,000 +25,000

2. +7,000 +7,000

3. +8,000 +8,000

4. -850 -850

5. -1,000 -1,000

$31,150 + $7,000 = $7,000 + $25,000 + $8,000 - $850 - $1,000

$18,050 $18,050
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 DO IT! 4 Tabular Analysis

4. The company paid $850 for this month’s rent.

Assets = Liabilities + Owner's Equity

Trans- Accounts Owner's Owner's
Cash + Equipment = + - + Rev. - Exp.
action Payable Capital Drawings
1. +25,000 +25,000

2. +7,000 +7,000

3. +8,000 +8,000

4. -850 -850

5. -1,000 -1,000

$31,150 + $7,000 = $7,000 + $25,000 + $8,000 - $850 - $1,000

$18,050 $18,050
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 DO IT! 4 Tabular Analysis

5. The owner withdrew $1,000 cash for personal use.

Assets = Liabilities + Owner's Equity

Trans- Accounts Owner's Owner's
Cash + Equipment = + - + Rev. - Exp.
action Payable Capital Drawings
1. +25,000 +25,000

2. +7,000 +7,000

3. +8,000 +8,000

4. -850 -850

5. -1,000 -1,000

$31,150 + $7,000 = $7,000 + $25,000 - $1,000 + $8,000 - $850

$38,150 $38,150
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 MULTIPLE CHOICE QUESTIONS

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.

Solution: (a)
decrease in accounts receivable and increase in cash, which are both assets

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 MULTIPLE CHOICE QUESTIONS

If an owner makes a withdrawal of cash from a

proprietorship, then
a. there has been a violation of accounting principles.
b. owner's equity will increase.
c. owner's equity will decrease.
d. there will be a new liability showing the owner owes
money to the business.
Solution: (c)

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 MULTIPLE CHOICE QUESTIONS

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.

Solution: (c)
revenues increase

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 MULTIPLE CHOICE QUESTIONS
Big Bite Diner received a bill of $800 from the Blackstone
Advertising Agency. The owner, K. T. Lang, is postponing
payment of the bill until a later date. The effect on specific items
in the basic accounting equation is
a. a decrease in Cash and an increase in Accounts Payable.
b. a decrease in Cash and an increase in Owner’s Capital.
c. an increase in Accounts Payable and a decrease in
Owner’s Equity.
d. a decrease in Accounts Payable and an increase in
Owner’s Equity.

Solution: (c)
expenses

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 MULTIPLE CHOICE QUESTIONS

Mellon Company purchases $1,500 of

equipment from Office Equipment Inc. for
cash. The effect on the components of the
basic accounting equation of Mellon
Company is
a. an increase in assets and liabilities.
b. a decrease in assets and liabilities.
c. no change in total assets.
d. an increase in assets and a decrease in
liabilities.
Solution: (c)
because equipment increased by 1500 and cash decreased by 1500, both are assets so no change in assets

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 Copyright

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