REVIEW OF ACCOUNTING FUNDAMENTALS

THE ACCOUNTING EQUATION

Assets = Liabilities + Equity

Equity = Contributed Capital + Retained Earnings

Retained Earnings = Beginning Retained Earnings + Net Income for the Period
Dividends

Net Income = Revenues Expenses + Gains Losses

Assets Probable future economic benefits obtained or controlled by a particular

accounting entity as a result of past transactions or events

Liabilities Probably future sacrifices of economic benefits arising from present

obligations of a particular accounting entity to transfer assets or provide services to
other entities in the future as a result of past transactions or events.

Equity Residual interest in the assets of an entity that remains after deducting its
liabilities.

ACCOUNTS

A company may have many assets and liabilities, and many revenues, expenses,
gains and losses. The effects of transactions that cause changes in the various
financial statement elements are summarized in accounts.

An account in T-account form, is:

Account Number and Title

Debit side Credit side

A dollar amount is debited to an account when it is entered on the left side and
credited to an account when it is entered on the right side.

Debits Indicate Credits Indicate

Asset increases Asset decreases
Liability decreases Liability increases
Equity decreases Equity increases
Expenses Revenues
Losses Gains
Revenue reductions Expense reductions
Gain reductions Loss reductions

FIN 591: VALUATION TECHNIQUES PAGE 1

RELATIONSHIP BETWEEN THE FINANCIAL STATEMENT ELEMENTS AND THE PRINCIPLE OF
DEBIT AND CREDIT

Assets = Liabilities + Equity Revenues/Gains Expenses/Losses

Assets Liabilities Equity Revenues Expenses

Increases Decreases Decreases Increases Decreases Increases Decreases Increases Increases Decreases
Debit Credit Debit Credit Debit Credit Debit Credit Debit Credit

Contributed Gains Losses

Capital
Decreases Increases Decreases Increases Increases Decreases
Debit Credit Debit Credit Debit Credit

Retained
Earnings
Decreases Increases
Debit Credit

Note:

Each transaction has a dual effect on the accounting equations

Dollar amounts of the transactions are entered into the appropriate accounts as
increases and decreases in accordance with the rules of debit and credit
For every debit made to an account, a corresponding credit is made to another
account double-entry system
A = L + E is maintained after each transaction

FIN 591: VALUATION TECHNIQUES PAGE 2

Example:

Economic Analysis
Event of Event Accounting Entry Assets = Liabilities + Equity
Cash Equity
A dentist Assets Debit Credit Debit Credit +10,000 +10,000
invested (cash) 10,000 10,000
$10,000 in a increased by
dental $10,000.
practice. Equity
increased by
$10,000.
Accounts
Supplies Payable
The dental Assets Debit Credit Debit Credit +800 +800
practice (supplies) 800 800
purchased increased by
supplies on $800.
account at a Liabilities
cost of $800. (accounts
payable)
increased by
$800.
Accounts
Receivable Revenues
Dental Assets Debit Credit Debit Credit +1,000 +1,000
services were (accounts 1,000 1,000
performed for receivable)
patients on increased by
account, $1,000.
$1000. Equity
(revenue)
increased by
$1,000.
Supplies
Expense Supplies
Supplies Assets Debit Credit Debit Credit -300 -300
costing $300 (supplies) 300 300
were used. decreased by
$300. Equity
(expenses
increased)
decreased by
$300
Accounts
Payable Cash
The practice Assets Debit Credit Debit Credit -600 -600
paid $600 on (cash) 600 600
accounts decreased by
payable $600.
Liabilities
(accounts
payable)
decreased by
$600
Totals 10,900 200 10,700

FIN 591: VALUATION TECHNIQUES PAGE 3

 ASSIGNMENT DUE AT THE BEGINNING OF SESSION 3

Assume that it is the end of May 2011. The transactions listed below took place
during the month, the first month in business.

1. May 1, corporate charter was received authorizing the issuance of 100,000 shares
of $5 par common stock. Issued 16,250 shares at $8 per share for cash.
2. May 1, borrowed $30,000 from City Bank by issuing a $30,000 note due in two
years. Interest at 10% is payable annually.
3. May 1, purchased the assets of Zenith Hardware Corporation for $75,000 in cash.
The assets consisted of inventory of $60,000, supplies of $4,000, and fixtures
and equipment of $11,000.
4. May 2, paid rent on a building for 12 months in advance, $7,200.
5. May 3, purchased display equipment for $10,000 from Northern Supply Company.
Paid $2,000 cash, the balance to be paid in 60 days.
6. May 4, purchased merchandise on account from Quick Wholesale for a cost of
$45,000.
7. May 4, paid $1,800 cash for office supplies.
8. May 5, sold miscellaneous hardware (i.e., merchandise) items totaling $25,000 to
Ace Builders on account.
9. May 9, purchased merchandise costing $30,000 from Nails, Inc. on account. The
transportation cost on the merchandise totaled $250 and was paid in cash.
10. May 11, received $12,000 of the amount due from Ace Builders.
11. May 12, paid sales salaries totaling $3,000.
12. May 20, cash sales of items, $15,000.
13. May 20, subleased the top floor of the building rented on May 2 for $300 per
month. Cash was received.
14. May 22, received $5,000 from sale of gift certificates.
15. May 24, purchased temporary investments for cash at a cost of $3,600.
16. May 25, returned defective merchandise costing $1,200 to Nails, Inc.
17. May 26, sold miscellaneous hardware totaling $24,000 to Rite-Way Construction.
Rite-Way paid $6,000 cash and the balance was on account.
18. May 28, paid the amount due to Quick Wholesale. Received a 2% discount for
prompt payment.
19. May 29, purchased merchandise on account from Handy Dandy Supply at a cost
of $6,000.
20. May 30, cash sales of hardware, $18,000.
21. May 30, depreciation for the month on fixtures and furniture is $350.
22. May 30, management estimates uncollectible accounts to be .5% of total credit
sales.
23. May 30, ending inventory, based on a physical count of merchandise on hand and
priced at cost, $72,000.
24. May 30, salaries of $2,500 since the last pay period havent been paid.
25. May 30, office supplies of $1,300 were used during the month.
26. May 30, earned revenue on rent needs to be adjusted.
27. May 30, sales from redemption of gift certificates totaled $3,500.
28. May 30, interest on the loan from the bank needs to be accrued.
29. May 30, the tax rate for the month was estimated to be 40%.

FIN 591: VALUATION TECHNIQUES PAGE 4

 Prepare journal entries for the above transactions using the following format
the first entry is shown. It is probably easier to use Excel.

Date Ref Accounts Debit Credit Assets Liabilities Equity

May 1 1 Cash 130,000 130,000
Common stock 81,250 81,250

Paid-in surplus 48,750 48,750

Next, construct an income statement and balance sheet for the month using
Excel.

FIN 591: VALUATION TECHNIQUES PAGE 5