Accounting Equation 01 Review and Examples U.S. GAAP Codification , Accounting Textbooks Financial Accounting , Intermediate Accounting , Advanced Accounting U.S. GAAP by Topic , Accounting by Topic Accounting Equation 01 Basic form of an equation --> Left side = Right side 1. Balance Sheet Version Assets = Liabilities + Equity 2. Income Statement Version Net Income = Revenue - Expenses 3. Combined Version Assets = Liabilities + Equity ---> Equity = Beginning Equity + Net Income Assets = Liabilities + Beginning Equity + Net Income ---> Net Income = Revenue - Expenses Assets = Liabilities + Beginning Equity + Revenue - Expenses An Example of Combined Version At January 1, 2010, the balance of equity was $100,000. During the year of 2010, revenue and expenses were as follows Revenue = $300,000 Expenses = $240,000 What is the balance of equity at December 31, 2010? Equity = Beginning Equity + Revenue - Expenses --> $100,000 + $300,000 - $240,000 = $160,000 At December 31, 2010, Entity A had the following balances Assets = $280,000 Liabilities = $120,000 Equity = $160,000 Balance sheet version Assets = Liabilities + Equity --> $280,000 = $120,000 + $160,000 Combined version Assets = Liabilities + Beginning Equity + Revenue - Expenses
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At January 1, 2010, the balance of equity was $100,000.During the year of 2010, revenue and expenses were as followsRevenue = $300,000Expenses = $240,000
What is the balance of equity at December 31, 2010?
In the following case, what is the amount of Beginning EquityAssets = $55,000Liabilities = $21,000Revenue = $76,000Expenses = $62,000Beginning Equity = ?
1. All accounting transactions are recorded--> using "Double Entry" recording system
2. Double Entry Recording System--> at least one "Debit" entry--> at least one "Credit" entry
3. An example of double entry recordingTransaction --> purchased merchandise and paid $3,200 in cash(1) One entry on debit --> merchandise 3,200(2) One entry on credit --> cash 3,200
debit credit
merchandise 3,200 cash 3,200
4. The sum of all debit entries = The sum of all credit entriesIf the sums of debit and credit entries are not equal for any journal entry--> the journal entry is not correct
5. Debit and credit sides of the accounting equationLeft side of the accounting equation = debit = assetsRight side of the accounting equation = credit = liabilities and equity
Assets = Liabilities + Equity
6. Debit side entries(1) Increase in assets(2) Decrease in liabilities(3) Decrease in equity
7. Credit side entries(1) Decrease in assets(2) Increase in liabilities(3) Increase in equity
8. Combined version of accounting equationAssets = Liabilities + Beginning equity + Revenue - Expenses
9. Debit side entries(1) Increase in assets(2) Decrease in liabilities(3) Decrease in equity(4) Decrease in revenue(5) Increase in expenses
10. Credit side entries(1) Decrease in assets(2) Increase in liabilities(3) Increase in equity
(4) Increase in revenue(5) Decrease in expenses
11. Normal Balances(1) Asset accounts have normal balances on debit side(2) Liability accounts have normal balances on credit side(3) Equity accounts have normal balances on credit side(4) Revenue accounts have normal balances on credit side(5) Expense accounts have normal balances on debit side
Practice Questions: Is it debit or credit?
decrease in expenses
credit
increase in expenses debit
increase in revenue credit decrease in revenue debit increase in liabilities credit decrease in liabilities debit decrease in equity debit increase in equity credit normal balances of equity accounts credit normal balances of asset accounts debit normal balances of liability accounts credit normal balances of expense accounts debit normal balances of revenue accounts credit decrease in cash account credit increase in inventory account debit increase in borrowings credit decrease in preferred stock debit increase in cost of goods sold debit decrease in accounts receivable credit increase in bonds payable credit
The following accounts have normal balances on the debit side
1. Asset accounts2. Expense and loss accounts
Increases and decreases
1. Increases in asset accounts are recorded on the debit side2. Decreases in asset accounts are recorded on the credit side 3. Increases in expense and loss accounts are recorded on the debit side
4. Decreases in expense and loss accounts are recorded on the credit side
Selling, general and administrative expenses Salaries expense Advertising expense Rent expense Travel expense Communication expense Insurance expense Supplies expense Utilities expense Depreciation expense Other expenses and losses Interest expense Loss on disposal of equipment Income tax expense
The following accounts have normal balances on the credit side
1. Liability accounts2. Equity accounts3. Revenue and gain accounts
Increases and decreases
1. Increases in liability accounts are recorded on the credit side2. Decreases in liability accounts are recorded on the debit side 3. Increases in equity accounts are recorded on the credit side4. Decreases in equity accounts are recorded on the debit side 5. Increases in revenue and gain accounts are recorded on the credit side6. Decreases in revenue and gain are recorded on the debit side
Examples of liability accounts
Accounts payable
Notes payable
Salaries payable
Rent payable
Insurance payable
Interest payable
Income taxes payable
Dividends payable
Unearned rent revenue
Borrowings
Short-term borrowings
Long-term borrowings
Bonds payable
Capital lease obligations
Examples of equity accounts
Paid-in capital
Common stock Preferred stock Additional paid-in capital Retained earnings
Examples of revenue and gain accounts
Sales revenue
Services revenue Commissions revenue Interest revenue Rent revenue Dividend income Gain on sale of buildings
1. Assets represent future economic benefits 2. Assets have normal balances on the debit side
3. Increases in asset accounts are recorded on the debit side4. Decreases in asset accounts are recorded on the credit side
Classification of assets
1. Assets are classified as current and noncurrent assets 2. Current assets are expected to be converted to cash or consumed--> within a year or normal operating cycle whichever is longer--> Codification link to current assets 3. Current assets include the following(1) Cash and cash equivalents(2) Receivables, current(3) Investments, current(4) Inventories(5) Prepaid expenses 4. Noncurrent assets are expected to be converted to cash or consumed--> after a year or normal operating cycle whichever is longer 5. Noncurrent assets include the following(1) Receivables, noncurrent(2) Investments, noncurrent(3) Property, plant and equipment(4) Intangible assets(5) Other noncurrent assets
Net working capital
1. Net working capital = Current assets - Current liabilities2. Net working capital measures the margin of current assets over current liabilities3. More net working capital implies that the entity has more liquidity
Current ratio
1. Current ratio = Current assets / Current liabilities2. Current ratio measures whether the entity has enough current assets to pay off current liabilities. Current Assets Current Ratio = ---------------------- Current Liabilities
Practice Questions
1. Current assets = $300,000, Current liabilities = $200,000
2. What is the amount net working capital? Net working capital = current assets - current liabilities = $300,000 - $200,000 = $100,000
3. What is the current ratio? Current ratio = Current assets / Current liabilities = $300,000 / $200,000 = 1.50
Examples of current assets
Cash and cash equivalents
Accounts receivable Notes receivable Interest receivable Rent receivable Inventories Merchandise Raw materials Work-in-process Finished goods Supplies Prepaid expenses Prepaid rent expense Prepaid insurance expense Prepaid interest expense Trading securities Available-for-sale securities, current Held-to-maturity securities, current Other current investments
Examples of noncurrent assets
Notes receivable, noncurrent
Long-term loans Available-for-sale securities, noncurrent Held-to-maturity securities, noncurrent Other noncurrent investments Property, plant and equipment Land Buildings Equipment
1. Liabilities are present obligations to transfer resources in the future 2. Such obligations are due to past transactions or events 3. Past, present and future(1) due to past transactions or events(2) present obligations(3) future transfer of resources
Debits and credits
1. Liability accounts have normal balances on the credit side
2. Increases in liability accounts are recorded on the credit side3. Decreases in liability accounts are recorded on the debit side
Classification of liabilities
1. Liabilities are classified as current and noncurrent liabilities
2. Current liabilities are expected to require the transfer of resources--> within a year or normal operating cycle whichever is longer--> Codification link to current liabilities 3. Current liabilities include the following(1) Accounts payable(2) Notes payable, due within a year(3) Short-term borrowings(4) Income taxes payable 4. Noncurrent liabilities are expected to require the transfer of resources--> after a year or normal operating cycle whichever is longer
5. Noncurrent liabilities include the following(1) Notes payable, due after a year(2) Long-term borrowings(3) Bonds payable(4) Capital lease obligations
Practice Questions
Entity A has the following account balances as of December 31, 2010.
Accounts Balances
1 Accounts payable due within a year $50,000 2 Notes payable due in 2011 $70,000 3 Notes payable due in 2012 $40,000 4 Accounts receivable due within a year $10,000 5 Notes receivable due in 2012 $10,000 6 Bonds payable due in 2015 $80,000 7 Income taxes payable $30,000 8 Short-term borrowings $20,000
1. What is the amount of current liabilities?
Accounts Balances
1 Accounts payable due within a year $50,000 2 Notes payable due in 2011 $70,000 7 Income taxes payable $30,000 8 Short-term borrowings $20,000 Total current liabilities $170,000
2. What is the amount of noncurrent liabilities?
Accounts Balances
3 Notes payable due in 2012 $40,000 6 Bonds payable due in 2015 $80,000 Total noncurrent liabilities $120,000
(Note) The following items are not liabilities
Accounts Balances
4 Accounts receivable due within a year $10,000 5 Notes receivable due in 2012 $10,000
2. Entity D had $230,000 balance of retained earnings as of December 31, 2009.During 2010, Entity D earned $60,000 net income and declared $15,000 dividends.What is the ending balance of retained earnings as of December 31, 2010?
Ending retained earnings= Beginning retained earnings + Net income - Dividends declared= $230,000 + $60,000 - $15,000 = $275,000
Examples of equity accounts
Common stock
Preferred stock Additional paid-in capital Retained earnings
Revenue Accounts 01Examples and Practice Questions
Revenue Accounts 01Examples and Practice Questions
Revenue
1. Revenue is the increase in resources from the operations of an entity
2. Increase in resources may be (A), (B) or (C)(A) Increase in assets(B) Decrease in liabilities(C) Both (A) and (B)
Recognition of revenue
1. Recognition means "recording" in accounting2. Revenue is reported when it is recognized3. Revenue is recognized when it is earned and realized (or realizable)4. Realized means the collection of cash5. Earned means the delivery of products or services
Debits and credits
1. Revenue accounts have normal balances on the credit side
2. Increases in revenue accounts are recorded on the credit side3. Decrease in revenue accounts are recorded on the debit side
Examples of revenue accounts
Sales revenue
Services revenue Interest revenue Rent revenue
Practice Questions
1. On December 15, 2010Entity A sold 300 units of products at the price of $20 per unit
2. On December 15, 2010Entity A received $3,600 in cash
3. On January 27, 2011Entity A received $2,400 in cash
4. What is the amount revenue for 2010?300 units x $20 = $6,000
5. What is the balance of accounts receivable at December 31, 2010?$6,000 - $3,600 = $2,400
6. Prepare journal entries at the following dates(1) December 15, 2010(2) December 31, 2010(3) January 27, 2011