UNIT 2THE BASIC ACCOUNTING CYCLE

In Unit 1 we learned about the different accounting careers and three forms of business organizations.

In Unit 2 we will analyze transactions and prepare financial records for a business

EFFECTIVE READING SKILLS

Needed even in accounting Without these skills accountants wouldn’t be

able to analyze important financial documents, make important financial recommendations or stay up-to-date on current events and changes in laws that affect the accounting field.

CHAPTER 3: BUSINESS TRANSACTIONS AND THE ACCOUNTING EQUATION

Big Idea To understand the financial condition of any

business, you must first understand the accounting equation.

Main Idea Any item of property has at least one

financial claim against it. Accounts are used to analyze business transactions. Owner’s equity is changed by revenues, expenses and withdrawals.

REAL WORLD CONNECTION

Hulu lets you watch TV shows, clips and movies online—anytime

Can use Hulu to embed video on your blog or Web page, or just email a clip to your friends

Hulu was founded in 2007 and have become very successful

Within the first year it was oneof the top five online video sites in the US

Hulu employs about 150 people, which is a much smaller staff that companies that generate similar revenues, and so is able to keep its payroll costs to a minimum. Lower operating cost is a big advantage in business because it helps increase profitability

Hulu’s main assets are virtual in the world of streaming online video, but producing its “product” requires technological equipment and real space in which staff develops Hulu’s innovative media distribution

3-1 PROPERTY AND FINANCIAL CLAIMS

We will look at basic accounting and concepts and terminology

UPS (United Parcel Service), a corporation the provides global delivery services, uses accounting reports to communicate with its managers, employees and investors

Financial reports identify the property used in the business such as airplanes, trucks and computers.

They also show how the property was obtained, either from loans or from funds provided by investors

WHAT IS PROPERTY?

It is anything of value that a person or business owns and therefore controls

You have a legal right to that property Businesses own property Financial claim: a legal right to property One of the purposes of accounting is to

provide financial information about property and financial claims to that property

When you buy property with cash you acquire all the financial claims to that property and the time of the purchase

EXAMPLE

For example, if you pay $600 for a mountain bike then you own that bike. Had you rented it for the weekend then you would pay less but only have it for a limited amount of time

Since you paid cash, you have ownership and a financial claim of $600

Property (Cost) = Financial Claims

Bike = Your Claim to the Bike

$600 = $600

BUYING ON CREDIT

CREDIT - when you buy something and agree to pay for it later

CREDITOR - the business or person selling the item on credit, can be any person/business you owe money to

When buying on credit, you do not have the only financial claim to the property. You share the financial claim with the creditor

EXAMPLE – BUYING ON CREDIT

If you purchase the bike by paying cash for $100 of it and sign agreement to pay the remaining $500 over the next 5 months then you share the financial claim

Two or more people/businesses can have financial claims to the same property, although only the owner has control of the property

If you don’t make payments the property can exercise its legal claim and take it back

Property (Cost)

= Financial Claims

Bike = Creditor’s Financial Claim

Owner’s Financial Claim

$600 = $500 $100

ASSETS

ASSETS: property or items of value owned by a business

There are a variety of assets a business can have: Cash Office Equipment Manufacturing Equipment Buildings

The accounting term for the financial claims to assets is EQUITIES

EXAMPLE

Zip Delivery Service purchases a delivery truck for $10,000 and puts a cash down payment of $3,000 and a local bank loans the remaining $7,000

Both Zip Delivery and the bank have financial claim to the truck

Property (Cost)

= Financial Claims

Truck = Creditor’s Financial Claim

Owner’s Financial Claim

$10,000 = $7,000 $3,000

Zip’s financial claim increases as the loan is repaid

Once the loan is paid in full Zip will have total financial claim and the bank will have none

Property (Cost)

= Financial Claims

Truck = Creditor’s Financial Claim

Owner’s Financial Claim

$10,000 = $3,500 $6,500

Property (Cost)

= Financial Claims

Truck = Creditor’s Financial Claim

Owner’s Financial Claim

$10,000 = $0 $10,000

ACCOUNTING EQUATION

In accounting there are separate terms for owner’s claims and creditor’s claims

Owner’s Equity is the owner’s claims to the assets of a business

Liabilities is the creditor’s claims to the assets of a business

Accounting Equation:

3-2 TRANSACTIONS THAT AFFECT OWNER’S INVESTMENT, CASH, AND CREDIT

Business transaction – an economic event that causes a change – either increase or decrease – in assets, liabilities or owner’s equity

When a business buys a computer with cash, its cash decreases, but its computer equipment increases

Account – a subdivision under assets, liabilities, or owner’s equity

ACCOUNTS

Each business sets up its accounts to meet its needs

The number of accounts needed varies Every account must be classified as an asset,

liability or owner’s equity Accounts Receivable: the total amount of

money owed to a business, an asset Accounts Payable: the total amount of money

owed to creditors, a liabilityAssets = Liabilities + Owner’s Equity

CashAccounts ReceivableComputer EquipmentOffice EquipmentDelivery Equipment

Accounts Payable

Capital

TRANSACTIONS AND THE ACCOUNTING EQUATION

Analyzing a business transaction1. Identify the accounts affected2. Classify the account affected3. Determine the amount of increase or decrease

for each account affected4. Make sure the accounting equation remains in

balance Every business transaction causes a change

in assets, liabilities or owner’s equity Analyzing each transaction to see how it

affects the accounting equation keeps everything in balance

TYPES OF TRANSACTIONS

Investments by the owner – money or property paid out in order to produce profit

Cash transactions – any asset purchased for cash

Credit transactions – any asset purchased on account

Revenue transactions Expense transactions Withdrawals by the owner

3-3 TRANSACTIONS THAT AFFECT REVENUE, EXPENSE, AND WITHDRAWALS BY THE OWNER

UPS has thousands of shareholders who expect a return on their investment in the business. The most common way for a business to provide a return is by selling goods or providing services. UPS earns revenue by providing a global delivery service. To provide the delivery service, UPS incurs expenses like salaries, transportation, and insurance.

WHAT ARE REVENUES AND EXPENSES?

Revenue is income earned from the sale of good or services

Revenue increases owner’s equity because it increase the assets of the business

To generate revenue most businesses must incur expenses by buying goods, materials and services

Expense is the cost of products or services used to operate a business

Expenses include: rent, utilities, advertising Expenses decrease owner’s equity because

they decrease the assets of the business or increase liabilities

EFFECTS OF REVENUE AND EXPENSES

Revenue increase assets and increase owner’s equity

Expenses decrease assets and decrease owner’s equity OR increase liabilities and decrease owner’s equity

THINK ABOUT IT….

What is the difference between revenue and investments by the owner?

WHAT IS A WITHDRAWAL?

Withdrawal: the owner takes cash or other assets from the business for personal use

A withdrawal decreases both assets and owner’s equity

Not the same as an expense

REVIEW

Describe the relationship between property and financial claims:

REVIEW

List and define each part of the accounting equation:

REVIEW

Use the following steps to analyze a business transaction: