Financial Accounting: The Effect of Business Transactions


The and credits diagram condenses this information. The accounting equation helps to assess whether the business transactions carried out by the company are being accurately reflected in its books and accounts. Below are examples of items listed on the balance sheet.

Which of the following is correct about the accounting equation?

The correct form of accounting equation is Assets – Liabilities = Equity. It can also be written as Assets = Liabilities + Equity.

A few days later, you buy the standing desks, causing your cash account to go down by $10,000 and your equipment account to go up by $10,000. Your liabilities are any debts your company has, whether it’s bank loans, mortgages, unpaid bills, IOUs, or any other sum of money that you owe someone else. On June 1, 2014, Nott Corp. loaned Horn $800,000 on a 12% note, payable in five annual installments of $160,000 beginning January 2, 2015. In connection with this loan, Horn was required to deposit $5,000 in a noninterest-bearing escrow account. The amount held in escrow is to be returned to Horn after all principal and interest payments have been made. Interest on the note is payable on the first day of each month beginning July 1, 2014.

Flotation Cost

Payments refer to a business paying another business for receiving goods or services. The business that makes the payment will decrease its accounts payable as well as its cash or equivalents. On the other hand, the business that receives the payment will see a decrease in accounts receivable but an increase in cash or equivalents. The balance sheet is a complex display of this equation, showing that the total assets of a company are equal to the total of liabilities and shareholder equity. Any purchase or sale has an equal effect on both sides of the equation or offsetting effects on the same side of the equation.

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Effective Tax Rate

A T- is called a “T-account” because it looks like a “T,” as you can see with the T-account shown here. In order for companies to record the myriad of transactions they have each year, there is a need for a simple but detailed system. Assets or liabilities should be further broken down into the type of asset or liability. Edgar Edwards sets up a small sole trader business as Edgar Edwards Enterprises on 1 July in the year 20X2. Complete the table below, in which the first six transactions of the business are listed in the left-most column. The accounting equation is fundamental to the double-entry bookkeeping practice.

Accountants must use their judgment to record transactions that require estimation. The number of years that equipment will remain productive and the portion of accounts receivable that will never be paid are examples of items that require estimation. In reporting financial data, accountants follow the principle of conservatism, which requires that the less optimistic estimate be chosen when two estimates are judged to be equally likely. Unless the Engineering Department provides compelling evidence to support its estimate, the company’s accountant must follow the principle of conservatism and plan for a three‐percent return rate. Losses and costs—such as warranty repairs—are recorded when they are probable and reasonably estimated. Prepaid expenses are first recorded in the prepaid asset account on the balance sheet as a current asset . Once expenses incur, the prepaid asset account is reduced, and an entry is made to the expense account on the income statement.

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