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FINANCIAL ACCOUNTING
BASICS
G. Transaction Analysis
H. Balance Sheet Changes
I. Accounting Conventions
Practice Exercise - at the end of Part Two there is an exercise that you should complete before proceeding to Part Three
(Once you have completed this exercise, you can compare your results with the solution available on
Blackboard)
G. TRANSACTION ANALYSIS
Every business transaction can be analyzed in terms of its effect on
Assets, Liabilities, and Equity. What combinations are possible,
given that the balance sheet equation must remain in balance?
A = L + E Sample Transaction
1. + + • Company borrows cash from bank (+ Cash, + Bank Loan Payable) • Purchases inventory on account (+ Inventory, + Account Payable)
2. + + • Investors purchase common stock from company (+ Cash, + Common Stock)
3. +, -
• Cash purchase of equipment (+ Equipment, - Cash)• Collection of account receivable (+ Cash, - Accounts Receivable)
G. TRANSACTION ANALYSIS (cont)
5. - - • Company pays dividend to stockholders (- Cash, - Retained earnings)
6. + - • Company purchases stock from stockholder, will pay in future (- Common Stock, + Payable to Stockholder)
4. - - • Company pays bank loan (- Loan Payable, - Cash)• Pays account payable to supplier (- Account Payable, - Cash)
A = L + E Sample Transaction
7. - + • Liability is converted into equity investment, e.g., convertible bonds are converted into common stock (- Bonds Payable, + Common Stock)
G. TRANSACTION ANALYSIS (cont)
8. +,-
• Company incurs new liability to pay existing liability, e.g., account payable to supplier is converted into long-term note payable (- Account Payable, + Note Payable)
Combinations 1 – 5 are most common; 6 – 9 are rare
A = L + E Sample Transaction
9. +,-
• Company distributes stock dividend to stockholders (+ Common Stock, - Retained Earnings)
Next, we will analyze the effect that each of a series of transactions has on a company’s balance sheet.
H. BALANCE SHEET CHANGES
ABC CompanyBalance Sheet
January 2, Year 1
Assets Liabilities and Equity
Assets Liabilities and Equity
Cash $10,000 Paid-in capital $10,000 Total $10,000 Total $10,000
2. On January 3, ABC Company borrows $5,000 from Multi Bank.
ABC CompanyBalance Sheet
January 3, Year 1
Cash $15,000 Note payable $ 5,000 Paid-in capital 10,000Total $15,000
Total $15,000
1. On January 2, owners invest $10,000 in ABC Company to begin the business.
H. BALANCE SHEET CHANGES (cont)3. On January 5, ABC Company purchases $8,000 of inventory from suppliers, on
account. Payment will be made on January 10.
ABC CompanyBalance Sheet
January 5, Year 1
Assets Liabilities and Equity
Inventory 8,000
Accounts payable $ 8,000 Cash $15,000
Total $23,000
Note payable 5,000 Paid-in capital 10,000
Total $23,000
4. On January 9, ABC Company sells inventory that cost $2,000 for $2,500 in cash. ABC Company
Balance SheetJanuary 9, Year 1
Assets Liabilities and EquityCash $17,500
Note payable 5,000 Accounts payable $ 8,000
Paid-in capital 10,000Retained earnings 500
Total $23,500
Inventory 6,000
Total $23,500
H. BALANCE SHEET CHANGES (cont)5. On January 10, ABC Company pays for inventory purchased on January 5.
6. On January 12, ABC Company sells inventory that cost $4,000 for $5,000, on account. Payment will be received on January 31.
ABC CompanyBalance Sheet
January 12, Year 1
ABC CompanyBalance Sheet
January 10, Year 1
Assets Liabilities and Equity
Assets Liabilities and Equity
Cash $ 9,500 Inventory 6,000
Total $15,500
Note payable $ 5,000 Paid-in capital 10,000
Retained earnings 500
Total $15,500
Cash $ 9,500
Accts receivable 5,000 Inventory 2,000
Total $16,500
Note payable $ 5,000
Paid-in capital 10,000
Retained earnings 1,500
Total $16,500
H. BALANCE SHEET CHANGES (cont)7. On January 31, ABC Company collects the account receivable in cash.
ABC CompanyBalance Sheet
January 31, Year 1
Assets Liabilities and EquityCash $14,500
Inventory 2,000
Total $16,500
Note payable $ 5,000Paid-in capital 10,000
Retained earnings 1,500Total $16,500
I. ACCOUNTING CONVENTIONS
1. Preparing a new balance sheet after each transaction is cumbersome. 2. Instead, changes in balance sheet amounts are reflected in “accounts”. 3. Any balance sheet account can be increased and decreased. 4. Accountants often use “T accounts” to summarize the effects of transactions. 5. The Cash T account for ABC Company is shown below.
+ Cash -
Balance, Jan 1 01. Jan 2 10,0002. Jan 3 5,0004. Jan 9 2,500
8,000 5. Jan 107. Jan 31 5,000
22,500 8,000
Balance, Jan 31 14,500
I. ACCOUNTING CONVENTIONS
6. Accounting Conventions a. Assets (including cash) are: increased by making entries
on the left side of the account and
decreased by making entries on the right side of the account
b. Liabilities and equity are: increased by making entries
on the right side of the account and
decreased by making entries on the left side of the account
Assets = Liabilities + Equity
+ - - + - +
c. If right side entries equal left side entries when each transaction is recorded, then A = L + Ed. Left side entries are called debits and right side entries are called
creditse. To make sure that A = L + E after each transaction, for each
transaction debits must equal credits
PRACTICE EXERCISE
On the next page, make the “T-account” entries necessary to account for transactions 1 - 7.
For each entry, make sure that debits equal credits.
PRACTICE EXERCISE (cont)
Cash Inventory
Note Payable
Paid-in Capital Retained Earnings
Accounts Receivable
Accounts Payable
End of Part Two