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Accounting Equation - Part 2
Accounting Equation - Part 2
Accounting Equation
Financial Accounting
9e FAC 102
Libby
Prof.•Shivangi
Libby • Hodge
Gupta
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Exhibit 2.2 • Typical Account Titles
Title expense accounts by what was
incurred or used followed by the
Accounts with “payable” in the title are word “expense,” except for
always liabilities and represent amounts inventory sold, which is titled Cost
owed by the company to be paid to of Goods Sold.
Accounts with others in the future.
“receivable” in
the title are
always assets; Stockholder’s
Assets Liabilities Revenues Expenses
they represent Equity
amounts owed
by (receivable Cash Accounts Payable Common Stock Sales Revenue Cost of Goods
from) customers Short-Term Accrued Expenses Additional Paid-in Fee Revenue Sold
and others to the Investments Capital Interest Revenue Wages Expense
business. Accounts Payable Retained Earnings Rent Expense
Rent Revenue
Receivable Notes Payable Interest Expense
Service Revenue
Notes Receivable Taxes Payable Depreciation
Inventory (to be Unearned Expense
sold) Revenue Advertising
Supplies Bonds Payable Expense
Prepaid Expenses Accounts with “unearned” in the
is always an asset; it Prepaid Expenses Insurance
title are always liabilities Expense
represents amounts Long-Term
representing amounts paid in the
paid in advance by Investments Repair Expense
past to the company by others who
the company to Equipment expect future goods or services Income Tax
others for future Buildings from the company. Expense
benefits, such as
Land Title revenue accounts by
future insurance
coverage, rental of Intangibles their source followed by
property, or the word “revenue.”
advertising.
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Principles of Transaction Analysis
Every transaction has at least two effects (dual effects) on the basic
accounting equation. Most transactions with external parties involve an
exchange where the business entity both receives something and gives
up something in return.
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Exhibit 2.3 • Analyzing Investing and Financing Transactions
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Analyzing Chipotle’s Transactions (1 of 9)
Assume that Chipotle engages in the following events during the first
quarter of 2020, the first three months following the balance sheet in
Exhibit 2.1. Account titles are from that balance sheet. All amounts are in
millions, except per share data.
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Analyzing Chipotle’s Transactions (2 of 9)
(a) Chipotle issued (sold) 100 additional shares of common stock with a
par value of $0.01 per share at a market value of $0.17 per share,
receiving $17 in cash from investors – a financing activity.
Step 1: What was received? (account name, type of account, amount, and direction of effect)
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Analyzing Chipotle’s Transactions (3 of 9)
(b) Chipotle borrowed $4 from its local bank, signing a note to be paid in
three years (a noncurrent liability) – a financing activity.
Step 1: What was received? (account name, type of account, amount, and direction of effect)
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Analyzing Chipotle’s Transactions (4 of 9)
(c) Chipotle purchased for cash $26 in new equipment and $5 in additional
intangible assets – an investing activity.
Step 1: What was received? (account name, type of account, amount, and direction of effect)
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Analyzing Chipotle’s Transactions (5 of 9)
(d) Chipotle acquired $20 in additional land and $40 in new buildings,
signed leases for $86 for right-of-use (ROU) assets, paid $29 in cash, and
signed $6 in current leases and $111 in long-term leases to rent facilities—
an investing activity.
Step 1: What was received? (account name, type of account, amount, and direction of effect)
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Analyzing Chipotle’s Transactions (6 of 9)
(e) Chipotle sold $19 in its short-term investments for $19 cash—an investing
activity.
Step 1: What was received? (account name, type of account, amount, and direction of effect)
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Analyzing Chipotle’s Transactions (7 of 9)
(f) Within the quarter, assume Chipotle paid $1 on the note payable in (b)
above (ignore any interest on the loan in this chapter)—a financing
activity.
Step 1: What was received? (account name, type of account, amount, and direction of effect)
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Analyzing Chipotle’s Transactions (8 of 9)
(g) Chipotle repurchased a portion of its issued common stock from
investors for $103 cash—a financing activity.
Step 1: What was received? (account name, type of account, amount, and direction of effect)
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Analyzing Chipotle’s Transactions (9 of 9)
(h) Chipotle does not pay dividends, but instead reinvests profits into growing
the business. However, for illustration purposes, assume Chipotle’s board of
directors declared that the Company will pay a total of $2 in cash as
dividends to shareholders next quarter.
Step 1: What was received? (account name, type of account, amount, and direction of effect)
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Transaction Analysis Wrap Up
In summary:
Transaction analysis involves identifying accounts
affected in a transaction (by title), recognizing that at
least two accounts are affected, classifying the
accounts (asset, liability, or stockholders’ equity), and
determining the direction of the effect on the account
(increase or decrease).
If all accounts and effects are correct, then the
fundamental accounting equation (A = L + SE) will
remain in balance.
Practice is the most effective way to develop your
transaction analysis skills.
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Exhibit 2.4 • The Accounting Cycle
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How Do Companies Keep Track of Account Balances?
General Journal
(chronological list of each
transaction’s effects)
POS
T
General Ledger
or T-accounts
(a record of effects to
and balances of each
account)
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Exhibit 2.5
• Basic Transaction Analysis Model
STOCKHOLDERS’ EQUITY
ASSETS LIABILITIES Contributed Capital Earned Capital
(many accounts) = (many accounts) + (2 accounts) (1 account)
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• In Summary:
Debits and Credits
https://www.youtube.com/watch?v=VhwZ9t2b3Zk
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The Journal Entry (1 of 2)
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The Journal Entry (2 of 2)
(a) Assume Chipotle issued (sold) 100 additional shares of common
stock with a par value of $0.01 per share at a market value of $0.17 per
share, receiving $17 in cash from investors.
Account Titles:
Debited accounts on top. Amounts:
Credited accounts on bottom, usually indented. Debited amounts on left.
Credited amounts on right.
Debit Credit
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Exhibit 2.7
• T-Accounts Illustrated
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Expressing the T-accounts as Equations
To find the account balances, we can express the T-accounts as
equations:
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Inferring Business Activities from T-Accounts
If we know the beginning and ending balances of Accounts Payable and the
amount of purchases on account (for credit) during a period, we can
determine the amount of cash paid.
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Transaction Analysis Illustrated (1 of 9)
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Transaction Analysis Illustrated (2 of 9)
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Transaction Analysis Illustrated (3 of 9)
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Transaction Analysis Illustrated (4 of 9)
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Transaction Analysis Illustrated (5 of 9)
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Transaction Analysis Illustrated (6 of 9)
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Transaction Analysis Illustrated (7 of 9)
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Transaction Analysis Illustrated (8 of 9)
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Transaction Analysis Illustrated (9 of 9)
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Exhibit 2.8 • T-Accounts
After analyzing the transactions from (a)–(h), the T-accounts balances are:
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Trial Balance
• List the names of the
T-accounts in
financial statement
order (assets,
liabilities,
stockholders’ equity,
revenues, and
expenses).
• The purpose of the
trial balance is to
check the equality of
the debits and
credits.
• Errors may still exist
if the wrong
accounts or amounts
were used in the
journal entries!
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Classified Balance Sheet
The balance sheet is prepared from the
trial balance. It has a good heading
(name of company, title of statement,
date, dollars if rounded to thousands or
millions).
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Exhibit 2.9 (1 of 3)
• Chipotle Mexican
Grill’s First
Quarter 2020
Balance Sheet
(based on hypothetical
investing and financing
activities)
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Chipotle Mexican Grill’s First Quarter 2020 Balance
Exhibit 2.9 (2 of 3) Sheet (based on hypothetical investing and financing activities)
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Chipotle Mexican Grill’s First Quarter 2020 Balance
Exhibit 2.9 (3 of 3) Sheet (based on hypothetical investing and financing activities)
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International Perspective
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Current Ratio
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Investing and Financing Activities (1 of 2)
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Investing and Financing Activities (2 of 2)