Equity Transactions and

Accounting Principles

Equity Transactions and Accounting Principles

• We are going to start working more with transaction data for equity accounts.

• Revenues are credited

• Drawings and expenses are debited.

• Why do these make sense?

Let’s look at an example:

• Eve Boa, a lawyer, draws up a legal agreement for J. Basso, a client, and for her services is paid a fee of $450 in cash.

• In the old way, what would changes would we make?

• What changes are made using the new way?

Let’s look at an example:

• Both “Fees Earned” transactions give more assets for the owner to claim.

• This increases equity (so we need credit entries).

• Fees Earned accounts will almost always have a credit balance. Debits to these accounts are VERY rare.

The Revenue Recognition Principle

• Very simple. Revenue needs to be recorded in the accounts at the time the transaction is completed.

• This means crediting the revenue account when the bill or invoice is sent to the customer.

• The law says that sellers have the right to send the bill if the service or good is provided.

• Where does the debit entry go that would balance the transaction?

Revenue Recognition Principle

• So, if the lawyer Eve Boa provides services to B. Singh for $700 (page 147) this principle lets her credit Fees Earned. She does not have to wait for him to pay her.

• What if though…J. Basso pays her for a service that she promises to perform in three months? Can she record it as revenue?

• NO. She still has a lot to do before she has earned that money.

• If she fails to do it…what happens?

• Let’s pretend though…that Eve does take his money but the service is not due for three months.

•What do we do?

•What do we do when Eve performs the service?

Let’s analyse some expense transactions

• Eve Boa writes a $3300 cheque for the monthly rent payment.

• What do we do?

Let’s analyse some expense transactions

• Eve Boa receives the monthly utilities bill for $395 from Municipal Gas. The bill is not paid immediately.

• What do we do this time?

Drawings Transactions

• Cash is the most common item withdrawn by an owner.

• Eve Boa, the owner of the business, withdraws $1975 for her personal use.

• What do we do here?

Drawings Transactions

• Sometimes owners buy things for themselves THROUGH the business.

• Eve Boa buys a coffee maker for herself from Kitchen Plus for $85. She buys it through her business and a bill arrives to the business for $85.

• What do we do?

Drawings Transactions

• Sometimes owners take other assets. Merchandise, computers, furniture, etc.

• Maybe the owner collects a debt and keeps the money. What would we do here?

• There has to be evidence of this, and the accounting clerks

Fiscal Periods

• Knowing revenues is not that useful unless we know the timeline.

• Need to be 12 consecutive months.

• Does not have to match the calendar year.

• There is also Quarterly periods (usually for investors).

The Matching Principle

• This is another simple principle to remember.

• Expense items related to revenue earned have to be recorded in the same period as the revenue that it helped earn.

• If this isn’t done, net income is not accurate.

• If a business buys $30,000 of advertising for a Boxing Day sale on December 26, 2014, and the bill does not get paid until January, what happens?

The Matching Principle

• What about if the sale lasted two weeks, starting on December 26, 2014 and ending on January 10, 2015?

• The advertisement has helped the business earn money in two fiscal periods.

• This means that the expense has to be recorded in both periods.

REVIEW

• Why can you be almost certain that revenue accounts will have a credit balance at the end of a period?

• Give me an example of when you debit a revenue account.

• When does the Revenue Recognition Principle require a transaction to be recorded in the accounts of a business.?

• What must the seller do before sending an invoice to a customer?

• Explain how a seller can record a sale without actually delivering anything!

REVIEW

• When purchasing advertising on credit, why does equity decrease from the debit to an expense account even though no assets have yet left the business?

• What is a fiscal period?

• When explaining the matching principle, a student said “Expenses give up their lives for the sake of earning revenue.” How accurate is that statement?

Exercises

• Going over the following transactions, we have to figure out what is being debited and what is being credited.

• 1. Purchased $400 of supplies for future use and paid cash.

• 2. Reduced the bank loan by $1000.

• 3. Received $800 cash from J. Cheung, a debtor.

• 4. Sold services for $900 cash.

• 5. Sold services on credit to B. Hull, $1500.

Exercises

• 6. Paid the utilities bill that arrived today, $125.

• 7. Mary Hartman, the owner, withdrew $750 cash for personal use

• 8. Paid an employee’s wages, $600.

• 9. Paid $20,000 cash for a new truck.

• 10. Mary Hartman, the owner, took supplies for personal use, $250.