Analyzing Transactions and

Preparation of Financial
Statements
 1-2

Accounting Principles
Measurement Principle Revenue Recognition Principle
(Cost Principle) 1. Recognize revenue when goods or
Accounting information is based on services are provided to customers
actual cost. Actual cost is and
considered objective. 2. at an amount expected to be
received from the customer.

Expense Recognition Principle Full Disclosure Principle

(Matching Principle) A company reports the details behind
A company records its expenses financial statements that would impact
incurred to generate the revenue users’ decisions in the notes to the
reported. financial statements.

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Accounting Assumptions
Going-Concern Assumption
The business is presumed to
continue operating instead of being
closed or sold.
Time Period Assumption
The life of a company
can be divided into time periods,
such as months and years.
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Monetary Unit Assumption
Transactions and events are
expressed in monetary, or
money, units.
Business Entity Assumption
A business is accounted for
separately from other business
entities, including its owner.
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 1-4

Business Transactions and Accounting

The Accounting Equation

Assets = Liabilities + Equity

Expanded Accounting Equation:

Net Income
1-4
 Transaction 1:
Investment by Owner
Chas Taylor invests $30,000 cash in
a new company named FastForward and
received Common Stock.

The accounts involved are:

(1) Cash (asset)
(2) Common Stock (equity)

1-5
 Accounting Equation 1
Chas Taylor invests $30,000 cash to start
the business, FastForward.
Assets = Liabilities + Equity
Accounts Notes Common
Cash Supplies Equipment Payable Payable Stock
(1) $ 30,000 $ 30,000

$ 30,000 $ - $ - $ - $ - $ 30,000

$ 30,000 = $ 30,000

1-6
 Transaction 2:
Purchase Supplies for Cash
FastFoward purchased supplies paying
$2,500 cash.
The accounts involved are:
(1) Cash (asset)
(2) Supplies (asset)

1-7
 Accounting Equation 2
FastFoward purchased supplies paying
$2,500 cash.
Assets = Liabilities + Equity
Accounts Notes Common
Cash Supplies Equipment Payable Payable Stock
(1) $ 30,000 $ 30,000
(2) (2,500) $ 2,500 Accounting Equation
must remain in
balance!!

$ 27,500 $ 2,500 $ - $ - $ - $ 30,000

$ 30,000 = $ 30,000
1-8
 Transaction 3:
Purchase Equipment for Cash
FastForward purchased equipment for
$26,000 cash.
The accounts involved are:
(1) Cash (asset)
(2) Equipment (asset)

1-9
 Accounting Equation 3
Purchased equipment for $26,000 cash.

Assets = Liabilities + Equity

Accounts Notes Common
Cash Supplies Equipment Payable Payable Stock
(1) $ 30,000 $ 30,000
(2) (2,500) $ 2,500
(3) (26,000) $ 26,000 Accounting Equation
still remains in
balance!!
$ 1,500 $ 2,500 $ 26,000 $ - $ - $ 30,000

$ 30,000 = $ 30,000

1-10
 Transaction 4:
Purchase Supplies on Credit
FastFoward purchased supplies of $7,100
on credit.

The accounts involved are:

(1) Supplies (asset)
(2) Accounts Payable (liability)

1-11
 Accounting Equation 4
FastForward purchased supplies of $7,100
on credit.
Assets = Liabilities + Equity
Accounts Notes Common
Cash Supplies Equipment Payable Payable Stock
(1) $ 30,000 $ 30,000
(2) (2,500) $ 2,500
(3) (26,000) $ 26,000 Accounting Equation still
(4) 7,100 $ 7,100 remains in balance!!

$ 1,500 $ 9,600 $ 26,000 $ 7,100 $ - $ 30,000

$ 37,100 = $ 37,100

1-12
 Transaction 5:
Provide Services for Cash
FastForward provided consulting services to
a customer and received $4,200 cash
immediately.

The accounts involved are:

(1) Cash (asset)
(2) Revenues (equity)

1-13
 Accounting Equation 5
FastForward provided consulting services to a
customer and received $4,200 cash
immediately.
Assets = Liabilities + Equity
Accounts Notes Common
Cash Supplies Equipment Payable Payable Stock Revenue
Bal. $ 1,500 $ 9,600 $ 26,000 $ 7,100 $ 30,000
(5) 4,200 $ 4,200

$ 5,700 $ 9,600 $ 26,000 $ 7,100 $ - $ 30,000 $ 4,200

$ 41,300 = $ 41,300

1-14
 Transactions 6 and 7:
Payment of Expenses in Cash
FastForward paid rent of $1,000 and
salaries of $700 to employees.
The accounts involved are:
(1) Cash (asset)
(2) Rent expense (equity)
(3) Salaries expense (equity)
Remember that the balance in the Expense accounts actually increase.

But, total Equity decreases, because expenses reduce equity.

1-15
 Accounting Equation 6 and 7
FastForward paid rent of $1,000 and
salaries of $700 to employees.
Assets = Liabilities + Equity
Accounts Notes Common
Cash Supplies Equipment Payable Payable Stock Revenue Expenses
Bal. $ 5,700 $ 9,600 $ 26,000 $ 7,100 $ 30,000 $ 4,200
(6) (1,000) (1,000)
(7) (700) $ (700)

$ 4,000 $ 9,600 $ 26,000 $ 7,100 $ - $ 30,000 $ 4,200 $ (1,700)

$ 39,600 = $ 39,600

Remember that expenses decrease equity.

1-16
 Transaction 8:
Provide Services and Facilities for Credit
FastForward provided consulting services of
$1,600 and rents facilities for $300 to a customer
for credit.

The accounts involved are:

(1) Accounts receivable (asset)
(2) Consulting revenues (equity)
(3) Rental revenue (equity)

1-17
 Accounting Equation 8
FastForward provided consulting services of $1,600
and rents facilities for $300 to a customer for credit.

Assets = Liabilities + Equity

Accounts Accounts Common
Cash Receivable Supplies Equipment Payable Stock Revenue Expenses
Bal. $ 4,000 $ 9,600 $ 26,000 $ 7,100 $ 30,000 $ 4,200 (1,700)
(8) 1,900 $ 1,600
300

$ 4,000 $ 1,900 $ 9,600 $ 26,000 $ 7,100 $ 30,000 $ 6,100 $ (1,700)

$ 41,500 = $ 41,500

1-18
 Transaction 9:
Receipt of Cash from Accounts Receivable
Client in transaction 8 pays $1,900 for consulting
services.

The accounts involved are:

(1) Cash (asset)
(2) Accounts receivable (asset)

1-19
 Accounting Equation 9
Client in transaction 8 pays $1,900 for consulting services.

Assets = Liabilities + Equity

Accounts Accounts Common
Cash Receivable Supplies Equipment Payable Stock Revenue Expenses
Bal. $ 4,000 1,900 $ 9,600 $ 26,000 $ 7,100 $ 30,000 $ 4,200 (1,700)
(9) 1,900 (1,900) $ 1,600
300

$ 5,900 0 $ 9,600 $ 26,000 $ 7,100 $ 30,000 $ 6,100 $ (1,700)

$ 41,500 = $ 41,500

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 Transaction 10:
Payment of Accounts Payable
FastForward pays $900 as partial payment for
supplies purchased in transaction 4.

The accounts involved are:

(1) Cash (asset)
(2) Accounts payable (liability)

1-21
 Accounting Equation 10
FastForward pays $900 as partial payment for supplies
purchased in transaction 4.
Assets = Liabilities + Equity
Accounts Accounts Common
Cash Receivable Supplies Equipment Payable Stock Revenue Expenses
Bal. $ 5,900 0 $ 9,600 $ 26,000 $ 7,100 $ 30,000 $ 4,200 (1,700)
(10) (900) (900) $ 1,600
300

$ 5,000 0 $ 9,600 $ 26,000 $ 6,200 $ 30,000 $ 6,100 $ (1,700)

$ 40,600 = $ 40,600

1-22
 Transaction 11:
Payment of Cash Dividend ($200) to
Owner
The accounts involved are:
(1) Cash (asset)
(2) Dividends (equity)
Remember that the Dividends account actually increases (just like our
Expense accounts).

But, total Equity decreases because dividends cause equity to go

down!!

1-23
 Accounting Equation 11
Payment of divindend $200 to owner.

Assets = Liabilities + Equity

Accounts Accounts Common
Cash Receivable Supplies Equipment Payable Stock Dividends Revenue Expenses
Bal. $ 5,000 0 $ 9,600 $ 26,000 $ 6,200 $ 30,000 $ 4,200 (1,700)
(11) (200) (200) $ 1,600
300

$ 4,800 0 $ 9,600 $ 26,000 $ 6,200 $ 30,000 $ (200) $ 6,100 $ (1,700)

$ 40,400 = $ 40,400

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Summary of Transactions

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 Rules for Accounting Equations
i. Capital :When capital is increased, it is credited (+) and when some part of the capital is withdrawn,
i.e., drawings are made, it is debited (-).

ii. Revenue : Owner's equity (Capital) is increased by the amount of revenue.

iii. Expenses :Owner's equity (Capital) is decreased by the amount of expenses.

iv. Outsider’s Liability :When liabilities are increased, outsiders' liabilities are credited (+).

v. Assets : If there is an increase in Assets, the increase is debited (+) in the Asset Account. If there is
decrease in Assets, the decrease in credited (-) in the Asset Account.

vi. Effects of Outstanding Expenses : Increase in liabilities and decrease in capital.

vii. Accrued Income :Increase in asset and increase in capital.

viii. Income Received in Advance : Increase in asset (as cash) and increase in liabilities.

ix. Interest on Capital is an expense for the business, and thus, profit is reduced by the amount and since
interest on capital is an income for the owner it is added to capital. So the net effect of this transaction
is nil on capital.

x. Asset and Liabilities will not be affected by interest on capital and interest on drawings.
 1 - 27

Financial Statements
The four financial statements and their purposes are:
1. Income statement — describes a company’s revenues and
expenses and computes net income or loss over a period of
time.
2. Statement of changes in Equity — explains changes in
position of equity
3. Balance sheet — describes a company’s financial position
(types and amounts of assets, liabilities, and equity) at a point
in time.
4. Statement of cash flows — identifies cash inflows (receipts)
and cash outflows (payments) over a period of time.
5.Notes

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 Exhibit 1.10: Financial Statements and Their Links – Part 1 1 - 28

(cont. next slide)

Learning Objective P2: Identify and prepare basic financial statements and explain how they interrelate. © McGraw-Hill Education 1-28
 Exhibit 1.10: Financial Statements and Their Links – Part 2 1 - 29

Learning Objective P2: Identify and prepare basic financial statements and explain how they interrelate. © McGraw-Hill Education 1-29