ANALYZING TRANSACTIONS: THE ACCOUNTING EQUATION

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CHAPTER 2

ANALYZING TRANSACTIONS: THE ACCOUNTING EQUATION

REVIEW QUESTIONS

• It is necessary to distinguish between business assets and liabilities and nonbusiness assets and

liabilities of a single proprietor because, according to the business entity concept, nonbusiness assets and liabilities are not included in the business entity’s accounting records. These distinctions allow the owner to make decisions based on the financial condition and results of the business apart from nonbusiness activities.

• The six major elements of the accounting equation are listed below.
• Assets are items owned by a business that will provide future benefits.
• Liabilities are items owed to another business.
• Owner’s equity is the amount by which the business assets exceed the business liabilities. Other

terms used for owner’s equity include net worth and capital.

• Revenues represent the amount a business charges customers for products sold or services

performed.

• Expenses represent the decrease in assets (or increase in liabilities) as a result of efforts made to

produce revenues.

• Withdrawals, or drawing, reduce owner’s equity as a result of the owner taking cash or other

assets out of the business for personal use.

• The three basic questions that must be answered when analyzing the effects of a business

transaction on the accounting equation are as follows:

• What happened?
• Which accounts are affected?
• How is the accounting equation affected?
• The function of an income statement is to report the profitability of business operations for a specific

period of time.

• The function of a statement of owner’s equity is to report the investments and withdrawals by the

owner and the profits and losses generated through operating activities for a specific period of time.

• The function of a balance sheet is to report the assets, liabilities, and owner’s equity on a specific

date. It is called a balance sheet because it confirms that the accounting equation is in balance.

• The three basic phases of the accounting process are listed below.

Input—Business transactions are used as input to the accounting process.Processing—The transactions are processed by recognizing their effects on assets, liabilities, owner’s equity, revenues, and expenses.Output—Output from the accounting process is provided in the form of financial statements.

College Accounting 21st Edition Heintz Solutions Manual Visit TestBankDeal.com to get complete for all chapters

6 CHAPTER 2

© 2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.Exercise 2-1A

Item Account Classification Money in bank Cash A Office supplies Supplies A Money owed Accounts Payable L Office chairs Office Furniture A Net worth of owner John Smith, Capital OE Money withdrawn by owner John Smith, Drawing OE Money owed by customers Accounts Receivable A

Exercise 2-2A

Assets = Liabilities + Owner’s Equity

$44,000 = $27,000 + $17,000

$32,000 = $18,000 + $14,000

$27,000 = $ 7,000 + $20,000

Exercise 2-3A

Assets = Liabilities + Owner’s Equity

(a)

27,000

27,000

Bal.

27,000

27,000

(b)

7,500

7,500

Bal.

34,500

7,500

27,000

(c)

(1,600)

1,600

Bal.

34,500

7,500

27,000

(d)

(2,300)

(2,300)

Bal.

32,200

5,200

27,000

Exercise 2-4A

Owner’s Equity

Assets = Liabilities + Capital – Drawing + Revenues – Expenses

Description Bal.from

E 2-3A

(d)

32,200)

5,200

27,000

(e) 1,500) 1,500 Service fees (f) (600) (600) Rent expense g (64) (64) Telephone exp.(h) (1,000) (1,000) (i) 750) 750 Service fees (j) (1,200) (1,200) Wages expense (k) 400) (400) Bal. 31,586) 5,200 27,000 (1,000) 2,250 (1,864)

Total Assets $31,586 Total Liabilities $ 5,200

Capital 27,000

Drawing (1,000)

Revenues 2,250

Expenses (1,864)

Total Liabilities and Owner’s Equity $31,586

CHAPTER

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© 2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

8 CHAPTER 2

© 2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.Exercise 2-5A

Account Classification Financial Statement Cash A BS Rent Expense E IS Accounts Payable L BS Service Fees R IS Supplies A BS Wages Expense E IS Ramon Martinez, Drawing OE SOE Ramon Martinez, Capital OE SOE, BS Prepaid Insurance A BS Accounts Receivable A BS

Exercise 2-6A Betsy Ray’s Accounting Service Statement of Owner’s Equity For Month Ended June 30, 20--

Betsy Ray, capital, June 1, 20-- $20,000 Investment during June 20,000 Total investment $20,000 Net income for June $10,000 Less withdrawals for June 8,000 Increase in capital 2,000 Betsy Ray, capital, June 30, 20-- $22,000