Accounting IBA 104 Lecture 2 Accounting Equation Dr. Mohamed A. Hamada Lecturer of Accounting Information Systems
The Building Blocks of Accounting • Financial Statements • Balance Sheet • Income Statement • Statement of Owner’s Equity • Statement of Cash Flows • Note Disclosure Various users need financial information The accounting profession has attempted to develop a set of standards that are generally accepted and universally practiced. Generally Accepted Accounting Principles (GAAP)
The Building Blocks of Accounting • Organizations Involved in Standard Setting: • Securities and Exchange Commission (SEC) • Financial Accounting Standards Board (FASB) • International Accounting Standards Board (IASB) http://www.sec.gov/ http://www.fasb.org/ http://www.iasb.org/
The Building Blocks of Accounting • Cost Principle (Historical)– dictates that companies record assets at their cost. • Issues: • Reported at cost when purchased and also over the time the asset is held. • Cost easily verified, whereas market value is often subjective. • Fair value information may be more useful.
Assumptions • Monetary Unit Assumption – include in the accounting records only transaction data that can be expressed in terms of money. • Economic Entity Assumption – requires that activities of the entity be kept separate and distinct from the activities of its owner and all other economic entities. • Proprietorship. • Partnership. • Corporation. Forms of Business Ownership
Forms of Business Ownership Proprietorship Partnership Corporation Generally owned by one person. Often small service-type businesses Owner receives any profits, suffers any losses, and is personally liable for all debts. Owned by two or more persons. Often retail and service-type businesses Generally unlimited personal liability Partnership agreement Ownership divided into shares of stock Separate legal entity organized under state corporation law Limited liability
Forms of Business Ownership Review Question A business organized as a separate legal entity under state law having ownership divided into shares of stock is a • proprietorship. • partnership. • corporation. • sole proprietorship.
The Basic Accounting Equation Assets Liabilities Owner’s Equity = + Provides the underlying framework for recording and summarizing economic events.
Asset- New Computer New computer worth $1700.00
Asset- Cash in Bank Checking account balance $525.00
Asset- Business Car Business car worth $20,000.00
Asset- Building Building you purchased for $250,000.00
Asset- Office Supplies Office supplies purchased for $75.00
Asset – Accounts Receivable I will receive the money later • When a person owesYOU money, this is also an asset. • The asset is called “Accounts Receivable”.
Asset – Prepaid Insurance I’ve paid my 6 month insurance premium • When you pay insurance premiums covering your property, this is also an asset. • Making payments in advance is called a “prepaid asset”.
Asset Definition of an • An asset is anything of value that is owned • An asset may be something which is paid for in advance, like prepaid insurance or prepaid rent. • Money you will receive later – Accounts Receivable
Check and Review Which account is NOT an asset. • Desk • Prepaid insurance • Money you owe another person • Money that another person owes you
Prepaid Insurance Try again… Remember, prepaid insurance is an asset because it has value.
Desk a desk is an asset because it has value.
Money you oweto another person • Great job! Money $ you owe another person would not be of value to you because you will eventually have to pay the person off. • Money you owe is a LIABILITY
Liability I will pay you later A liability is when you oweto another person or business money.
Liability • A liability is when you oweto another person or business money. • Liabilities typically include the word “payable” in the description.
Examples of Liability Accounts • Accounts Payable • Notes Payable • Income Tax Payable • Social Security TaxPayable
Check and Review So what’s the key word for a liability? Payable Receivable
Let’s think… Receivable means that you will “receive” money at a later date.
Check and Review - Asset Select the asset below Money I owe to a business Money that someone owes to me
Review – Accounts Payable Remember, if you owe another person money it’s not really a good thing. When you owe to another person, you have a Liability.
Larger asset/larger debt Great job, Since the building is a larger asset which costs more than a car, you would incur a higher debt.
Smaller asset/smaller debt Try Again, Since the car probably costs less than the building, you would not need to borrow as much money from the bank.
The Basic Accounting Equation Assets Liabilities Owner’s Equity + = Assets • Resources a business owns. • Provide future services or benefits. • Cash, Supplies, Equipment, etc.
The Basic Accounting Equation Assets Liabilities Owner’s Equity + = Liabilities • Claims against assets (debts and obligations). • Creditors - party to whom money is owed. • Accounts payable, Notes payable, etc.
The Basic Accounting Equation Assets Liabilities Owner’s Equity + = Owner’s Equity • Ownership claim on total assets. • Referred to as residual equity. • Capital, Drawings, etc. (Proprietorship or Partnership).
Owners’ Equity Illustration 1-6 Revenuesresult from business activities entered into for the purpose of earning income. Common sources of revenue are: sales, fees, services, commissions, interest, dividends, royalties, and rent.
Owners’ Equity Illustration 1-6 Expenses are the cost of assets consumed or services used in the process of earning revenue. Common expenses are: salaries expense, rent expense, utilities expense, tax expense, etc.
Using The Basic Accounting Equation • Transactionsare a business’s economic events recorded by accountants. • May be external or internal. • Not all activities represent transactions. • Each transaction has a dual effect on the accounting equation.
Transactions (Question?) Q1-15:Are the following events recorded in the accounting records? Owner withdraws cash for personal use. Supplies are purchased on account. An employee is hired. Event Is the financial position (assets, liabilities, or owner’s equity) of the company changed? Criterion Record/ Don’t Record
Transactions Discussion Question Q1-18:In February 2010, Ahmed invested an additional $10,000 in his business, ABC, which is organized as a proprietorship. ABC’s accountant, recorded this receipt as an increase in cash and revenues. Is this treatment appropriate? Why or why not? See notes page for discussion
Transactions Analysis Transaction (1). Investment By Owner.Ray Neal decides to open a computer programming service which he names ABS. On September 1, 2010, he invests $15,000 cash in the ABS. The effect of this transaction on the basic equation is:
Transactions Analysis Transaction (2). Purchase of Equipment for Cash. ABSpurchases computer equipment for $7,000 cash.
Transactions Analysis Transaction (3). Purchase of Supplies on Credit.ABSpurchases for $1,600 from Acme Supply Company computer paper and other supplies expected to last several months.
Transactions Analysis Transaction (4). Services Provided for Cash.ABSreceives $1,200 cash from customers for programming services it has provided.
Transactions Analysis Transaction (5). Purchase of Advertising on Credit.ABS receives a bill for $250 from the Daily News for advertising but postpones payment until a later date.
Transactions Analysis Transaction (6). Services Provided for Cash and Credit.ABS provides $3,500 of programming services for customers. The company receives cash of $1,500 from customers, and it bills the balance of $2,000 on account.
Transactions Analysis Transaction (7). Payment of Expenses.ABSpays the following Expenses in cash for September: store rent $600, salaries of employees $900, and utilities $200.
Transactions Analysis Transaction (8). Payment of Accounts Payable.ABSpays its $250 Daily News bill in cash.
Transactions Analysis Transaction (9). Receipt of Cash on Account.ABSreceives $600 in cash from customers who had been billed for services [in Transaction (6)].
Transactions Analysis Transaction (10). Withdrawal of Cash by Owner.Ray Neal withdraws $1,300 in cash from the business for his personal use.
Transactions Analysis Illustration 1-8 Tabular summary of Softbyte transactions Summary of Transactions