CHAPTER 2

Analyzing Transactions of a Business

2-2

LARGE ROLE OF SMALL BUSINESS

Small businesses

Are independently owned & operated

Are not dominant in field

Have revenues less than $500,000

2-3

DO YOU KNOW?

TRUE OR FALSE99.7% of employers are small businesses

True53% of private workforce employed in small businesses

TrueLarge businesses generate 47% US sales & 96% US importers

False

2-4

FINANCIAL STATEMENTS

Report effects of business events

Balance SheetSee Susan’s application form Ch. 1

Income StatementSee Susan’s operating budget Ch. 1

2-5

TWO QUESTIONS WHEN EVALUATING A BUSINESS

What things of value were owned or controlled?

What are the claims against or sources of these things of value?

2-6

DISTINGUISHING ACTIVITIES & TRANSACTIONS

Activities are generalFinancing activities Investing activitiesOperating activities

TransactionsTransfer, exchange between two partiesClassified into three types of activities

2-7

ACTIVITIES EXPLAINED: Financing

Financing ActivitiesObtaining money to start, maintain,

expand business

2-8

ACTIVITIES EXPLAINED: Investing

Investing ActivitiesBuying things of value with money

from financing activities

2-9

ACTIVITIES EXPLAINED: Operating

Operating activitiesApplying money, things of value to

produce goods, services

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TRANSACTION A1: Financing Activity

Sources of financingLenders Owners

2-11

TRANSACTION A1:Transaction & Explanation

Susan Newman contributes $30,000 cash to finance her business

Classified as financing becauseProvides $30,000 cash to CMU from its

owner, Susan Newman

2-12

TRANSACTION A1:Analysis

What are things of value owned?Cash

What are sources of things of value?Owner

2-13

TRANSACTION B:Investing Activity

Acquiring things of value

To develop, produce, sell products

By using money from financing

2-14

TRANSACTION B:Transaction & Explanation

Susan Newman withdraws $6,000 from business checking account to open a business savings account

Classified as investing becauseTransfer of money into savings gives

business the right to earn interest in future

2-15

TRANSACTION B:Analysis

What are things of value owned?CashSavings

What are sources of things of value?Owner

2-16

TRANSACTION C1:Investing Transaction & Explanation 2

Susan buys $10,000 worth of store equipment on credit

Classified as investing becauseAcquired of $10,000 worth of

productive equipment

2-17

TRANSACTION C1:Analysis

What are things of value ownedCashSavings Store equipment

What are sources of things of value?Accounts payableOwner

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TRANSACTION D:Operating Activity

Developing

Producing

Selling

Products & services

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TRANSACTION D:Transaction

Susan acquires $15,000 worth of inventory by paying cash

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TRANSACTION D:Explanation

Classified as operating becauseCMU acquires inventory to sell

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TRANSACTION D:Analysis

What are things of value owned Cash Savings Inventory Store equipment

What are sources of things of value? Accounts payable Owner

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EFFECTS OF TRANSACTIONS: Balance Sheet

Financial statementReports financial position at a point in time

Information providedAssets: things of value ownedLiabilities: source of assets from creditorsEquity: claim against assets held by

owners

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AIS

Accounting information system

Captures accounting informationUsing criteria to identify monetary

transactions

Processes accounting informationGather, determine proper dollar, accounts

Reports accounting information

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FUNDAMENTAL ACCOUNTING EQUATION

Assets = Sources of Assets

Assets = Liabilities + Owner’s Equity

or

Assets – Liabilities = Owner’s Equity

or

Assets – Liabilities = Net Assets

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TRANSACTION ANALYSIS:Conditions to be Met

Event must be:

Be measurable in dollars

Be Related to the entity being measures

Affect the entity’s current financial position

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TRANSACTION ANALYSIS 1: Money Measurement Concept

Financial statements report only the effects of those transactions that can be expressed in monetary or financial terms

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TRANSACTION ANALYSIS 2: Entity Concept

Financial statements report only the effects of an entity’s transactionsA promise, exchange related to the entity

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TRANSACTION ANALYSIS 3: Effect on Current Financial Position

Requires that transaction inAssetsLiabilitiesOwner’s Equity

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ACCOUNTING TRANSACTIONS

A financial event Usually supported by business

documentCheck, Sales invoice

Results in measurable changes inAssets, liabilities, owner’s equity

As of current date

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EFFECT ON FUNDAMENTAL EQUATION 1

Transaction A1 Assets = Liabilities + Equity

On 1/2 Susan contributes $30,000

$30,000 $30,000

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EFFECT ON FUNDAMENTAL EQUATION 2

Transaction B Assets = Liabilities + Equity

On 1/2 Susan transfers $6,000 to savings

$6,000

<6,000>

2-32

EFFECT ON FUNDAMENTAL EQUATION 3

Transaction C1 Assets = Liabilities + Equity

On 1/4, acquires store equipment $10,000 on credit

$10,000 $10,000

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EFFECT ON FUNDAMENTAL EQUATION 4

Transaction D Assets = Liabilities + Equity

On 1/6, acquires merchandise for cash

$15,000

<$15,000>

2-34

EFFECT ON FUNDAMENTAL EQUATION

Assets = Liabilities + Equity

Totals $40,000 $10,000 $30,000

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DUAL EFFECT CONCEPT

Every recorded transaction must have at least 2 effects on the fundamental accounting equation.

Balance sheet shows effect in balance between assets & their sources

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Give & Get 1

Transaction Assets = Liabilities + Equity

A1

B

Get cash

Get savings

Give cash

Give owner claim

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Get & Give 2

Transaction Assets = Liabilities + Equity

C1

D

Get store equipment

Get inventory

Give cash

Give promise to pay

2-38

EFFECTS OF TRANSACTIONS:Income Statement

Financial statementReports results of operations for

period of time

Information providedRevenues earnedExpenses incurred

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EFFECTS OF TRANSACTIONS:Statement of Cash Flows

Financial statementReports cash receipts or payments for period

of time

Information providedCash flows from operating activitiesCash flows from investing activitiesCash flows from financing activities

2-40

CLASSIFYING TRANSACTIONS INTO ACTIVITIES

Transactions Operating Investing Financing

A1 Owner

B Savings

C1 Equipment

D Inventory $15,000

$6,000

$10,000

$30,000

2-41

STATEMENT OF CASH FLOWS

Cash flows Operations

Net cash used <$15,000>

Cash flows Investing

Net cash used <$6,000>

Cash flows Financing

Net cash provided $30,000

Increase in cash

Beginning balance

Ending balance

$9,000

0

$9,000

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ACCOUNTING’S ROLE IN SOCIETY

Feedback to decision makers

Audited informationSystematically examined

2-43

USER FOCUSWhy Study Accounting ?

Accounting plays indispensable role in decision making

Information system for business

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BENEFITS OF LEARNING ACCOUNTING 1

Introduces business terminology & activities “Language of business”

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BENEFITS OF LEARNING ACCOUNTING 2

Facilitates business decision making Investors: return on investment; analyze

opportunities: Creditors: lending decisions Government: tax & regulation Other Not-for-Profit organizations: assurance

about use of contributions Union negotiators: improve worker pay Media investigators: financial wrongdoing

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BENEFITS OF LEARNING ACCOUNTING 3

Facilitates growth as professional

Facilitates personal decision makingManaging money

Cash budget Bank reconciliation

Preparing for job interviewFinancial analysis

2-47

BENEFITS OF LEARNING ACCOUNTING 4

Introduces time value of moneyPlanning for retirement, major needsUnderstanding how installment loan

worksLease or purchase?

2-48

Assignment #3Questions, pg. 73-74 – #1, 6, 14, 20

Assignment #4Reinforcement Exercises, pg. 74-78 – #7, 11, 12, 14, 16

Critical Thinking Problems, pg. 79-82 - #3, 7, 9, 13, 14