Accounting 3

BUSINESS
TRANSACTIONS
AND THE
ACCOUNTING
EQUATION
Chapter 3
WHAT YOU’LL LEARN
 Describe the relationship between property and financial claims
 Explain the meaning of the term equities as it is used in accounting
 List and define each part of the accounting equation
 Demonstrate the effects of transactions on the accounting equation
 Check the balance of the accounting equation after a business transaction has
been analyzed and recorded
 Define the accounting terms introduced in this chapter
BUSINESS TRANSACTIONS AND THE
ACCOUNTING EQUATION
▪ Read Investing Capital: HARPO Productions, Inc.
▪ What do you think?

Capital may have been used to purchase assets like equipment for production,
lighting, or sound; cameras; furnishings for sets; company vehicles; etc.
PROPERTY AND
FINANCIAL CLAIMS
3.1
PROPERTY AND FINANCIAL CLAIMS
▪ What types of items are owned?
Land; houses; machines; supplies; pets; etc.
▪ Is the owner the only person who has a legal claim to the item?
Not necessarily—if the owner borrowed to buy the item, the lender also has a legal
claim
All property has one or more legal claims to it
▪ Review the Main Idea
▪ Why is it important to keep track of financial claims?

Determines legal rights to property
Helps assess the condition of a business
▪ You Will Learn

▪ What it means to own property
▪ The two types of financial claims to property
KEY TERMS
▪ property
▪ financial claim
▪ credit
▪ creditor
▪ assets
▪ equities
▪ owner’s equity
▪ liabilities
▪ accounting equation
▪ Property
▪ Property is anything of value that a person or business owns
▪ A purpose of accounting is to provide:
▪ financial information about property
▪ financial claims (legal rights) to property
▪ What forms of claim have you experienced?
Family vehicle; personal computer; DVDs; gaming equipment; etc.
▪ What do you know about equations?

An equation has equal amounts on either side of the equals sign
Property
There is a relationship between property and financial claims that can be
expressed as an equation:
PROPERTY = FINANCIAL CLAIMS
▪ When you buy something and agree to pay for it later, you are buying it
on credit
▪ You share the financial claim with the creditor (the business or person selling you
the item on credit)
▪ Why is it dangerous to make minimum payments on credit card

balances?
Interest and fees will increase your liability to the card company
▪ Look at the bike lock example
▪ Suppose you pay the creditor another $10. What would be the amount
of owner’s equity?
$70
▪ Accounting records show the historical cost of property
▪ If you buy a vehicle for $12,500 and you make a $3,300 down payment
in cash, what is the property value?
$12,500
Financial Claims in Accounting
▪ A company can possess various property or items of value, known as assets:
 cash
 office equipment
 manufacturing equipment
 buildings
 land
▪ Equities are financial claims to these assets
▪ When a business obtains a loan to help purchase an item, the owner’s financial claims
to the assets are called the owner’s equity
▪ Calculate the differences between the first and second financial claims
equations.
▪ How did the owner’s financial claim increase from $3,000 to $6,500?
When the creditor’s financial claim was decreased by $3,500 after the partial loan
payment, the owner’s claim increased by the same amount
($3,000 + $3,500 = $6,500)
Financial Claims in Accounting
▪ The creditor’s financial claims to the assets are called liabilities.
▪ The relationship between assets, liabilities, and owner’s equity are
shown in the accounting equation:
Assets = Liabilities + Owner’s Equity
▪ Take another look at the accounting equation
▪ Why do liabilities come before owner’s equity?
Creditors have first claim to the assets of a business
▪ Which of the three parts of the accounting equation is actually the

result of the other two parts?
Owner’s equity because it is the amount “left over” after subtracting liabilities from
assets
▪ Why is the equation not expressed as Owner’s Equity = Assets-

Liabilities?
The financial claims to an asset are listed together on one side of the equation
DO THE MATH
1. .5 7. 889/1000
2. .2 8. 6/10
3. .3333 9. 375/1000
4. .8 10. 25/100
5. .875 11. 667/1000
6. .7 12. 75/100
PROBLEM 3-1
$10,000
$26,000
$3,000
$26,000
$6,000
$13,000
$16,000
$8,000
$21,000
$20,000
$35,000
$4,500
SECTION 1 QUIZ
▪ What is the definition of property?
Anything of value that a person or business owns
▪ What terms are used to describe the two types of financial claims to
assets?
Liabilities and owner’s equity
▪ What are assets?
Property owned by a business
▪ What is the accounting equation?
▪ What are liabilities?
▪ Debts of a business
▪ What is meant by owner’s equity?
▪ The owner’s claims to the assets of a business
SYNTHESIZING
Put into the accounting equation:
Vehicle $16,000
Vehicle loan $12,000
Computer system $2,000
$18,000 = $12,000 + $6,000
TRANSACTIONS THAT AFFECT
OWNER’S INVESTMENT, CASH,
AND CREDIT
3.2
TRANSACTIONS THAT AFFECT OWNER’S
INVESTMENT, CASH, AND CREDIT
▪ Review the Main Idea
▪ Main Idea
Accounts are used to analyze business transactions
▪ What do you think is meant by the term transaction?

An exchange of goods, services, or funds between parties
You Will Learn

 how businesses use accounts
 the steps used to analyze a business transaction
KEY TERMS
▪ business transaction
▪ account
▪ accounts receivable
▪ accounts payable
▪ investment
▪ on account
Business Transactions
▪ A business transaction is an event that causes a change in assets, liabilities, or
owner’s equity.
▪ A business records these changes in subdivisions called accounts.
▪ The number of accounts will vary from business to business.
▪ Two possible business accounts are:
 accounts receivable, an asset account
 accounts payable, a liability account
Roadrunner Delivery Service

Cash in bank Accounts payable Maria Sanchez, capital
Accounts receivable
Computer equipment
Office equipment
Delivery equipment
Effects of Transactions on the Accounting Equation
▪ To analyze a business transaction, follow these steps:
▪ Identify the accounts affected
▪ Classify the accounts affected
▪ What does it mean to classify accounts?
To determine whether they are assets, liabilities, or owner’s equity
▪ Determine the amount of increase or decrease for each account affected
▪ Make sure the accounting equation remains in balance
Investments by the Owner
Money or other property paid out in order to produce profit is an investment
What does the +/- symbol

represent?
The process of determining
the increase or decrease to
each account in the
transaction
Investments by the Owner
Money or other property paid out in order to produce profit is an investment
How do you know to use an
account called Office Equipment
instead of Telephone Equipment?
By referring to the list of
accounts used by this business
(see p. 54)
Cash Payment Transaction
Analyze a cash purchase business transaction:
Cash Payment Transaction
Analyze a cash purchase business transaction:
• How would owner’s equity change

if Roadrunner bought the
computer on account instead of
for cash?
It wouldn’t
Credit Transaction
Purchasing an item on credit is also called buying on account
• Which accounts will be

affected by the transaction?
Delivery equipment and
Accounts Payable
Credit Transaction
Credit Transaction
Why would Roadrunner agree

to be paid in the future for the
telephone?
There could be many different
reasons, but one might be that
Roadrunner got the best price
from this particular buyer and
had the confidence the buyer
would pay the debt
Credit Transaction
Credit Transaction
• Roadrunner paid $350 toward the

truck loan.
• Why does the delivery account
still have a $12,000 balance?
Because the payment reduces a
liability and is subtracted from
the liability balance, not the
asset balance
Credit Transaction
Credit Transaction
• If you see the word Receivable in

an account name, what type of
account is it? Why?
Asset account because it
represents a claim to the assets
of other people or businesses
Credit Transaction
• What is the balance of Accounts

Receivable after this transaction?
$0
DO THE MATH
1. L = A – OE
2. OE = A – L
$? = $9,000 + $21,000
$30,000
$25,000 = $14,000
$? + $11,000
$10,000 = $2,000 + $8,000
$?
PROBLEM 3-2
1. Cash in Bank increased $30,000; Jan Swift, Cap. increased $30,000
2. Office Furniture increased $700; Jan Swift, Cap. increased $700
3. Cash in bank decreased $4,000; Computer Equipment increased
$4,000
4. Office Furniture increased $5,000; Accounts Payable increased $5,000
5. Accounts Receivable increased $700; Office Furniture decreased $700
6. Cash in Bank decreased $2,000; Accounts Payable decreased $2,000
SYNTHESIZING
$18,000 = $12,000 + $6,000
▪ The owner then withdrawals $1,500 for personal use.
▪ What is the new accounting equation?

$16,500 = $12,000 + $4,500
ADDITIONAL
Brandon’s Car Wash has the following assets and liabilities:
Assets: Cash in Bank $9,500; Accounts Receivable $500; Computer
Equipment $3,500; Car Wash Equipment $75,000; Building $450,000
Liabilities: Alto’s Equipment Service $2,500; First National Bank building
mortgage $200,000
What is the owner’s equity for Brandon’s?
Step 1: Calculate total assets
($9,500+$500+$3,500+$75,000+$450,000=$538,500)
Step 2: Calculate total liabilities ($2,500+$200,000=$202,500)
Step 3: Calculate owner’s equity ($538,500-$202,500=$336,000)
SECTION 2 QUIZ
1. What is a business transaction?
An economic event that causes a change in assets, liabilities, or owner’s equity
2. What do you call the subdivisions of assets, liabilities, and owner’s equity?
Accounts
3. What information is contained in an account?

Balance and record of increases and decreases
4. What is an investment?
Money or other property paid out to produce a profit
5. What account categories are affected when an owner invests in the

business?
Assets and Owner’s Equity
KEY TERMS REVIEW
▪ Business transaction
An economic event that causes a change – either an increase or a decrease – in
assets, liabilities, or owner’s equity.
▪ Account
A subdivision under assets, liabilities, or owner’s equity that summarizes the changes
and shows the balance for a specific item.
▪ Accounts receivable
The amount of money owed to a business by its credit customers.
KEY TERMS REVIEW
▪ Accounts payable
The amount of money owed, or payable, to the creditors of a business.
▪ Investment
Money or other property provided for the purpose of making a profit.
▪ On account
The purchase of an item on credit.
TRANSACTIONS THAT AFFECT
REVENUE, EXPENSE, AND
WITHDRAWALS BY THE OWNER
3.3
TRANSACTIONS THAT AFFECT REVENUE,
EXPENSE, AND WITHDRAWALS BY THE
OWNER
Review the Main Idea
Main Idea
▪ Owner’s equity is changed by revenue, expenses, investments, and withdrawals
▪ How do you think revenue, expenses, investments and withdrawals affect owner’s
equity?
Revenue and investments increase owner’s equity
Expenses and withdrawals decrease it
You Will Learn
▪ How revenue and expenses affect owner’s equity
▪ How withdrawals affect owner’s equity
KEY TERMS
▪ Revenue
▪ Expense
▪ Withdrawal
OWNER
Revenue and Expense Transactions
▪ Revenues increase owner’s equity and expenses decrease owner’s equity
▪ Examples of revenue (income earned from the sales of goods and services):
 fees earned for services performed
 cash received from the sale of merchandise
▪ To generate revenue, a business may also incur expenses (costs)
 rent
 utilities
 advertising
OWNER
• How would this transaction be

different if Sims Corporation made a
promise to pay (bought on account)?
The Cash in Bank balance would not
change. Accounts Receivable would
increase by $1,200
OWNER
OWNER
OWNER
OWNER
Withdrawals by the Owner
▪ An owner can make a withdrawal of cash or other assets from the business assets if
revenue is earned
▪ A withdrawal has the opposite effect on owner’s equity than investments:
 Withdrawals decrease assets and owner’s equity
 Investments increase assets and owner’s equity

• What accounting assumption

requires that the business owner’s
withdrawals must be accounted for?
Business entity
OWNER
Persuasive Writing
▪ As the owner of ABC Company, write a memo justifying the withdrawal of cash from the
business.
REVIEW
▪ A business owner invests $12,000 cash in the business.
▪ How would you analyze this transaction?
1. Identify the accounts affected
a. Cash in Bank is affected
b. Owner’s Capital is affected
2. Classify the accounts affected
a. Cash in Bank is an asset account
b. Owner’s Capital is an owner’s equity account
3. Determine the amount of increase or decrease for each account affected
a. Cash in Bank is increased by $12,000
b. Owner’s Capital is increased by $12,000
4. Make sure the accounting equation remains in balance
$12,000 = 0 + $12,000
DO THE MATH
$9,900
PROBLEM 3-3
1. Cash in Bank decreased $50; Jan Swift, Cap. decreased $50
2. Cash in Bank increased $1,000; Jan Swift, Cap. increased $1,000
3. Cash in bank decreased $600; Jan Swift, Cap. decreased $600
4. Cash in bank decreased $800; Jan Swift, Cap. decreased $800
5. Cash in Bank increased $200; Accounts Receivable decreased $200
SYNTHESIZING
▪ Write a paragraph or draw a diagram to show how revenue, expenses,
and withdrawals affect the accounting equation.
SECTION 3 QUIZ
1. How do revenue and investments affect owner’s equity?
Both increase owner’s equity
2. Which is earned: revenue, investments, or both?

Revenue
3. How do expenses and withdrawals affect owner’s equity?

Both decrease owner’s equity
4. Which is a cost of operating the business: expenses, withdrawals, or both?

Expenses
5. What account categories are affected when an owner withdraws money?

Assets and Owner’s Equity
HOMEWORK
▪ Finish problems 3-4 to 3-8

Accounting 3

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BUSINESS

▪ What do you think?

▪ Why is it important to keep track of financial claims?

▪ You Will Learn

▪ What do you know about equations?

▪ Why is it dangerous to make minimum payments on credit card

▪ Which of the three parts of the accounting equation is actually the

▪ Why is the equation not expressed as Owner’s Equity = Assets-

▪ What do you think is meant by the term transaction?

You Will Learn

Assets = Liabilities + Owner’s Equity

What does the +/- symbol

• How would owner’s equity change

• Which accounts will be

Why would Roadrunner agree

• Roadrunner paid $350 toward the

• If you see the word Receivable in

• What is the balance of Accounts

▪ The owner then withdrawals $1,500 for personal use.

▪ What is the new accounting equation?

3. What information is contained in an account?

5. What account categories are affected when an owner invests in the

• How would this transaction be

▪ A withdrawal has the opposite effect on owner’s equity than investments:

 Withdrawals decrease assets and owner’s equity

 Investments increase assets and owner’s equity

• What accounting assumption

2. Which is earned: revenue, investments, or both?

3. How do expenses and withdrawals affect owner’s equity?

4. Which is a cost of operating the business: expenses, withdrawals, or both?

5. What account categories are affected when an owner withdraws money?

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