Amanda White; Mitchell Franklin; Patty Graybeal; and Dixon Cooper Show
In the previous section, we gained a basic understanding of both the basic and expanded accounting equations, and looked at examples of assets, liabilities, and shareholders’ equity. Now, we can consider some of the transactions a business may encounter. We can review how each transaction would affect the basic accounting equation. The first step in the accounting cycle is to identify and analyse transactions. Each original source transaction must be evaluated for financial implications. Meaning, will the information contained on this original source affect the financial statements? If the answer is yes, the business will then analyse the information for how it affects the financial statements. For example, if a business receives a cash payment from a customer, the business needs to know how to record the cash payment in a meaningful way to keep its financial statements up to date. Here is a reminder of the common account names that we covered in the previous section
In practice, there are many variations and sub-definitions under these main account names – so if you’ve look at some accounting information in your employment or volunteering experience – it may look similar but not identical. That is absolutely normal. The ‘Word hints’ are phrases you may see in the description of a transaction that will give you a hint to use this account. Not all accounts have word hints because many accounts are self-explanatory. You are the accountant for a startup mobile app developer, Kids Learn Online (KLO). Here are the business transactions from the current month:
We now analyse each of these transactions, paying attention to how they impact the accounting equation and corresponding financial statements. Transaction 1:Issues $20,000 of share equity for cash. Analysis: The business has received cash resulting in an increase in the assets. In exchange for the cash, the business has issued shares, thereby increasing equity (and the overall value of the business). Transaction 2:Purchases computer equipment on account (to be paid for later) for $3,500, payment due within the month. Analysis: We know that the business purchased computer equipment, which is an asset. We also know that the business purchased the equipment on account, meaning it did not pay for the equipment immediately and asked for payment to be billed instead and paid later. Since the business owes money and has not yet paid, this is a liability, specifically labeled as accounts payable. There is an increase to assets because the business has equipment it did not have before. There is also an increase to liabilities because the business now owes money. The more money the business owes, the more that liability will increase. The accounting equation remains balanced because there is a $3,500 increase on the asset side, and a $3,500 increase on the liability and equity side. Transaction 3:Receives $4,000 cash in advance from a customer for an app not yet developed Analysis: We know that the business collected cash, which is an asset. This collection of $4,000 increases assets because money is coming into the business. The business has yet to provide the app development service. According to the revenue recognition principle, the business cannot recognise that revenue until it provides the service. Therefore, the business has a liability to the customer to provide the service and must record the liability as unearned revenue. The liability of $4,000 worth of services increases because the business has more unearned revenue than previously. The equation remains balanced, as assets and liabilities increase. The balance sheet would experience an increase in assets and an increase in liabilities. Transaction 4:Provides $5,500 in app development services to a customer who asks to be billed for the services. Analysis: The customer asked to be billed for the service, meaning the customer did not pay with cash immediately. The customer owes money and has not yet paid, signaling an accounts receivable. Accounts receivable is an asset that is increasing in this case. This customer obligation of $5,500 adds to the balance in accounts receivable. The business did provide the services. As a result, the revenue recognition principle requires recognition as revenue, which increases equity for $5,500. The increase to assets would be reflected on the balance sheet. The increase to equity would affect three statements. The income statement would see an increase to revenues, changing net income (loss). Net income (loss) is computed into retained earnings on the statement of retained earnings. This change to retained earnings is shown on the balance sheet under shareholders’ equity. Transaction 5:Pays a $300 electricity (utility) bill with cash. Analysis: The business paid with cash, an asset. Assets are decreasing by $300 since cash was used to pay for this utility bill. The business no longer has that money. Utility payments are generated from bills for services that were used and paid for within the accounting period, thus recognised as an expense. The expense decreases equity by $300. The decrease to assets, specifically cash, affects the balance sheet and statement of cash flows. The decrease to equity as a result of the expense affects three statements. The income statement would see a change to expenses, changing net income (loss). Net income (loss) is computed into retained earnings on the statement of retained earnings. This change to retained earnings is shown on the balance sheet under shareholders’ equity. Transaction 6:Distributed $100 cash in dividends to shareholders. Analysis: The business paid the distribution with cash, an asset. Assets decrease by $100 as a result. Dividends affect equity and, in this case, decrease equity by $100. The decrease to assets, specifically cash, affects the balance sheet and statement of cash flows. The decrease to equity because of the dividend payout affects the statement of retained earnings by reducing ending retained earnings, and the balance sheet by reducing shareholders’ equity. Let’s summarise the transactions and make sure the accounting equation has remained balanced. Shown are each of the transactions. As you can see, assets total $32,600, while liabilities added to equity also equal $32,600. Our accounting equation remains balanced. Are all business events recorded as transactions?To determine which business events are to be recorded – always think back to the idea of inflows and outflows – is something flowing into the business? It could be cash, or some other asset. Or are there any outflows from the business to another party? Let’s work through an example with Tiny Holidays – a relatively new business owned by Hazel Nguyen – that specialises in short breaks in tiny homes – ultra small accomodation – in remote rural locations. She has a collection of 6 tiny homes across 2 rural properties in New South Wales. An example of one of her tiny homes is in the photograph below. Photo by Roberto Nickson on Unsplash Tiny Holidays had the following transactions:
Which events will be recorded in the accounting system? Solution
The following questions are adapted from the Principles of Accounting 1 into H5P format. Which of the following is not considered to be a recordable financial transaction?-Answer: c. A customer inquires about the availability of a service. A customer inquiring about the availability of a service does not necessarily result in guaranteed service revenue during the period. Hence, this is not a recordable transaction.
Which of the following is considered a recordable transaction?An accounting transaction is said to be a recordable transaction when it could be accountable and reliably measured.
Which of the following events would not be recorded as an accounting transaction?Answer and Explanation: D) Signing an agreement with a supplier is not a transaction recorded in financial accounting. While signing an agreement is a big decision by the business, it does not change any financial accounts the business has.
Which of the following is not recorded in a general journal quizlet?A general journal provides a place for recording all of the following except: The balance in each account.
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