Textbook Notes (369,099)
BUS 251 (101)
Chapter 2

# Chapter 2 Notes.docx

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BUS 251
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Steve Gibson

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Chapter 2: Analyzing Transactions and their Effects on FS The Basic Accounting Equation  How does sets of transactions affect company’s accounts  Basic Accounting Equation o Assets = Liabilities + Shareholder’s Equity  Transactions are recorded in the accounting system (two sides must balance)  In the beginning the amounts are balanced showed on the outside column  Comparative statement: have more than 2 periods in the same FS  To find out what transaction happened in the company that changed the FS ending balance we can take a look at the cash flow statement and earnings  Accounting period: the period of time that the FS cover  Revenues increase retained earnings, dividends decrease retained earnings Transaction Analysis and the Basic Accounting Equation  Transaction Analysis: analyze economic substance to decide what accounts are affected and by how much  Transaction 1: Issuance of Shares for Cash from investors o Analysis – the shareholder’s trade the company \$17500 (asset) for share ownership rights (share capital)  Cash increased by \$17500, share capital increased by \$17500 o Effects – financing activity (cash flow), not earnings, not revenue because revenue only comes from operating activities  Transaction 2: Used \$4500 cash to buy equipment o Analysis – decrease of cash (asset), increase equipment (long term asset) o Effect – investing activity (cash flow), no earning,  Accrual-basis accounting: cost of equipment is only recorded as expense when the item is consumed; if not then it is an asset because it will be used in the future to generate revenues  Cash-basis accounting: classify costs as expense when cash is spent and is recorded on the statement of earnings  Transaction 3: Paid \$360 cash for insurance policy o Analysis – prepaid expense (paid in advance of the coverage period)  Cash decreased \$360, prepaid insurance increased \$360 (asset) o Effect – operating activity (cash flow), no earnings  Transaction 4: borrowed \$10,000 from bank o Analysis – increase cash (asset), increase bank loan (liabilities)  principal + interest amount, no accrual because the loan was not taken out and no time has passed o Effect – Financing activity (cash flow), no earnings, not revenue  Transaction 5: purchased land for \$15000 o Analysis – cash decreased by \$15000, land (asset) increased by \$15000 o Effect – investing activity (cash flow), no earnings  Land should be recorded at its acquisition cost because it cannot depreciate in the long run.  Transaction 6: purchased \$23000 inventory on account o Analysis – on account (extended credit by suppliers), increase of inventory (asset) and promised supplier to pay later (accounts payable – liabilities)  Asset increased by \$23000, accounts payable increased by \$23000 o Effect – no cash flow, no earnings, record at acquisition cost, no interests on accounts payable because it is a current liability, longer term payable is note payable which has interests and formal loan agreements  Transaction 7: sold inventory \$13000 on account (Part I) o Analysis – customer promised to pay later (sales on accounts), company is allowed to receive payment (accounts receivable)  Inflow increased asset (accounts receivable) = increase in revenue  increase in retained earnings, decreased another asset (inventory) recorded as expense  when revenue > expense = profit and vice versa for loss on the exchange  Sales revenue + cost of goods sold (expense) increase and decrease shareholder’s equity from sale transactions  On accounting equation, sale transaction that affect retained earnings is recorded until shareholder’s equity as net income  Increase accounts receivable by \$13000, increase retained earnings by \$13000 o Effect – no cash flow, sales revenue recorded as retained earnings  Revenue recognition criteria determines when should revenue be recorded that balance off timeliness and reliability: the company should delivery the product, record and wait for payment  accrual basis accounting  For cash-basis you may delay the accounting period waiting for the cash  Matching concept: costs to generate sale = revenue earned, cost of goods sold and recorded in the same accounting period  Transaction 8: cost of items sold and removed from inventory for Jan was \$9000 (Part II) o Analysis - outflow of item decreased asset and retained earnings, cost of goods sold is an expense that decreases net income and retained earnings shown on SE  Inventory decreased by \$9000, retained earnings decreased by \$9000 o Effect – no cash flow, no earnings, expense (E), matching concept  Accrual basis: cost can be recorded as expense or asset depending on its nature  Expense: when it is used and cannot bring future benefit
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