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FINANCIAL ACCOUNTING

A USER PERSPECTIVE

Hoskin Fizzell Davidson


Second Canadian Edition
Transaction Analysis and
Accounting Entries

Chapter Two
Basic Accounting Equation

Assets =
Liabilities +
Shareholders Equity
Transaction Analysis

Demo Retail Company, Inc. is


formed as a company in
December of 2000.
Transaction Analysis

Transaction A: Common shares


are issued for $7,500.
Effects:
Assets (Cash) increase
Shareholders Equity (Common
Shares) increase
Effects on the Balance Sheet
Exhibit 2-1
Assets = Liabilities + Share- Equity
holders
Cash Inven- Equip- Accounts Common Retained
tory ment Payable Shares Earnings

A +7,500 +7,500

C
Transaction Analysis

Transaction B: Purchased
equipment for $4,500.
Effects:
Assets (Cash) decrease
Assets (Equipment) increase
Effects on the Balance Sheet
Exhibit 2-1
Assets = Liabilities + Share- Equity
holders
Cash Inven- Equip- Accounts Common Retained
tory ment Payable Shares Earnings

A +7,500 +7,500

B -4,500 +4,500

C
Transaction Analysis

Transaction C: Purchased $2,500


of inventory on account.
Effects:
Assets (Inventory) increase
Liabilities (Accounts Payable)
increase
Effects on the Balance Sheet
Exhibit 2-1
Assets = Liabilities + Share- Equity
holders
Cash Inven- Equip- Accounts Common Retained
tory ment Payable Shares Earnings

A +7,500 +7,500

B -4,500 +4,500

C +2,500 +2,500

+3,000 +2,500 +4,500 = +2,500 + +7,500 +0


Demo Retail Company, Ltd.
Balance Sheet
As at December 31, 2000
Assets Liabilities
Cash $ 3,000 Accounts payable $ 2,500
Inventory 2,500
Equipment 4,500 Shareholders Equity
Common shares 7,500
Retained earnings 0
Total liabilities and
Total assets $10,000 shareholders equity $10,000
Transaction Analysis -
Operating Period
Transaction 1: Sold units of
inventory on account for $2,500.
Effects:
Assets (Accounts Receivable) increase
Shareholders Equity (Retained
Earnings) increases
Revenue Recognition Criteria

Accrual basis accounting:


measures performance in the
period in which the
performance takes place, rather
than when the cash is collected.
Transaction Analysis
Transaction #1
Assets
Cash Accounts Inventory Prepaid Land Equipment
Receivable Insurance
+3,000 0 +2,500 0 0 +4,500
1 +2,500

Liabilities + Share- Equity


holders
Accounts Interest Bank Common Retained
Payable Payable Loan Shares Earnings
+2,500 0 0 +7,500
1 +2,500 R
Transaction Analysis -
Operating Period
Transaction 2: The cost of units
removed from inventory: $1,800.
Effects:
Assets (Inventory) decreases
Shareholders Equity (Retained
Earnings) decreases
Matching Concept
All costs associated with generating
sales revenue must be matched
with the revenue earned.
Cost of goods sold related to revenue
should be recognized in the same
period as the sales revenue.
Transaction Analysis
Transaction #2
Assets
Cash Accounts Inventory Prepaid Land Equipment
Receivable Insurance

2 -1,800

Liabilities + Share- Equity


holders
Accounts Interest Bank Common Retained
Payable Payable Loan Shares Earnings

2 -1,800 E
Transaction Analysis -
Operating Period
Transaction 3: Purchase of new
inventory: cost of $2,100.
Effects:
Assets (Inventory) increase
Liabilities (Accounts Payable)
increase
Transaction Analysis
Transaction #3
Assets
Cash Accounts Inventory Prepaid Land Equipment
Receivable Insurance

3 +2,100

Liabilities + Share- Equity


holders
Accounts Interest Bank Common Retained
Payable Payable Loan Shares Earnings

3 +2,100
Transaction Analysis -
Operating Period
Transaction 4: Received $2,200 from
customers as payments on their
accounts.
Effects:
Assets (Cash) increase
Assets (Accounts Receivable) decrease
Transaction Analysis
Transaction #4
Assets
Cash Accounts Inventory Prepaid Land Equipment
Receivable Insurance

4 +2,200 -2,200

Liabilities + Share- Equity


holders
Accounts Interest Bank Common Retained
Payable Payable Loan Shares Earnings
Transaction Analysis -
Operating Period
Transaction 5: Made payments on
accounts payable: $2,700.
Effects:
Assets (Cash) decrease
Liabilities (Accounts Payable)
decrease
Transaction Analysis
Transaction #5
Assets
Cash Accounts Inventory Prepaid Land Equipment
Receivable Insurance

5 -2,700

Liabilities + Share- Equity


holders
Accounts Interest Bank Common Retained
Payable Payable Loan Shares Earnings

5 -2,700
Transaction Analysis -
Operating Period
Transaction 6a: Paid $360 for six-
month insurance policy.
Effects:
Assets (Prepaid Insurance) increase
Assets (Cash) decrease
Prepaid Expenses

An amount paid in advance of


the coverage period is recorded
as an Asset (Prepaid Expense).
When time passes, the coverage
is consumed, and is then
recognized as an expense.
Transaction Analysis
Transaction #6a
Assets
Cash Accounts Inventory Prepaid Land Equipment
Receivable Insurance

6 - 360 + 360
a

Liabilities + Share- Equity


holders
Accounts Interest Bank Common Retained
Payable Payable Loan Shares Earnings
Transaction Analysis -
Operating Period
Transaction 6b: One months
insurance consumed: $60.
Effects:
Assets (Prepaid Insurance) decrease
Shareholders Equity (Retained
Earnings) decrease
Transaction Analysis
Transaction #6b
Assets
Cash Accounts Inventory Prepaid Land Equipment
Receivable Insurance

6 - 60
b

Liabilities + Share- Equity


holders
Accounts Interest Bank Common Retained
Payable Payable Loan Shares Earnings

6 - 60 E
b
Amortization of Assets
When an asset is used up over time,
some of the cost of the asset should
be shown as an expense in each
period in which it is used.
The amount shown as an expense in
any period is called the amortization
of the asset.
Amortization of Assets

Straight-line Amortization:

Original Estimated Residual


Cost Value
Estimated Useful Life
Transaction Analysis -
Operating Period
Transaction 7: Amortize
equipment for January: $150.
Effects:
Assets (Equipment) decrease
Shareholders Equity (Retained
Earnings) decrease
Transaction Analysis
Transaction #7
Assets
Cash Accounts Inventory Prepaid Land Equipment
Receivable Insurance

7 - 150

Liabilities + Share- Equity


holders
Accounts Interest Bank Common Retained
Payable Payable Loan Shares Earnings

7 - 150 E
Transaction Analysis -
Operating Period
Transaction 8a: Issued new shares
for $5,000.
Effects:
Assets (Cash) increase
Shareholders Equity (Common
Shares) increase
Transaction Analysis
Transaction #8a
Assets
Cash Accounts Inventory Prepaid Land Equipment
Receivable Insurance

8 +5,000
a

Liabilities + Share- Equity


holders
Accounts Interest Bank Common Retained
Payable Payable Loan Shares Earnings

8 +5,000
a
Transaction Analysis -
Operating Period
Transaction 8b: Borrowed from
the bank: $10,000.
Effects:
Assets (Cash) increase
Liabilities (Bank Loan) increase
Transaction Analysis
Transaction #8b
Assets
Cash Accounts Inventory Prepaid Land Equipment
Receivable Insurance

8 +10,000
b

Liabilities + Share- Equity


holders
Accounts Interest Bank Common Retained
Payable Payable Loan Shares Earnings

8 +10,000
b
Transaction Analysis -
Operating Period
Transaction 8c: Purchased land
for $15,000.
Effects:
Assets (Cash) decrease
Assets (Land) increase
Transaction Analysis
Transaction #8c
Assets
Cash Accounts Inventory Prepaid Land Equipment
Receivabl Insurance
e

8 -15,000 +15,000
c

Liabilities + Share- Equity


holders
Accounts Interest Bank Common Retained
Payable Payable Loan Shares Earnings

8
c
Accrued Expense

Expenses that are recognized


on the income statement in the
period in which they are
incurred, which is prior to the
period in which they are paid in
cash.
Transaction Analysis -
Operating Period
Transaction 9: Recorded one months
interest on the loan at 6%:
$10,000 x 6% x 1/12 = $50.
Effects:
Shareholders Equity (Retained Earnings)
decrease
Liabilities (Interest Payable) increase
Transaction Analysis
Transaction #9
Assets
Cash Accounts Inventory Prepaid Land Equipment
Receivable Insurance

Liabilities + Share- Equity


holders
Accounts Interest Bank Common Retained
Payable Payable Loan Shares Earnings

9 + 50 - 50 E
Transaction Analysis -
Operating Period
Transaction 10: Dividends were
declared and paid: $250.
Effects:
Assets (Cash) decrease
Shareholders Equity (Retained
Earnings) decrease
Transaction Analysis
Transaction #10
Assets
Cash Accounts Inventory Prepaid Land Equipment
Receivable Insurance

10 - 250

Liabilities + Share- Equity


holders
Accounts Interest Bank Common Retained
Payable Payable Loan Shares Earnings

10 - 250 D
Financial Statements

Balance Sheet
Income Statement
Cash Flow Statement
Classified Balance Sheet

Current assets and liabilities


are distinguished from
noncurrent assets and liabilities
Demo Retail Company, Ltd.
Balance Sheet
As at December 31, 2000
Current Assets Current Liabilities
Cash $ 1,890 Accounts payable $ 1,900
Accts receivable 800 Interest payable 50
Inventory 2,800 Total current liabilities 1,950
Prepaid insurance 300 Bank loan 10,000
Total current assets 5,290 Total liabilities 11,950
Land 15,000 Common shares 12,500
Equipment 4,350 Retained earnings 190
Total liabilities and
Total assets $24,640 shareholders equity $24,640
Income Statement

Calculates profit (net income) by


subtracting expenses from revenues
for the period.
Dividends:
are not expenses
are payments of earnings to
shareholders.
Demo Retail Company, Ltd.
Income Statement
For the month ended January 31, 2001
Sales revenues $ 2,500
Less:
Cost of goods sold (1,800)
Gross profit 700
Amortization expense (150)
Insurance expense ( 60)
Interest expense ( 50)
Net income $ 440
Profitability Ratios

Profit Margin Ratio:

Profit
Revenues
Profitability Ratios

Return on Assets:

Profit
Average total assets invested
Profitability Ratios

Return on Equity:

Profit
Average total shareholders
equity
Cash Flow Statement

Explains the changes in cash flow


during the period
Details changes in:
Operating activities
Investing activities
Financing activities
Demo Retail Company, Ltd.
Cash Flow Statement
For the month ended January 31, 2001
Cash from operating activities:
Cash receipts from customers $ 2,200
Cash disbursement to suppliers (2,700)
Cash disbursement for insurance ( 360)
Cash flow from operating activities $ (860)
Demo Retail Company, Ltd.
Cash Flow Statement
For the month ended January 31, 2001
Cash from investing activities:
Purchase of land (15,000)
Cash from financing activities:
Proceeds from issuance of common shares 5,000
Proceeds from bank loan 10,000
Dividends paid ( 250)
Cash flow from financing activities 14,750
Decrease in cash $ ( 1,110)

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