Basic Accounting

Learning Objectives

Part 1: Identify the users of accounting and the objectives of Financial Reporting
Part 2: Compare the different forms of business organizations
Part 3: Explain the building blocks of Accounting: GAAP
Part 4: Describe the components of the Financial Statement and explain the Accounting
Equation
Part 5: Analyze the Effects of business transactions on the Accounting Equation
Part 6: Prepare financial Statements
 What is Accounting?

Every element of society—from the individual to an entire industry or

government branch—must make decisions on how to allocate its resources.

• Accounting is the process that aids these decisions by (1) recording, (2)
classifying, (3) summarizing, and (4) reporting business transactions and
interpreting their effects on the affairs of the business entity.
 What is Accounting?

• Accounting is quantitative (Numbers)

• Accounting is financial in nature.
• Accounting is meant to be useful (useful for what?)
• Useful in making decisions

• Numbers about Money that helps people (you and me) make better decisions
 What is Accounting?

When looked at with a trained eye, a business’s accounting records truly tell the story of the business. Using
nothing but a business’s “books” (accounting records), you can learn practically anything about a business

You can learn simple things such as whether it’s growing or declining, healthy or in trouble.

Or, if you look closely, you can see things such as potential threats to the business’s health that might not be
apparent even to people within the company.
 What is Accounting?

At its most fundamental level, accounting is the system of tracking the

income, expenses, assets, and debts of a business.

In total, accounting involves the entire process of identifying,

recording, and communicating economic events.
 Why is Accounting Important
• Accounting is the information system that identifies, records, and communicates the economic
events of an organization to a wide variety of interested users.

• As a starting point to the accounting process, a company identifies the economic events relevant
to its business.

• Once a company identifies economic events, it records those events in order to provide a history
of its financial activities.
 Recording Events
• Recording consists of keeping a systematic, chronological diary of events, measured in dollars
and cents.

• The systematic collection of these data allows a company to prepare financial statements that are
used to then communicate financial information to interested users.

• Financial statements report the recorded data in a standardized way to make the reported
information meaningful.
 Data Analysis and Interpretation

• A vital element in communicating economic events is the accountant’s ability to

analyze and interpret the reported information.

• Analysis involves using ratios, percentages, graphs, and charts to highlight significant
financial trends and relationships.

• Interpretation involves explaining the uses, meaning, and limitations of reported data.
 Internal and External users of Accounting
Information
• There are two broad groups of users of accounting information: internal users and external users.

• Internal Users Internal users of accounting information plan, organize, and run companies. They
work for the company.

• This includes finance directors, marketing managers, human resources personnel, production
supervisors, and company officers.
 Internal Users

• Internal Users must answer many important questions, such as:

• Finance Questions: Is there enough cash to pay the bills?

• HR Questions: How many employees can we afford to hire this year?
• Marketing Questions: What price should we set to maximize profits?
• Production Questions: Which production line is the most profitable?
 Internal Users

To answer these and other questions, users need detailed information such as:
1. forecasts of cash flows for the next year,
2. projections of profit from new sales campaigns,
3. analyses of salary costs, and
4. budgeted financial statements.

Internal users generally have direct access to the business’s accounting information
 External Users

• There are several types of external users of accounting information.

1. Investors, who are owners—or potential owners—of the business, use accounting information to
make decisions to buy, hold, or sell their ownership interest.
2. Creditors—persons or other businesses that are owed money by the business, such as suppliers and
bankers—use accounting information to evaluate the risks of granting credit or lending money.

Other external users can be Labor Unions, Taxing Authorities, Economic Planners…etc.
 External Users
• Some questions that External Users might ask about a company are:

• Investors: Is the company earning enough to give me ROI

• Creditors: Does the company generate enough cash flow to pay back amounts owed

• Unlike internal users, external users have access to only the accounting information available publicly
and/or provided to them by the business.
• Determining what information should be provided to external users, and how, is the focus of financial
accounting.
 What are the different types of Accounting?

1. Bookkeeping: Systematic gathering of information

2. Financial Accounting: Reporting to people outside the organization (External
Users)
3. Managerial accounting: Detailed data used inside the organization to help in
decision making (Internal Users)
4. Income Taxes
 Bookkeeping

• All accounting begins with Bookkeeping.

• You must first record the information
• Then you can start to organize it in order to make better decisions

Therefore, bookkeeping is the preservation of a systematic quantitative

record of an activity
 Bookkeeping

• Bookkeepers must keep records of daily financial transactions in the business.

• They record invoices, payments made, receipts, and any such financial transactions that are made in
that business.
• They don't have to calculate or make projections for the business.
• So basically, bookkeepers are only required to keep records and maintain data for the business.
• It is the accountant's job to utilize this data accumulated by the bookkeeper.
• The accountant gives the financial statement for the business, but the data he uses is compiled by the
bookkeeper.
 Objectives of Financial Reporting

• The main objective of financial reporting is to provide useful information to investors

and creditors (external users) to make decisions about providing resources to a business.

• This information is most commonly supplied in general purpose financial statements

• To make the decision to invest in a business or to lend to a business, users need

information about the business’s ability to earn a profit and generate cash.
 Questions answered using Financial
Statements
Consequently, financial statements must give information about the following:

1. The business’s economic resources. What resources does the business have that it can use to carry out its business
activities?

2. The claims to the business’s economic resources. What are the amounts owed by the business and the owner’s rights to
the business’s resources?

3. Economic performance. Is the business generating a profit and enough cash to pay its debts, and provide a return to its
owners?
 Exercise #1

The following is a list of some users of accounting information. For each user indicate: (a) whether
they are an internal or external user and (b) an example of a question that might be asked by that user.

1. Creditor
2. Canada Revenue Agency
3. Investor
4. General manager of the production department
5. Manager of the human resources department
 Forms of Business Organizations

It is important to note that how the financial statements are prepared depends on the form and nature of
the business organization.

The most common forms of business organization are:

1. Proprietorship
2. Partnership
3. Corporation.
 Proprietorship
• A business owned by one person is a proprietorship. The owner is usually the operator of the
business.

• Examples are small service businesses (hair stylists, plumbers), farms, and small retail stores…
etc.

• Often only a relatively small amount of money (capital) is needed to start in business as a
proprietorship.
 Proprietorship

• The owner (the proprietor) receives any profits, suffers any losses, and is personally
liable (responsible) for all debts of the business.

• This is known as unlimited liability.

• There is no legal distinction between the business as an economic unit and the owner.
 Partnership

• A business owned by two or more persons who are associated as partners is a partnership.

• In most aspects, a partnership is similar to a proprietorship, except that there is more

than one owner.

• Partnerships are often used to organize service-type businesses, including professional

practices (lawyers, doctors, and accountants).
 Partnership
• As in a proprietorship, for accounting purposes a partnership’s business activities must be kept separate
from the personal activities of each partner.

• The partners’ share of the profit must be reported and taxed on the partners’ personal income tax returns.

• Typically, a partnership agreement (written or oral) defines the initial investments of each partner, the
duties of each partner, how profit (or loss) will be divided, and what the settlement will be if a partner
dies or withdraws.
 Partnership
• Each partner generally has unlimited liability for all debts of the
partnership, even if one of the other partners created the debt.

• This means that any of the partners can be forced to give up his or her
personal assets in order to repay the partnership debt, just as can
happen to an owner in a proprietorship.
 Corporation

• A business that is organized (incorporated) as a separate legal entity under federal or provincial
corporate law is a corporation.

• A corporation can have one owner or many owners.

• A corporation is responsible for its debts and paying taxes on its profit.

• A corporation’s ownership is divided into transferable shares.

 Corporation

• The corporation’s separate legal status provides the owners of the shares (shareholders) with limited
liability because they risk losing only the amount that they have invested in the company’s shares.

• They are not personally liable for the debts of the corporate entity.

• Shareholders, also known as investors, may sell all or part of their shares to other investors at any time.

• Easy changes of ownership are part of what makes it attractive to invest in a corporation.
 Corporation
• Because ownership can be transferred through the sale of shares and without dissolving the
corporation, the corporation enjoys an unlimited life.

• Although there are many more proprietorships and partnerships than corporations in Canada, the
revenue produced by corporations is far greater.

• Most of the largest companies in Canada—for example, Suncor Energy, Bombardier Inc.,
Toronto-Dominion Bank, Barrick Gold, and Shaw Communications— are corporations.
 Corporations

• Corporations are publicly traded.

• That is, their shares are listed on Canadian stock exchanges and the public can buy the
shares.

• Public corporations commonly distribute their financial statements to shareholders,

creditors, other interested parties, and the general public upon request.
 Summary
Characteristics Proprietorship Partnership Corporation
Owners Proprietor: One Partners: 2 or more Shareholders (1 or more)
Owners Liability Unlimited Unlimited Limited
Private or Public Private Usually private Private or Public
Taxation of Profits Paid by the owner Paid by the partners Paid by the Corporation
Life of Organization Limited Limited Unlimited
 Exercise #2
• For each type of organization (proprietorship, partnership, and
corporation) indicate:

1. Number and type of owners.

2. If it has limited or unlimited liability.
3. If it is a separate legal entity from its owners.
 GAAP (Generally Accepted Accounting
Principles)
• In order to prepare useful financial information, the accounting profession has developed
standards that are generally accepted and universally practiced.
• This common set of standards is called generally accepted accounting principles (GAAP).
• GAAP represent broad principles, procedures, concepts, and standards that act as guidelines
for accountants.
• Taken together, GAAP guide the reporting of economic events. However, for these standards
to be meaningful, a fundamental business concept must be present—ethical behavior.
 Ethics in Financial Reporting
• For financial information to have value to its users, whether internal or external, it must be prepared
by individuals with high standards of ethical behavior.

• The standards of conduct by which actions are judged as right or wrong, honest or dishonest, fair or
not fair are ethics.

• Ethics in accounting is of the utmost importance to accountants and decision makers who rely on the
financial information they produce. Effective financial reporting depends on sound ethical behavior.
ACCOUNTING ARE THE RULES & BENCHMARKS IN ACCOUNTING
FIELD THAT WE SHOULD FOLLOW WHILE
PRINCIPLES REPORTING FINANCIAL STATEMENTS.
ECONOMIC OWNER AND BUSINESS AS TWO DIFFERENT
ENTITY ENTITIES HAVING DIFFERENT LIABILITIES
Historical cost RECORDING OF THE ASSEST SHOULD BE ON THEIR
PURCHASED VALUES
MATCHING THE DEBIT SIDE SHOULD MATCH THE CREDIT SIDE
CONCEPT
 CONSISTENCY IS THE USAGE OF METHODS,
CONSISTENCY PRINCIPLES UNTIL ANOTHER OUTSTANDING
METHOD COMES PROVES TO BE BETTER
MONETARY TRANSACTIONS THAT CARRY A MONETARY VALUE
UNIT SHOULD BE ENTERED IN THE SAME CURRENCY
 ONLY THOSE TRANSACTIONS SHOULD BE
RELIABILITY RECORDED THAT CAN BE PROVEN AND HAS
SIGNIFICANT EVIDENCE
 GOING BUSINESS MAY CONTINUE FOREVER AND WILL
CARRY OUT IT’S GOAL AND PLANS IN THE FUTURE
CONCERN WITH NO INTENTION OF LIQUIDATION
 FULL DISCLOSURE OF ALL IMPORTANT INFORMATION
FOR THE USERS, LENDERS OR INVESTORS WITHIN
DISCLOSURE THE FINANCIAL STATEMENTS
 The business transactions should be
REVENUE recorded in the time periods when they
RECOGNITION actually occur and not on the basis of
the cash flows correlated with that
 Accounting Standards

• To make the information in financial statements meaningful, accountants have to

prepare the reports in a standardized way.

• Standards specify how to report economic events.

• All standards, principles, assumptions, and concepts make up the body of knowledge
known as GAAP.
 What is the Accounting Model?

• Financial Statements are the end result of Accounting.

• To prepare the financial statements, we need to use the accounting
equation, which is the basis for recording and summarizing all
transactions.
• We can think of the accounting model as what it takes to prepare
financial statements, which are the end result of accounting.
 The Accounting Model

• To prepare the financial statements, we need to use the accounting

equation, which is the basis for recording and summarizing all
transactions.
 Financial Statements

• The main objective of the financial statements is to provide

information to allow investors and creditors (external users) to make
decisions about a business.
• We will introduce four basic financial statements—the balance
sheet, income statement, statement of owner’s equity, and cash
flow statement
 Balance Sheet

• The balance sheet is like a snapshot of the company’s financial

condition at a specific point in time (usually the end of a month,
quarter, or year).
• The Elements of the Balance sheet are: Assets, Liabilities and
Owner’s Equity
 Balance Sheet

• In accounting, economic resources that are owned or controlled by a

business are called “assets.”
• Claims on the economic resources are the amounts owed by the
business and the owner’s rights to the resources.
• In accounting, amounts owed by the business are called “liabilities”
• The owner’s right to these resources is called “owner’s equity.”
 Balance Sheet

• The heading of a balance sheet must identify the company,

statement, and date.

• To indicate that the balance sheet is at a specific point in time, the

date only mentions the point in time (e.g., as of December 31, 2020).
 Assets

• Assets are resources controlled by a business as a result of past events

and from which future economic benefits are expected to flow to the
business.

• Assets are used to carry out activities, such as the production and
distribution of merchandise.
 Examples of Assets

• Cash • Insurance (Prepaid expense)

• Inventory
• Rent (prepaid expense)
• Investments
• Land • Supplies (prepaid expense)
• Buildings • Account Receivables (Promise
• Patents of future payment)
• Copyrights
 Liabilities

• Liabilities. are present obligations, arising from past events, the

settlement of which will include an outflow of economic benefits.

• An economic benefit here generally refers to cash outflows

(payments) but can also include other assets or services.
 Examples of Liabilities

• Borrowing money (Notes • Salaries

Payable) • Taxes Payable to the federal and
• Obligations to pay suppliers the provincial Govt (GST and
(Accounts payable) PST)
• Advanced payments from • Property tax to the municipality
customers (Unearned revenue)
 Owner’s Equity

• The owner’s claim on the assets of the company is known as owner’s equity
(after the creditors claims are paid)
• There are 2 ways owners can invest in a business:
• Capital Contribution or Capital Stock which means Investing own personal money into
the business
• Retained earnings: profits generated by the company which the owners then decide to
reinvest or keep in the company rather than withdrawing it for personal use (dividends)
 The Accounting Equation

• The relationship between assets, liabilities, and owner’s equity is

expressed as an equation, called the accounting equation.
• Assets must equal the sum of liabilities and owner’s equity.
• Liabilities are shown before owner’s equity in the accounting
equation because creditors have the right to receive payment before
owners.
 The Expanded Accounting Equation

• The basic accounting equation has been expanded to show the

different parts of owner’s equity and the relationship between
revenues, expenses, profit (or loss), and owner’s equity.
 Income Statement

• The main purpose of the income statement is to report the

profitability of the business’s operations over a specified period of
time (a month, quarter, or year).

• Profit is measured by the difference between revenues and expenses.

 Income Statement

• Revenue and expense are referred to as elements of the financial

statements and are reported in the income statement along with profit
or loss.
• Profit results when revenues are greater than expenses and conversely
a loss results when expenses are greater than revenues.
 Revenues

• Revenues result from business activities that are undertaken to earn

profit
• Example performing services, selling merchandise inventory, renting
property, lending money…etc.
• Revenues result in an increase in an asset or a decrease in a liability
and an increase in owner’s equity.
 Expenses

• Expenses are the costs of assets that are consumed and services that
are used in a company’s business activities.
• Expenses are decreases in assets or increases in liabilities, and result
in a decrease in owner’s equity.
• Withdrawals of assets by an owner are not considered expenses.
 Revenues and Expenses

• Revenues and expenses come in many different kinds and are identified by
various names, depending on the type of asset consumed or service used.
• Example of revenues are sales, service, commissions, interests, rent...etc
• Example of expenses are cost of items, salaries expense, utilities expense,
telephone expense, rent expense…etc
 Statement of Owner’s Equity

• The statement of owner’s equity shows the changes in owner’s equity

for the same period of time as the income statement.
• In a proprietorship, owner’s equity is increased by investments made
by the owner and decreased by withdrawals made by the owner.
• Owner’s equity is also increased when a business generates a profit
from business activities or decreased if the business has a loss.
 Investments

• Investments by the owner are contributions of cash or other assets

(e.g., a vehicle or computer) made by the owners to the business.

• Accordingly, investments by owners result in an increase in an asset

and an increase in owner’s equity.
 Drawings

• An owner may withdraw cash (or other assets) for personal use. In a
proprietorship, these withdrawals could be recorded as a direct decrease to the
owner’s capital account.
• However, it is generally considered better to use a separate account called
drawings so that the total withdrawals for the accounting period can be
determined.
• Drawings result in a decrease in an asset and a decrease in owner’s equity.
 Profit

• As previously explained, revenues increase owner’s equity and

expenses decrease owner’s equity.
• We also learned that profit results from revenues being greater than
expenses and a loss results if expenses are greater than revenues.
• Therefore, profit increases owner’s equity and losses decrease
owner’s equity.
Transactions that changes Owner’s Equity
Increase in Owner’s Equity Decreases in Owner's Equity

Investment by the owner Drawings by the Owner

Revenues Expenses
 Cash Flow Statement

• Investors and creditors need information on the business’s ability to

generate cash from its business activities and how the business uses
cash.
• The cash flow statement gives information about the cash receipts
and cash payments for a specific period of time.
 Cash Flow Statement

• The cash flow statement gives answers to the following simple but
important questions:
1. Where did the cash come from during the period?
2. What was the cash used for during the period?
3. What was the change in the cash balance during the period?
 Cash Flow Statement

• To help investors, creditors, and others analyze a company’s cash, the cash flow statement
reports the following:
1. the cash effects of the company’s operating activities during a period;
2. the cash inflows and outflows from investing transactions (e.g., the purchase and sale of land,
buildings, and equipment);
3. the cash inflows and outflows from financing transactions (e.g., borrowing and repayments of debt,
and investments and withdrawals by the owner);
4. the net increase or decrease in cash during the period; and
5. the cash amount at the end of the period.
 Cash Flow Statements

• We separate cash into 3 categories:

1. Operating activities
2. Investing activities
3. Financial Activities
 Operating Activities

• Operating activities: activities you do every single day (your

operations)
• Example, selling goods, providing services…etc. (cash inflow)
• Paying taxes, electricity… (cash outflow)
 Investing activities

• Investing or spending cash to enhance the productive capacity of a business

• Those are cash outflow activities, example, buying equipment, buying a building,
buying a truck…etc.
• Investing activities can also generate cash inflow: Example, selling the equipment
you purchased once you no longer need it
• These are not routine things, they happen occasionally. So investing activities are
things I do to enhance the productive capacity of my business
 Financial activities

• Mostly refers to inflow of money or cash to enhance the business

activities.
• Borrowing, new investment from owners (inflow)
• Repaying loans, Paying dividends to owners (outflow)
• Done occasionally
 Exercise

• The following are a few of the items that are reported in financial
statements: (1) cash, (2) service revenue, (3) drawings, (4) accounts
receivable, (5) accounts payable, and (6) salaries expense.

1. Classify the items as assets, liabilities, or owner’s equity. For the owner’s equity
items, indicate whether these items increase or decrease equity.
2. Indicate which financial statement the item is reported in.
 Transaction Analysis

• Once it has been determined that an event or transaction should be

recognized, it must be analyzed for its effect on the components of
the accounting equation before it can be recorded.
• This analysis must identify the specific items that are affected and
the amount of change in each item.
 The Expanded Accounting Equation

• The basic accounting equation has been expanded to show the

different parts of owner’s equity and the relationship between
revenues, expenses, profit (or loss), and owner’s equity.
 Transaction Analysis

Each transaction must have a dual effect on the equation for the two sides
of the accounting equation to remain equal. For example, if an asset is
increased, there must be a corresponding
1. decrease in another asset, or
2. increase in a liability, or
3. increase in owner’s equity.
 Example

• Transaction (1): Investment by Owner. Andrew Leonid decides to

open a computer programming business, which he names Soft byte.
On September 1, 2020, he invests $15,000 cash in the business,
which he deposits in a bank account opened under the name of Soft
byte. This transaction results in an equal increase in both assets and
owner’s equity for Soft byte.
 Transaction #1: Investment by Owner

• Analysis: The asset Cash is increased by $15,000 and the owner’s

equity account, A. Leonid, Capital, is increased by $15,000.
• Notice that the two sides of the basic equation remain equal.
 Transaction #2 Purchase of Equipment for
Cash
• Soft byte purchases computer equipment for $7,000 cash. This
transaction results in an equal increase and decrease in total assets,
though the composition of the assets changes. Th e specific effect of
this transaction and the cumulative effect of the first two transactions
are:
 Transaction #2

• Analysis: The asset Cash is decreased by $7,000 and the asset

Equipment is increased by $7,000.
•`
 Transaction #3 Purchase of Supplies on
Credit
• Soft byte purchases $1,600 of computer paper and other supplies that are
expected to last several months from the Alpha Supply Company. Alpha
Supply will allow Soft byte to pay this bill next month (in October). Th is
transaction is referred to as a purchase on account, or a credit purchase.
Assets are increased because the use of the paper and supplies is capable of
producing economic benefits. Liabilities are increased by the amount that is
due to Alpha Supply Company.
 Transaction #3

• Analysis: The asset Supplies is increased by $1,600 and the liability

Accounts Payable is increased by the same amount.
 Transaction #4: Services provided for Cash

• Soft byte receives $1,200 cash from customers for programming

services it has provided. This transaction is Soft byte’s main revenue-
producing activity. Remember that revenue increases profit, which
then increases owner’s equity.
 Transaction #4

• Analysis: The asset Cash is increased by $1,200 and the owner’s

equity account Service Revenue is increased by $1,200. `
 Transaction #5 Purchase of Advertising on
Credit
• Soft byte receives a bill for $250 from the local newspaper for
advertising the opening of its business. It postpones payment of the
bill until a later date. The cost of advertising is an expense, and not
an asset, because the benefits have already been used. Owner’s
equity decreases because an expense is incurred. Expenses reduce
profit and owner’s equity.
 Transaction #5

• Analysis: The liability Accounts Payable is increased by $250 and the

owner’s equity account Advertising Expense is increased by $250
 Transaction #6 Services provided for Cash
and Credit
Soft byte provides $3,500 of programming services for customers.
Cash of $1,500 is received from customers, and the balance of $2,000
is billed to customers on account. This transaction results in an equal
increase in assets and owner’s equity.
 Transaction #6

• Analysis: Three specific items are affected: the asset Cash is

increased by $1,500; the asset Accounts Receivable is increased by
$2,000; and the owner’s equity account Service Revenue is increased
by $3,500.
 Transaction #7: Payment of Expense

• The expenses paid in cash for September are store rent, $600;
salaries of employees, $900; and utilities, $200. These payments
result in an equal decrease in assets and owner’s Equity
 Transaction #7

• Analysis: The asset Cash is decreased by $1,700 in total ($600 +

$900 + $200) and owner’s equity expense accounts are increased by
the same amount, which then decreases owner’s equity.
Transaction #8 Payment of Account Payable

• Soft byte pays its $250 advertising bill in cash. Remember that the
bill was previously recorded in transaction (5) as an increase in
Accounts Payable and a decrease in owner’s equity.
 Transaction #8

• Analysis: The asset Cash is decreased by $250 and the liability

Accounts Payable is decreased by $250.
 Transaction #9 Receipt of Cash on Account

• The sum of $600 in cash is received from some customers who were
billed for services in transaction (6). Th is transaction does not
change total assets, but it does change the composition of those
assets.
 Transaction #9

• Analysis: The asset Cash is increased by $600 and the asset Accounts
Receivable is decreased by $600.
 Transaction #10

• Andrew Leonid and an equipment supplier sign a contract for Soft

byte to rent equipment for the months of October and November at
the rate of $250 per month. Soft byte is to pay each month’s rent at
the start of the month.
 Transaction #10

• Analysis: There is no effect on the accounting equation because the assets,

liabilities, and owner’s equity have not been changed by the signing of the
contract. An accounting transaction has not occurred. At this point, Soft byte has
not paid for anything, nor has it used the equipment, and therefore it has not
incurred any expenses

• NO Entry
 Transaction #11: Withdrawal of Cash by
Owner.
Andrew Leonid withdraws $1,300 in cash from the business for his
personal use. This transaction results in an equal decrease in assets and
owner’s equity.
 Transaction #11

• The asset Cash is decreased by $1,300, and the owner’s equity

account Drawings is increased by $1,300, which then decreases
owner’s equity, as follows:
Summary of Transactions
 Significant Facts concluded

1. Each transaction must be analyzed for its effects on:

1. the three components (assets, liabilities, and owner’s equity) of the
accounting equation, and
2. specific items within each component.

2. The two sides of the equation must always be equal.

 Exercise #2 – Dawd & Co.
• Transactions for the month of August by Dawd & Co., a public accounting firm, are shown below. Make
a table that shows the effects of these transactions on the accounting equation, like the tabular we just
completed
1. The owner, John Dawd, invested $25,000 of cash in the business.
2. Equipment was purchased on credit, $7,000.
3. Services were performed for customers for $8,000. Of this amount, $2,000 was received in cash and $6,000 is due on
account.
4. Rent of $850 was paid for the month.
5. Customers on account paid $4,000 (see transaction 3).
6. The owner withdrew $1,000 of cash for personal use.
 Preparing Financial Statements

• Once all transactions for the month have been recognized, financial
statements can be prepared.
• You will recall that these include the balance sheet, income
statement, statement of owner’s equity, and cash flow statement.
 The Expanded Accounting Equation

• The basic accounting equation has been expanded to show the

different parts of owner’s equity and the relationship between
revenues, expenses, profit (or loss), and owner’s equity.
 Income Statement

• The income statement is prepared from the data in the owner’s equity columns
(specifically the Revenues and Expenses columns)

• The statement’s heading names the company and type of statement, and to indicate
that it applies to a period of time, the income statement date names the time period.
• The income statement is always prepared first in order to determine the amount of
profit or loss to be used in the statement of owner’s equity.
 Statement of Owner’s Equity

• Data for preparing the statement of owner’s equity are taken from the
owner’s equity columns (specifically the Capital and Drawings
columns) of the tabular summary and from the income statement.

• The heading of this statement names the company and type of

statement and shows the time period covered by the statement.
 Statement of Owner’s Equity

• The beginning owner’s equity amount is shown on the first line of the
statement.
• In this example, it is a zero balance because it is Soft byte’s first
period of operations.
• For a company that is continuing its operations, the beginning
balance is equal to the ending balance from the previous period.
 Balance Sheet
• The heading of a balance sheet must identify the company, statement, and date.
• To indicate that the balance sheet is at a specific point in time, the date only mentions the point
in time (there is no indication of a time period).
• For Soft byte, the date is September 30, 2017.
• Notice that the assets are listed at the top, followed by liabilities and owner’s equity. This
presentation is a common convention used in Canada
• Total assets must equal total liabilities and owner’s equity. In other words, the balance sheet must
balance.
 Cash Flow Statement

• Soft byte’s cash flow statement is for the same period of time as the
income statement and the statement of owner’s equity.
• Note that the positive numbers indicate cash inflows or increases.
• Numbers in parentheses indicate cash outflows or decreases. At this
time, you do not need to know how these amounts are determined.
 To Summarize
• Assets, liabilities, and owner’s equity are reported in the balance sheet.
• Assets are present economic resources controlled by the business as a result of past events that
can produce economic benefits.
• Liabilities are present obligations of a business to transfer an economic resource as a result of
past events.
• Owner’s equity is the owner’s claim on the company’s assets and is equal to total assets minus
total liabilities.
• The balance sheet is based on the accounting equation: Assets = Liabilities + Owner’s Equity
 To Summarize

• The income statement reports the profit or loss for a specified period of time.
• Profit is equal to revenues minus expenses.
• Revenues are the increases in assets, or decreases in liabilities, that result from business
activities that are undertaken to earn profit.
• Expenses are the cost of assets consumed or services used in a company’s business
activities.
• They are decreases in assets or increases in liabilities and result in a decrease to owner’s
equity.
• Expenses do not include Withdrawals made by owner
 To Summarize

• The statement of owner’s equity summarizes the changes in owner’s equity during the
period.
• Owner’s equity is increased by investments by the owner and profits.
• It is decreased by drawings and losses.
• Investments are contributions of cash or other assets by owners.
• Drawings are withdrawals of cash or other assets from the business for the owner’s
personal use.
• Owner’s equity in a partnership is referred to as partners’ equity and in a corporation as
shareholders’ equity.
 To Summarize

• A cash flow statement summarizes information about the cash

inflows (receipts) and outflows (payments) for a specific period of
time.
 Exercise #3 – Park Accounting
Listed below, in alphabetical order, are the financial statement items for Park
Accounting Services. Prepare an income statement, statement of owner’s
equity, and balance sheet for the month ended January 31,2020

• Accounts payable $5,000 • M. Park, capital, $10,350

• Accounts receivable $2,500 • M. Park, drawings $3,000
• Advertising expense $500 • Prepaid rent $1,300
• Cash $8,200 • Rent expense $850
• Equipment $10,000 • Service revenue $11,000
 Practice Exercise 2

Adina Falk opened her own law office on July 1, 2020. During the first month
of operations, the following transactions occurred:

1. Invested $15,000 in cash in the law practice 7. Provided legal services to a client on account,
$4,000.
2. Hired a legal assistant to work part-time for
$1,500 per month. 8. Collected $1,200 of the amount owed by a
client on account (see transaction 7).
3. Paid $1,800 for July rent on office space.
9. Paid monthly expenses: salaries, $1,500;
4. Purchased equipment on account, $3,000.
telephone, $200; and utilities, $300.
5. Provided legal services to clients for cash,
10. Withdrew $2,000 cash for personal use.
$2,500.
6. Borrowed $7,000 cash from a bank on a note
payable.
 Instructions

a) Prepare a tabular analysis of the transactions.

b) Prepare the following Financial Statements:
a. income statement
b. statement of owner’s equity, and
c. balance sheet