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Accounting Equation 01
Review and Examples
c
U.S. GAAP Codification, Accounting Textbooks c
Financial Accounting, Intermediate Accounting, Advanced Accounting c
U.S. GAAP by Topic, Accounting by Topic c
c

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

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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
--> $280,000 = $120,000 + $100,000 + $300,000 - $240,000
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Cases and Practice Questions

Case 1:
Assets = $12,000
Liabilities = $5,000
Equity = $7,000
Assets = Liabilities + Equity
$12,000 = $5,000 + $7,000

Practice Question 1:

If Assets = $12,000 and Liabilities = $3,000

what is the amount of equity?

--> Equity = Assets - Liabilities = $12,000 - $3,000 = $9,000

Case 2:

Revenue = $16,000
Expenses = $10,000
Net income = Revenue - Expenses = $16,000 - $10,000 = $6,000

Practice Question 2:

If Revenue = $16,000 and Expenses = $11,000

what is the amount of net income?

--> Net income = Revenue - Expenses = $16,000 - $11,000 = $5,000

Case 3:

Assets = $25,000
Liabilities = $11,000
Beginning Equity = $10,000
Revenue = $36,000
Expenses = $32,000
Assets = Liabilities + Beginning Equity + Revenue - Expenses
$25,000 = $11,000 + $10,000 + $36,000 - $32,000

Practice Question 3:

In the following case, what is the amount of Beginning Equity

Assets = $55,000
Liabilities = $21,000
Revenue = $76,000
Expenses = $62,000
Beginning Equity = ?

Assets = Liabilities + Beginning Equity + Revenue - Expenses

$55,000 = $21,000 + ? + $76,000 - $62,000
--> Beginning Equity = ? = $20,000
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 Double Entry Recording 01
Debits and Credits
c
U.S. GAAP Codification, Accounting Textbooks c
Financial Accounting, Intermediate Accounting, Advanced Accounting c
U.S. GAAP by Topic, Accounting by Topic c
c

Ñouble Entry Recording 01

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 recording

Transaction --> purchased merchandise and paid $3,200 in cash
(1) One entry on debit --> merchandise 3,200
(2) One entry on credit --> cash 3,200

c debit c credit c
merchandise c 3,200 c c
cash c c 3,200 c

4. The sum of all debit entries = The sum of all credit entries
If 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 equation

Left side of the accounting equation = debit = assets
Right 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 equation

Assets = 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
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Practice Questions: Is it debit or credit?
c
decrease in expenses c c credit c
increase in expenses c debit c c
increase in revenue c c credit c
decrease in revenue c debit c c
c c c
increase in liabilities c c credit c
decrease in liabilities c debit c c
decrease in equity c debit c c
increase in equity c c credit c
c c c
normal balances of equity accounts c c credit c
normal balances of asset accounts c debit c c
normal balances of liability accounts c c credit c
c c c
normal balances of expense accounts c debit c c
normal balances of revenue accounts c c credit c
c c c
decrease in cash account c c credit c
increase in inventory account c debit c c
increase in borrowings c c credit c
c c c
decrease in preferred stock c debit c c
increase in cost of goods sold c debit c c
decrease in accounts receivable c c credit c
increase in bonds payable c c credit c
ccc
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 c
Debit Accounts 01
Examples
c
U.S. GAAP Codification, Accounting Textbooks c
Financial Accounting, Intermediate Accounting, Advanced Accounting c
U.S. GAAP by Topic, Accounting by Topic c
c

ë e following accounts ave normal balances on t e debit side

1. Asset accounts
2. Expense and loss accounts

Increases and decreases

1. Increases in asset accounts are recorded on the debit side

2. 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 cc
ccc
Examples of asset accounts
c
c Cash and cash equivalents c
c Accounts receivable c
c Notes receivable c
c Interest receivable c
c Rent receivable c
c c
c Inventories c
c Merchandise c
c Raw materials c
c Work-in-process c
c Finished goods c
c Supplies c
c c
c Prepaid expenses c
c Prepaid rent expense c
c Prepaid insurance expense c
c Prepaid interest expense c
c c
c Investment in debt and equity securities c
c Trading securities c
c Available-for-sale securities c
c Held-to-maturity securities c
c c
c Property, plant and equipment c
c Land c
c Buildings c
c Equipment c
c Machinery c
c Capitalized leases c
c Leasehold improvements c
c c
c Intangible assets c
c Goodwill c
c Trademarks c
c Patents c
cc
 ccc
Examples of expense and loss accounts
c
c Cost of goods sold c
c c
c Selling, general and administrative expenses c
c Salaries expense c
c Advertising expense c
c Rent expense c
c Travel expense c
c Communication expense c
c c
c Insurance expense c
c Supplies expense c
c Utilities expense c
c Depreciation expense c
c c
c Other expenses and losses c
c Interest expense c
c Loss on disposal of equipment c
c Income tax expense c
cc
c

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 Credit Accounts 01
Examples
c
U.S. GAAP Codification, Accounting Textbooks c
Financial Accounting, Intermediate Accounting, Advanced Accounting c
U.S. GAAP by Topic, Accounting by Topic c
c

ë e following accounts ave normal balances on t e credit side

1. Liability accounts
2. Equity accounts
3. Revenue and gain accounts

Increases and decreases

1. Increases in liability accounts are recorded on the credit side

2. Decreases in liability accounts are recorded on the debit side

3. Increases in equity accounts are recorded on the credit side

4. Decreases in equity accounts are recorded on the debit side

5. Increases in revenue and gain accounts are recorded on the credit side
6. Decreases in revenue and gain are recorded on the debit side
cc
ccc
Examples of liability accounts
c
c Accounts payable c
c Notes payable c
c c
c Salaries payable c
c Rent payable c
c Insurance payable c
c Interest payable c
c Income taxes payable c
c Dividends payable c
c c
c Unearned rent revenue c
c c
c Borrowings c
c Short-term borrowings c
c Long-term borrowings c
c c
c Bonds payable c
c Capital lease obligations c
ccc
ccc
Examples of equity accounts
c
c Paid-in capital c
c Common stock c
c Preferred stock c
 c Additional paid-in capital c
c c
c Retained earnings c
ccc
ccc
Examples of revenue and gain accounts
c
c Sales revenue c
c Services revenue c
c Commissions revenue c
c c
c Interest revenue c
c Rent revenue c
c c
c Dividend income c
c c
c Gain on sale of buildings c
ccc
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 Asset Accounts 01
Examples and Practice Questions
c
U.S. GAAP Codification, Accounting Textbooks c
Financial Accounting, Intermediate Accounting, Advanced Accounting c
U.S. GAAP by Topic, Accounting by Topic c
c

Assets

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 side

4. 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 liabilities

2. Net working capital measures the margin of current assets over current liabilities
3. More net working capital implies that the entity has more liquidity

Current ratio

1. Current ratio = Current assets / Current liabilities

2. Current ratio measures whether the entity has enough current assets to pay off current liabilities.

c c Current Assets c
c Current Ratio =c ---------------------- c
c c Current Liabilities c

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
c
ccc
Examples of current assets
c
c Cash and cash equivalents c
c Accounts receivable c
c Notes receivable c
c Interest receivable c
c Rent receivable c
c c
c Inventories c
c Merchandise c
c Raw materials c
c Work-in-process c
c Finished goods c
c Supplies c
c c
c Prepaid expenses c
c Prepaid rent expense c
c Prepaid insurance expense c
c Prepaid interest expense c
c c
c Trading securities c
c Available-for-sale securities, current c
c Held-to-maturity securities, current c
c Other current investments c
cc
ccc
Examples of noncurrent assets
c
c Notes receivable, noncurrent c
c Long-term loans c
c Available-for-sale securities, noncurrent c
c Held-to-maturity securities, noncurrent c
c Other noncurrent investments c
c c
c Property, plant and equipment c
c Land c
c Buildings c
c Equipment c
c Machinery c
c Capitalized leases c
c Leasehold improvements c
c c
c Intangible assets c
c Goodwill c
c Trademarks c
c Patents c
cc
c

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 Liability Accounts 01
Examples and Practice Questions
c
U.S. GAAP Codification, Accounting Textbooks c
Financial Accounting, Intermediate Accounting, Advanced Accounting c
U.S. GAAP by Topic, Accounting by Topic c
c

ëiabilities

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

Ñebits and credits

1. Liability accounts have normal balances on the credit side

2. Increases in liability accounts are recorded on the credit side

3. 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
c
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Practice Questions

Entity A has the following account balances as of December 31, 2010.

c
c Accounts c Balances c
1 c Accounts payable due within a year c $50,000 c
2 c Notes payable due in 2011 c $70,000 c
3 c Notes payable due in 2012 c $40,000 c
4 c Accounts receivable due within a year c $10,000 c
5 c Notes receivable due in 2012 c $10,000 c
6 c Bonds payable due in 2015 c $80,000 c
7 c Income taxes payable c $30,000 c
 8 c Short-term borrowings c $20,000 c

1. What is the amount of current liabilities?

c
c Accounts c Balances c
1 c Accounts payable due within a year c $50,000 c
2 c Notes payable due in 2011 c $70,000 c
7 c Income taxes payable c $30,000 c
8 c Short-term borrowings c $20,000 c
c Total current liabilities c $170,000 c

2. What is the amount of noncurrent liabilities?

c
c Accounts c Balances c
3 c Notes payable due in 2012 c $40,000 c
6 c Bonds payable due in 2015 c $80,000 c
c Total noncurrent liabilities c $120,000 c

(Note) The following items are not liabilities

c
c Accounts c Balances c
4 c Accounts receivable due within a year c $10,000 c
5 c Notes receivable due in 2012 c $10,000 c
cc
c
Examples of current liabilities
c
c Accounts payable, due within a year c
c Notes payable, due within a year c
c c
c Salaries payable c
c Rent payable c
c Insurance payable c
c Interest payable c
c Income taxes payable c
c Dividends payable c
c c
c Unearned rent revenue c
c c
c Short-term borrowings c
cc
ccc
Examples of noncurrent liabilities
c
c Notes payable, due after a year c
c c
c Long-term borrowings c
c c
c Bonds payable c
c Capital lease obligations c
cc
c
 Equity Accounts 01
Examples and Practice Questions
c
U.S. GAAP Codification, Accounting Textbooks c
Financial Accounting, Intermediate Accounting, Advanced Accounting c
U.S. GAAP by Topic, Accounting by Topic c
c

Equity

1. Equity represents the owners' equity

2. For corporations, shareholders are owners

--> equity represents the shareholders' equity

3. Equity is a residual concept

--> equity is what's left after subtracting liabilities from assets

4. Equity = Assets - Liabilities

Components of equity

1. Paid-in capital
--> the amount shareholders contributed to the entity
--> in exchange of the shares of common stock or preferred stock

2. Retained earnings
--> net income is accumulated in retained earnings
--> dividends are paid from retained earnings

Debits and credits

1. Equity accounts have normal balances on the credit side

2. Increases in equity accounts are recorded on the credit side

3. Decrease in equity accounts are recorded on the debit side
c
ccc
Practice Questions

1. Issuance of common stock

Entity A issued 8,000 shares of common stock

Par value = $1 per share
Issue price = $10 per share c
c debit c credit c
Cash c 80,000 c c
Common stock c c 8,000 c
Additional paid-in capital c c 72,000 c

2. Issuance of common stock with no par value

Entity B issued 7,000 shares of common stock

No par value
Issue price = $20 per share c
c debit c credit c
Cash c 140,000 c c
Common stock c c 140,000 c
 Retained earnings

1. Net income is added to retained earnings

Ending retained earnings
= Beginning retained earnings + Net income

2. Dividends decrease retained earnings

Ending retained earnings
= Beginning retained earnings + Net income - Dividends declared

Practice Questions

1. Dividends are declared

Entity C has 500,000 shares of common stock outstanding
--> and declared $3 per share dividends c
c debit c credit c
Retained earnings c 150,000 c c
Dividends payable c c 150,000 c

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 c
cc
ccc
Examples of equity accounts c
c Common stock c
c Preferred stock c
c Additional paid-in capital c
c c
c Retained earnings c
cc
c

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 Revenue Accounts 01
Examples and Practice Questions
c

U.S. GAAP Codification, Accounting Textbooks c

Financial Accounting, Intermediate Accounting, Advanced Accounting c
U.S. GAAP by Topic, Accounting by Topic c
c

Revenue Accounts 01
Examples 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 accounting

2. Revenue is reported when it is recognized
3. Revenue is recognized when it is earned and realized (or realizable)
4. Realized means the collection of cash
5. 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 side

3. Decrease in revenue accounts are recorded on the debit side
c
ccc
Examples of revenue accounts c
c Sales revenue c
c Services revenue c
c Interest revenue c
c Rent revenue c
ccc
c
Practice Questions

1. On December 15, 2010

Entity A sold 300 units of products at the price of $20 per unit

2. On December 15, 2010

Entity A received $3,600 in cash

3. On January 27, 2011

Entity 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

7. Journal entry at December 15, 2010 c

c debit c credit c
Cash c 3,600 c c
Accounts receivable c 2,400 c c
Sales revenue c c 6,000 c

8. Journal entry at December 31, 2010

--> No journal entry is required at December 31, 2010

9. Journal entry at January 27, 2011 c

c debit c credit c
Cash c 2,400 c c
Accounts receivable c c 2,400 c

ccc
c

c
 Expense Accounts 01
Examples and Practice Questions
c

U.S. GAAP Codification, Accounting Textbooks c

Financial Accounting, Intermediate Accounting, Advanced Accounting c
U.S. GAAP by Topic, Accounting by Topic c
c

Expense Accounts 01
Examples and Practice Questions

Expense

1. Expense is the use of resources to generate revenue

2. Expense is recognized when related revenue is recognized

--> this is called "matching principle"

* Debits and credits

1. Expense accounts have normal balances on the debit side

2. Increases in expense accounts are recorded on the debit side

3. Decrease in expense accounts are recorded on the credit side
c
c
Examples of expense accounts c
c Cost of goods sold c
c c
c Selling, general and administrative expenses c
c Salaries expense c
c Advertising expense c
c Rent expense c
c Travel expense c
c Communication expense c
c c
c Insurance expense c
c Supplies expense c
c Utilities expense c
c Depreciation expense c
c c
c Other expenses and losses c
c Interest expense c
c Income tax expense c
ccc
c
Practice Questions

1. On November 1, 2010
Entity A purchased 500 units of merchandise at the price of $10 per unit
and paid full amount in cash

2. On November 12, 2010

Entity A sold 200 units of merchandise at the selling price of $14 per unit
and received full amount in cash

3. Prepare journal entries at the following dates

(1) November 1, 2010
(2) November 12, 2010
4. Journal entry at November 1, 2010 c
c debit c credit c
Merchandise c 5,000 c c
Cash c c 5,000 c

5. Journal entry at November 12, 2010, to record revenue c

c debit c credit c
Cash c 2,800 c c
Sales revenue c c 2,800 c

6. Journal entry at November 12, 2010, to record expense c

c debit c credit c
Cost of goods sold c 2,000 c c
Merchandise c c 2,000 c

7. Sales revenue = $2,800

Cost of goods sold = $2,000
Gross profit = Sales - Cost of goods sold = $2,800 - $2,000 = $800

8. At December 31, 2010

Balance of merchandise = 300 units x $10 = $3,000 c