BA1 Lesson #8 - The Accounting Equation and Making Tabular Analysis

On our last topic you have learned how to analyze business transactions and you are able to identify the affected accounts. This time, we will discuss the accounting equation.

It is very important for you to know the accounting equation because at the date of financial statements preparation, your total assets must equal to the sum of your total liabilities and your total capital.

Many times you will encounter a problem that asks for the total liabilities and with a strong grip in this equation, you can find the unknown value.

Below is the equation that must be true all the times. In case your total assets and the sum of total liabilities and total capital do not equal, you must have analyzed a transaction erroneously.

To prove that the accounting equation is true all the times, tabular analysis is done. Note that making tabular analysis is not a part of an accounting process. This is just a tool for beginners to grasp the equation excellently.

Consider the following transactions and check on our tabular analysis how the transactions affect the accounts and how we maintain the truthfulness of the equation.

1.    Invest $250,000 cash, $120,000 worth of equipment and $10,000 worth of office supplies.

2.    Purchase a machine on account $15,000

3.    Rendered services for $1,000 on account

4.    Paid $7,800 for the outstanding account in transaction (b)

5.    Collected the accounts in transaction (c) in full amount

6.    Used $1,500 worth of office supplies

7.    Purchased company’s computer for cash, $25,000

8.    Rendered services for cash, $1,500

9.    The owner withdrew $10,000

10.  The total payroll is $15,000, paid half of it, and accrue the other half

11.  Total of repair expense, telephone bill, and electric bill is $2,500. All are paid.

Click the image to enlarge and see how transactions occur and satisfy the accounting equation

Transactions results to different scenarios and affect the accounting equation. The following are the summary of the possible effects of a transaction in the equation:

1.    Increase in asset, decrease in another asset

2.    Increase in asset, increase in capital

3.    Increase in asset, increase in liability

4.    Decrease in asset, decrease in liability

5.    Decrease in asset, decrease in capital

6.    Increase in liability, decrease in capital

7.    Decrease in liability, increase in capital

8.    Increase in liability, decrease in another liability

9.    Decrease in capital, increase in another capital

Note that this is for illustration purposes and you do not have to memorize these. Making a tabular analysis is easy if you master analyzing transactions. Go and test yourself if you know how to analyze transactions with our problems and exercises. There are also printable exercises for tabular analysis available for you!

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BA Lesson #7 - Analyzing Business Transactions

Welcome to our seventh lesson! From the definition of accounting, to its history, to the generally accepted accounting principles, and lastly to the elements of financial statements, we think that you are well-equipped to jump on this seventh lesson as we discuss Analyzing Business Transactions.

Analyzing business transactions is the number one step for you to grasp the concept of debit and credit or the so-called double-entry system. This is very crucial so take time reading this.

The only thing that you need to do in analyzing business transactions is to identify the elements affected by the transaction. You must identify which accounts increase and which accounts decrease. Let’s look on the following transaction:

a.    NVESTMENT OF CASH

Increase in Cash

Increase in Owner’s Capital

b.    PURCHASE OF EQUIPMENT ON CASH

Increase in Equipment

Decrease in Cash

c.    PURCHASE OF MACHINE ON ACCOUNT

Since you did not use your cash to pay for the machine, it arises to a liability. So the effect would have to be:

Increase in Equipment

Increase in Accounts Payable

d.    RENDERED SERVICES AND RECEIVED CASH PAYMENT

Increase in Cash

Increase in Service Revenue

e.    RENDERED SERVICES ON ACCOUNT

Increase in Account Receivable

Increase in Service Revenue

f.     PAYMENT OF ACCOUNTS RECEIVABLE ON ACCOUNT

Increase in Cash

Decrease in Account Receivable

g.    SETTLEMENT OF ACCOUNTS PAYABLE

Decrease in Account Payable

Decrease in cash

h.    PURCHASE OF OFFICE SUPPLIES ON CASH

Increase in Office Supplies

Decrease in Cash

i.      USE OF OFFICE SUPPLIES

Increase in Office Supplies Expense

Decrease in Office Supplies

j.      WITHDRAWAL OF CASH FOR PERSONAL USE

               Increase Owner’s Drawing

               Decrease Cash

k.    PAID CASH FOR EMPLOYEES SALARIES

Increase Wages Expense

Decrease Cash

            Make sure that before you jump from transaction to another, you have understood it very well. The purpose of this lesson is not for you to memorize the effects. It is just a tool for you to analyze the transaction. Again, do not memorize. Just analyze.

         Now let’s go to more complex illustrations and let us put amounts in the transactions.

a.    The owner invested $100,000

Increase in Cash by 100,000

Increase in Owner’s Capital by 100,000

b.    The entity purchased equipment for $50,000. Half of the amount is paid and half of it is promised to be paid next year.

Increase in Equipment by 50,000

Increase in Note Payable by 25,000

Decrease in Cash by 25,000

Note that we use Note Payable here because the firm signed a promissory note.

c.    Rendered services for $50 and collected half of the bill

Increase in Cash by 25

Increase in Account Receivable by 25

Increase in Service Revenue by 50

Purchased office supplies on account for $1,000

Increase in Office Supplies by 1,000

Increase in Account Payable by 1,000

e.    Used $200 worth of office supplies

Increase in Office Supplies Expense by 200

Decrease in Office Supplies by 200

f.     Collected the balance of the customer from transaction (c)

Increase in Cash by 25

Decrease in Account Receivable by 25

g.    Paid $200 for electric bill

Increase in Electrical Expense by 200

Decrease in Cash by 200

h.    Paid $1,200 for employees’ salaries

Increase in Wages Expense by 1,200

Decrease in Cash by 1,200

i.      Withdrew $60

Increase in Owner’s Drawing by 60

Decrease in Cash by 60

Now we’re done in our analysis! Probably you are ready to the next level. On our next lesson, we will discuss the accounting equation and how to make tabular analysis. Tabular analysis is an effective tool to illustrate that the accounting equation is always true.

You may want to check our free test materials to evaluate yourself. Feel free to print and reproduce it for educational purposes!

PHOTO REFERENCE

http://www.whitleylegalgroup.com/practices/transactions.html

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BA Lesson #6 - Elements of Financial Statements

Hey buddy! You’re on our sixth lesson and today, we will discuss the elements of financial statements. Knowing the elements of financial statements is very vital for you to understand the concept of debits and credits, which is the life of accounting. So let’s get started!

Note that these are just the basic elements of financial statements and we will discuss the remaining on our Intermediate Accounting Lessons.

ASSETS
Assets are economic resources controlled by an entity as a result of past events and from which future economic benefits are expected to flow to the enterprise

Cash

Cash includes not only the bills but also the checks as well.

Prepaid Expense

A prepaid expense is an expense that is paid in advance. Since it is not yet incurred, it is considered as an asset. Common prepaid expenses are prepaid insurance and prepaid rent.

Accounts Receivable

These are your claims against your customers for unpaid bills.

Notes Receivable

These are written promissory notes and are your claims against your customers for unpaid bills. Notes receivables arise as well as the mere transfer of accounts receivable. For example, today is the due date of an account receivable but the customer cannot pay today. As a result, he asked for an extension. This transaction transfers the account receivable into the Notes Receivable account.

Machine, Equipment, Furniture and Fixture, Truck

LIABILITIES

Liabilities are present obligations of an enterprise arising from past transactions, the settlement of which is expected to result in an outflow from the enterprise of resources embodying economic benefit.

Accounts Payable

These are the claims of your creditors against you.

Notes Payable

These are your written promissory notes for your creditors and they usually bear interest.

Unearned Revenue

These are customers’ claim against you as they pay in advance for your future services or products.

CAPITAL OR EQUITY

This is the residual interest of an entity after deducting its liabilities. It is also called as net assets.

Owner’s Equity

It is the claim of an owner in the firm. This account increases as the owner invests cash or properties in the firm.

Drawing Account

It represents the amount withdrawn by the owner for his personal use.

ELEMENTS OF FINANCIAL PERFORMANCE

Income

It is the increase in economic benefits during an accounting period through the enhancements of assets which results in increase in Capital. It may also be resulted from the decreases in liabilities which results in increase in Capital as well.

Expense

It is the decrease in economic benefit during an accounting period in the form of outflows or incurrence of liability that result in decrease in equity. In fact, expense also arises from depletion of assets; however this shall be discussed in our Intermediate Accounting lessons.

LAST WORD

That ends our topic. It is important not just to familiarize yourself from these elements but you shall have memorized them all by heart. In journalizing entries, that is applying the rules of debit and credit, you shall know which elements of financial statements are affected by the transaction. Test yourself if you already know these with our free test materials!

PHOTO REFERENCES

http://www.vandelaydesign.com/accounting-tips/

http://ezylearn.com.au/wordpress/2012/07/ato-says-write-off-6499-of-capital-purchases-in-the-2013-financial-year/

http://www.loscostos.info/financial-accounting/liabilities.html

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BA Lesson #5 - Generally Accepted Accounting Principles

Accounting is very conservative. It requires unity, comparability and understandability. To achieve these, accountants follow Generally Accepted Accounting Principles.

As starting accountancy students, it is very essential for you to know the Generally Accepted Accounting Principles because there are times that you have to intellectually assume principles and treatments in certain scenarios where you have no idea on your head. Shall you recognize this profit/expense immediately or just defer it?

ECONOMIC ENTITY CONCEPT

This principle states that the business is separate and distinct from its owners. Any expenses for the personal good of the owner are not considered as expenses of the business. Suppose a business is situated exactly on the house of the owner, who shall incur the electrical expense? The answer is both because both of the owner and the business benefited from electric consumption. However, there must be an accurate basis as to the proration of the expense.

MONETARY UNIT ASSUMPTION

            Monetary Unit Assumption is the easiest GAAP to understand. It just says that the figures in financial statements are in money terms and they are in the currency of your country. For example, in a financial statements published by a reporting entity in the United States, the figures are in US Dollar. You shall not assume that they are in Canadian Dollar.

GOING CONCERN ASSUMPTION

This assumption explains that the business has an indefinite period of existence unless otherwise it has prima facie evident to the contrary. No matter how much a business incurs loss for consecutive periods, accountants still prepare financial statements.

Going Concern Assumption is also the underlying principle to accrual basis of accounting (See accrual basis). Why would a creditor lend if he knows that a business shall terminate tomorrow or next week? Why shall you record a receivable if you know that you cannot collect it this next month? You could have written it off.

PERIODICITY CONCEPT

Periodicity concept explains the indefinite life of business is divided into equal periods and accountants have to present financial statements at the end of each period. When a period starts in the first of January and ends in the 31^st of December, then it is called as calendar year. When a period is exactly one year, regardless when it started, then it is called as fiscal year. Therefore, a period that starts from the first of January and ends in the 31^st of December is both a calendar year and a fiscal year.

            Entities may also decide to report in less than a year and we call this period as interim period. Interim period can be weekly, bi-weekly, monthly, quarterly and semi-annually.

            Note that the periodicity concept divides the indefinite life of business into equal periods. Dividing it into equal periods gives accurate insights. Do you think you can compare the net income of the financial statements done annually and weekly?

ACCRUAL BASIS OF ACCOUNTING

This is one of the famous generally accepted accounting principles. Accrual basis is the common practice of all accountants. It states that a revenue shall be recorded when realized regardless when it is collected. Because of this, we shall record Accounts Receivable or any appropriate accounts title. On the other hand, it also states that an expense shall be recorded when incurred regardless when it is paid. This assumption gives birth to an account called Accounts Payable or any appropriate accounts.

        Because of accrual basis, there shall be a need for adjusting entries to update the balances of the accrued and deferred accounts. Adjusting entries shall be discussed on our future lesson in Basic Accounting 1.

CASH BASIS OF ACCOUNTING

Cash basis of accounting is considered to be the opposite of the accrual basis. You only record revenue and an expense when collected and paid respectively. This practice is done by tax accountants as they appear to be more accurate in computing the income of the firm and it also gives a more truthful result when it comes to assessing financial performance of an entity.

MATCHING PRINCIPLE

This states that you record an expense upon the record of income or revenue. Matching principle is the underlying principle in accounting for warranties and premiums. For example, you sold a washing machine with warranty certificate. In matching principle of accounting, you must record the warranty expense and the warranty liability immediately from the time of its sale.

OTHER CONSERVATIVE ASSUMPTIONS

When there is no existing generally accepted accounting principles of recording and you are FORCED (note that this is your last resort) to assume among alternative amounts of expense, always choose whichever is higher and among alternative amounts of revenue, always choose whichever is lower. These are more conservative assumptions. To be conservative in accounting, you must always choose which amount likely results to lower revenue.

These are just the basic GAAPs that you need to know in Basic Accounting. We will review these and discuss more accounting principles in our Intermediate Accounting lessons.

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BA1 Lesson #4 - Types of Business as to Activities

Hi there! Welcome to the fourth lesson of The Accounting Buddy. This lesson is just a continuation of our previous topic about the types of business. In our previous lesson, we have discussed the types of business as to organizations namely sole proprietorship, partnership and corporation. This time, we will focus on the types of business as to activity.

The following are the types of business as to activity:

• Servicing
• Merchandising
• Manufacturing

Let’s see their differences.

SERVICING

The first type of business is the Service Type. These are the businesses engaged in rendering their services for a fee. By merely looking at the financial statements of a particular firm, you can identify if it is a service type of business. Usually, it uses the account title Service Revenue. Other alternatives are Professional Fees and Service Income.

Examples of service types of business are laundry shop, schools, massage parlor, barbershop and hospitals.

When it comes to degree of conversion, this type has a moderate to high degree of conversion. For example, if you are rendering your cooking skills, it is not enough to buy the ingredients. You have to slice, to mince, to chop, to boil, to cook and to serve them before you can bill your professional fee.

MERCHANDISING

            Next is the Merchandising type. This sells finished goods and items at higher profits. If the service type uses Service Revenue, merchandising uses Sales account. Other account titles usually used are Merchandise Inventory, Sales Discount, Purchases, Purchases Returns and Allowances and Sales Returns and Allowances. We will further discuss each of them as we go on the process of a Merchandising type business.

            Examples of merchandising firms are groceries, sari-sari store and other buy and sell firms. Because of its simple way of generating profit, merchandising has a low degree of conversion.

MANUFACTURING

            Manufacturing engages in the whole process of making the product. It starts from the purchasing of raw materials up to the finishing part of the process. Manufacturing type can either choose whether they shall use a periodic inventory system or perpetual inventory system.

            As for its accounting, it also uses the account title Sales.

         Sometimes, when a manufacturing business start assembling a product, it is not guaranteed that it can be finished before the preparation of financial statements that is why accounts are segregated as Raw Materials Inventory, Work-in Process Inventory, and Finished Goods Inventory. This shall be further discussed on our Cost Accounting lessons.

        Examples of manufacturing types of business are car, computer, and other gadgets assembly.

SPECIAL NOTES

We have mentioned before that in a service type of business, you can either use the account titles Professional Fees or Service Revenue. You might ask which one you shall use. Actually, this depends on the company where you work. There must be consistency so use the account titles on the previous financial statements.

For classroom purposes, clarify this matter to your professor. Some professors do not consider an answer correct if the student does not follow the account title he assigned. Well, that is very reasonable because in real world, you have to follow what the management has assigned.

PHOTO REFERENCES

http://oasismassagekaty.com/

http://en.wikipedia.org/wiki/7-Eleven

http://www.slideshare.net/Sukthankar2312/evolution-of-a-productcar

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BA1 Lesson #3 - Types of Business as to Organization

       Different accounting treatments are applied depending on the nature, structure and types of the business. In this lesson, we will cover the different types of business for you to grasp the necessary accounting requirements and treatments for these.

 Actually, the types of business can be enumerated as to 1) organization and as to 2) activity. In this lesson, we will tackle the types of business as to its organization.

This lesson will cover the three types of business as to organization namely:

• Sole Proprietorship
• Partnership
• Corporation

SOLE PROPRIETORSHIP

Ease of organization and the enjoyment of profit

This type of business is run by a single owner. The structure is from small to medium. Sole proprietorship is indeed easy to organize and the net income is enjoyed purely by the owner called the proprietor.

Ability to raise capital

However, there are several disadvantages in a sole proprietorship. The ability to raise the capital is very limited because there is only one person who can contribute money or properties. Truly the growth will have to be slower.

Decision making

Another disadvantage is the lack of managerial strategies. Sole proprietorship is limited as to ideas on how to run and manage the business well. The decision solely depends on the proprietor and he is not exposed to some improvisations, suggestions and other alternatives. However, the good side of this is that the proprietor can do whatever he wants without consulting the ideas of the others.

Unlimited liability

Business creditors can run after personal assets the sole proprietor just to satisfy their claims in case of bankruptcy. 

 PARTNERSHIP

Definition and Perfection

The law defines the partnership as the association of two or more persons who bind themselves together to contribute money, property and industry to a common fund with the intention of dividing the profit among themselves. A partnership is perfected as soon as the partners have stipulated a partnership contract, verbally or written.

If you do not have the money, you can be a partner as long as you have a property to contribute. If you do not have a property, you can still be a partner as long as you have a special talent or expertise to contribute. In other words, anyone can be a partner.

Partnership as a juridical person

A partnership has a juridical personality separate and distinct from its owners. A partnership can acquire a property on its name, can sue and be sued and can incur obligations and bring civil or criminal actions in conformity with laws.

Mutual Agency and Decision Making

Partnership has the characteristic of mutual agency. Mutual agency means that the decision of one binds the decision of the partnership. Say majority of the partners want to sell idle equipment but the other partner disagrees, even though he is only one against the majority, the partnership cannot sell the equipment because they are bounded by the latter’s decision.

To surmise it, partnership requires the vote of all of the partners for whatsoever decisions they would have.

Partnership is open for many ideas and suggestions as to management because it is run by two or more partners. However, as stated before, all of the partners must be consulted and must have agreed.

Transferability of interest

In case a partner wants to terminate his privilege as a partner, he can retire anytime unless otherwise stipulated in the contract when shall he retire. As soon as a partner retires, the partnership is automatically dissolved and if the other partners want to continue the business, there shall be a birth of a new partnership.

In any case a partner wants to transfer his interest to another person, all of the other partners must agree, otherwise he cannot transfer the interest. Even though he will just transfer his interest to another person, the partnership is deemed to be dissolved as well.

The reason for the automatic dissolution is because the partnership is contracted only among the “original” partners and not among the people who are not involved in the contract.

Unlimited Liability

Just like the sole proprietorship, the partners are personally liable in times of bankruptcy.

CORPORATION

Definition

 A corporation is composed of board of directors/trustees and shareholders/members. The terms directors and shareholders are applied only to a stock corporation while the terms trustees and members are applied to a non-stock corporation. We shall distinguish the two in our Basic Accounting Part II.

A board of director is essentially a shareholder so we can say that all board of directors are shareholders. However, the converse is not true. We cannot say that all shareholders are board of directors.

Actually, board of directors are elected. They are the ones who control corporation’s cash and properties and they are engaged in management. Shareholders aside from the board of directors, idly earn income in the form of dividends.

Corporation as juridical person

Just like the partnership, a corporation can own/acquire a property, can sue and be sued and can incur obligations and bring civil or criminal actions in conformity with laws.

Commencement of juridical personality

         Corporation’s juridical personality is perfected upon the issuance of certificate of incorporation of the Securities and Exchange Commission (SEC) under its official seal.

Limited Liability

       Unlike the first to types of business, corporation has limited liability. The stockholders are not personally liable to the creditors. They are only liable up to the amount of the capital contribution.

Terms of existence

       Sole Proprietorship and Partnership can exist for as long as they want unless otherwise stipulated or they are terminated by the law. However, corporation’s maximum term of existence is only fifty years. Corporation’s term of existence can be extended depending on the governing law. For example in the Philippines, the term can be extended not before five years of the expiration of the term.

Transferability of interest

Stockholders own a part of the company in the form of shares. These shares can be sold and transferred to anyone without consulting the other shareholders.

This is just the first part of the types of business. In our next lesson, we will discuss to you the other types of business as to activity and they are: servicing, merchandising and manufacturing. Stay tune buddy!

You might also want to test your understanding with our free test materials! Click here.

PHOTO REFERENCES

http://www.realmagick.com/sole-proprietorships/

http://www.iccwbo.org/about-icc/policy-commissions/banking/partnership/

http://www.telegraph.co.uk/technology/google/10343014/Googles-UK-division-paid-12m-in-corporation-tax-in-2012.html

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