Chapter 1 Section 2

1. Chapter 1 Section 2 Business Transactions that Change the Accounting Equation

2. Equity • EQUITY is the financial rights to the assets of a business. • What does this mean? • If a business closes, its liabilities or debts must be paid before the owner(s) can claim any assets. • Individuals, financial institutions or other businesses who lent money or services to the owner(s) have shared equity in the business with the owner(s).

3. Equity - continued • If a business’s assets are insufficient to cover all liabilities, the owner(s) cannot claim any assets of the business. • Consider the following INDIVIDUAL example: If you borrow money to buy a car, and stop making regular monthly payments to the financial institution who lent you the money, what happens? Do you continue to drive the car? What about the payments you already made?

4. Commutative Property & The Accounting Equation • People and businesses both usually have multiple assets and liabilities. Individuals Businesses

5. Commutative Property & The Accounting Equation • The accounting equation (A = L + OE) MUST be balanced atalltimes. • The Commutative Property states that values may be ordered in any manner. • Therefore, 1 + 2 + 3 = 3 + 2 + 1 OR 6 = 6. • Furthermore, any variation or combination of the same or similar values will also be true. • 3 + 3 = 1 + 5 OR 2 + 2 + 2 = 2 + 3 and so on.

6. Commutative Property - continued • Asset values are the following: Cash = 6,000; Supplies = 2,500; Prepaid Insurance = 2,000 • Liability values are the following: Accts. Pay. – Ink, Toner & Accessories = 900 and Accts. Pay. – Supplies, Inc. = 1,100 • What is the TOTAL value of Assets? Liabilities? • Calculate Owner’s Equity

7. Do TOTAL Assets equal TOTAL Liabilities AND Owner’s Equity? • (Does 6,000 + 2,500 + 2,000 = 900 + 1,100 + 8,500) • Is the Accounting Equation in balance?

8. Practice • Calculate the unknown amounts to complete the chart. Remember, the equation MUST remain BALANCED.

9. Transactions Change the Accounting Equation • Every day a business is open and serving clients/customers, it is conducting business transactions with the goal of making money. • Each transaction will change the balance of atleastTWOaccounts within the accounting equation. • The accounting equation MUST remain inbalance.

10. Analyzing Transactions – Step 1 TRANSACTION: Received cash from the owner as an investment in the business, 5,000. R1. • Ask yourself, “What two accounts are involved?” Look closely at the transaction and try to match words with account titles or classifications. You may even want to underline, circle or hi-light the appropriate words. EXAMPLE: Received cash from the owner as an investment in the business. R1. Q: What account does cash change? A: Cash Q: What account does owner change? A: Capital

11. Analyzing Transactions – Step 2 2. Now that you know which accounts are involved, determine HOW they are changed. Are the accounts increased or decreased? Transaction: Received cash as an investment in the business, 5,000. R1. If you receive cash, you have more cash, therefore it is increased. If you have more cash you are worth more, therefore capital, or owner’s equity, in also increased. Analysis: Both cash and capital are increased.

12. Analyzing Transactions – Step 3 3. Record the transaction. TRANSACTION: Received cash from the owner as an investment. 5,000. R1. • The transaction above would be recorded as follows:

13. Analyzing Transactions – Step 4 4. Check to see if the accounting equation is still balanced. Do TOTAL assets equal TOTAL liabilities AND owner’s equity?

14. More Common Business Transactions TRANSACTION 2: Bought supplies for cash, 200. C1. • What two accounts are involved? • How is each account changed? • Record the transaction. • Is the accounting equation balanced?

15. Transaction 2 – completed

16. Transaction 3 Transaction 3: Paid cash to buy insurance, 500. C2. • What two accounts are involved? • How is each account changed? • Record the transaction. • Is the accounting equation balanced?

17. Transaction 3 - competed

18. Practice Transaction 1: Received cash from the owner as an investment in the business, 3,000. R1. Transaction 2: Paid cash for insurance, 400. C1 Transaction 3: Paid cash for supplies, 200. C2.

19. Credit Transactions • Businesses and individuals use credit to make purchases. • Businesses typically use credit to purchase supplies or materials which, in turn, are used to sell goods or services to customers/clients for payment/cash greater than the cost of the supplies/materials. • Business then repay the debt and keep the difference as gross profit.

20. Analyzing Credit Transactions • The same four questions used to break down cash transactions are used for credit transactions: • What two accounts are involved? • How is each account changed? • Record the transaction. • Is the accounting equation balanced?

21. Transaction 4 Transaction 4: Bought supplies on account from Ink, Toner & Accessories, 500. M1. • What two accounts are involved? • How is each account changed? • Record the transaction. • Is the accounting equation balanced?

22. Transaction 4 - completed • Why did the balance of A/P – Ink, Toner & Accessories increase? • Is the equation still balanced? • Is the new balance the same as it’s been?

23. Transaction 5 Transaction 5: Bought supplies on account from A/P – Supplies, Inc., 300. M2. • What two accounts are involved? • How is each account changed? • Record the transaction. • Is the accounting equation balanced?

24. Transaction 5 - completed • Why did the balance of A/P – Supplies, Inc. increase?

25. Transaction 6 Transaction 6: Paid cash on account to A/P – Supplies, Inc., 200. M2. • What two accounts are involved? • How is each account changed? • Record the transaction. • Is the accounting equation balanced?

26. Transaction 6 - completed