Attendance sheet Accounting LEVEL II

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 Processing customer transactions timely
1. The Accounting Equation and Business Transactions
1.1. The Accounting Equation

Assets:

Assets are properties or economic resources owned by a business as a result of past

transactions and are expected to benefit future operations.

The common characteristic possessed by all assets is "service potential" or "future economic
benefit". E.g. Cash, Supplies (office, store, delivery, etc.), Equipment (office, store, delivery,
etc.), Land, Building etc.

Equities:

Equity refers to the rights (claims) against the assets of the business.

Therefore, we can develop a simple equation

Asset = equity
Equities are, therefore, further subdivided into two:

 Equities of creditors (claims of creditors) = Liabilities

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  Equities of owners (claims of owners) = Owner‘s Equity

Liabilities:

Liabilities are obligations arising from past transactions of the entity to transfer assets or
services to other entities or individuals in the future.

To put it more simply, Liabilities are debts owed by the business.

Examples: Accounts Payable—when goods and services are purchased on credit Loan Payable,
Notes Payable—when money is borrowed from different parties Salary payable—amounts
owed to employees

Owner's Equity:

Equity is the owner‘s claim on the assets of the business. It is often referred to as the residual
claim (interest) in the assets of a business because creditors have preferential claims on the
assets of a business.

Also called Capital, Proprietorship, or Net Worth (Net Asset)

Accounting equation:

Asset = Liabilities + Equities

In a sole proprietorship and partnership the owner‘s equity is composed of a single type of item
called capital preceded by the name of the owner(s).

Capital is affected by investment, revenues, expenses and withdrawals .

 Investment:

Investment is the transfer of cash or noncash assets into the business by the owner and they
increase capital

 Revenues:

The inflows of assets from providing goods or services to other economic entities
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  Expenses:

Cost of items and services used to produce revenue

 Withdrawals:

Cash or noncash assets taken away from the business for personal use by the owner

Drawings decreases total owner's equity

1.2. Business Transactions –

Business transaction refers to the occurrence of an event that must be recorded.

An accounting transaction occurs when assets, liabilities, or owner‘s equity items change as a
result of an economic event. –

Business transactions may be identified as external or internal

 External transaction:

These involve economic events between the company and some other enterprise or party

 Internal transactions:

These are economic events that occur entirely within one company. Items are moved and
utilized

Analysis of Transactions –

Transaction analysis is the process of identifying the specific effects of economic events on the
accounting equation.

All transactions from simplest to the most complex must be analyzed in terms of its effect on
the components of the basic accounting equation.

This analysis must also identify the specific items affected and the amount of the change in
each item.

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Illustration

On January 1, 2007, Ato Siraj started Smart Software Company which develops customer-
specific computer software. The following transactions took place during the first month:
Year 2007

Jan. 1 Ato Sira deposited Br.30, 000 in the company‘s bank account.

Jan. 2 Purchased supplies of flash disks, stationery etc. for Br. 9,000 on credit

Jan. 5 purchased for cash two computers each costing Br.6000.

Jan. 7 Received Br.15, 000 in fees for software developed for a small retail store

Jan 13 Paid creditor for supplies, Br.5, 000

Jan.18 took a loan of Br.12, 000 from Dashen Bank

Jan.22 completed a software package for a shoe shop. The customer agrees to pay the price of
Br.19, 000 in two weeks’ time.

Jan.27 Paid various business expenses for the month: office rent, Br.2, 500; Advertising, Br.1,
000; Utilities Br.250; Miscellaneous, Br 150; Electricity charges, Br 1200

Jan.29 Ato Siraj withdrew cash of Br.4, 000 from the company and bought a TV set his family.

Jan.31 Paid salary for employees, Br 6,000

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 Jan.31 the cost supplies on hand is determined to be Br.5, 000

Required: 1. Analyze the effects of these transactions on the accounting equation

Assets = Liabilities +Owner's Equity

Cash A/R Supply Off.Eqt A/P Loan.p Sira, Capital
Jan 1 30000 30000
Jan 2 9000 9000
Jan 5 (12000) 12000
Jan 7 15000 15000 Prof fees
Jan 13 (5000) (5000)
Jan 18 12000 12000
Jan 22 19000 19000 Prof. Fees
Jan 27 (5100) (5100) Total Expense
Jan 29 (4000) (4000) Withdrawal
Jan 31 (6000) (6000) Salary expanse
Jan 31 (4000) (4000) Supplies Expanse
Total 24900 19000 5000 12000 4000 12000 44900

1.3. Financial Statements

Financial information comes in many forms, but the most important are the Financial Statements.
- Financial statements are the means of conveying to management and to interested outsiders a
concise (organized) picture of the profitability and financial position of the business.

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They are prepared on a regular basis at the end of an accounting period. The accounting period
typically is one year; however,

Financial statements have generally agreed-upon formats and follow the same rules of
disclosure. - Since financial statements are in a sense the end products of the accounting process,
having a clear understanding of the content and meaning of financial statements will be crucial to
appreciate the purpose of the earlier steps of recording and classifying business transactions.

All financial statements are inter-connected; therefore, the order of preparation is important.

1.3.1. Income Statement

-It is a summary of the revenues and expenses of a business entity for a specific period of
time, such as a month or a year. The net result of revenues and expenses show the profit (or
loss) for the period.

o Net Income is realized when revenue exceeds expenses.

o Net loss is realized when expenses exceed revenue

1.3.2. Statement of Owner's Equity

-It shows the changes that occurred in the components of owners ‘equity during a specific period
of time, such as a month or a year.

-It provides a link between the Income Statement and the Balance Sheet.

-The statement of owner's equity is prepared after the income statement

1.3.3. Balance Sheet

A list of the assets, liabilities, and owner's equity of a business entity as of a specific date,
usually at the close of the last day of a month or a year

Preparing Financial Statements

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Ato Siraj started Smart Software Company

 Income statement
 Statement of Owner’s Equity
 Balance sheet