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review. The final version of this teacher’s resource manual will be published as soon as the review has been completed.
 Learning Objectives

1. State the accounting equation and define each

element of the equation.
2. Describe and illustrate how business transactions can
be recorded in terms of the resulting change in the
elements of the accounting equation.
3. Describe the financial statements of a proprietorship
and explain how they interrelate.
4. Describe and illustrate the use of the ratio of
liabilities to owner’s equity in evaluating a company’s
financial condition.

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review. The final version of this teacher’s resource manual will be published as soon as the review has been completed.
DISCLAIMER: This document is a draft and the information contained herein is subject to change as this document is currently undergoing
review. The final version of this teacher’s resource manual will be published as soon as the review has been completed.
 The Accounting Equation

o The resources owned by a business are its

assets.
o The rights of creditors are the debts of the
business and are called liabilities.
o The rights of the owners are called owner’s
equity.
o The equation Assets = Liabilities + Owner’s
Equity is called the accounting equation.

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review. The final version of this teacher’s resource manual will be published as soon as the review has been completed.
THE ACCOUNTING
EQUATION

Assets = Liabilities + Owner’s Equity

The resources
owned by a
business

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review. The final version of this teacher’s resource manual will be published as soon as the review has been completed.
THE ACCOUNTING
EQUATION

Assets = Liabilities + Owner’s Equity

The rights of
creditors are the
debts of the
business

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review. The final version of this teacher’s resource manual will be published as soon as the review has been completed.
THE ACCOUNTING
EQUATION

Assets = Liabilities + Owner’s Equity

The rights of the

owners

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review. The final version of this teacher’s resource manual will be published as soon as the review has been completed.
DISCLAIMER: This document is a draft and the information contained herein is subject to change as this document is currently undergoing
review. The final version of this teacher’s resource manual will be published as soon as the review has been completed.
 Business Transaction

o A business transaction is an economic event or

condition that directly changes an entity’s
financial condition or its results of operations.

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review. The final version of this teacher’s resource manual will be published as soon as the review has been completed.
 TRANSACTION A

On November 1, 2013, Chris Clark deposited

$25,000 in a bank account in the name of
NetSolutions.

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review. The final version of this teacher’s resource manual will be published as soon as the review has been completed.
 TRANSACTION B

On November 5, 2013, NetSolutions paid

$20,000 for the purchase of land as a future
building site.

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review. The final version of this teacher’s resource manual will be published as soon as the review has been completed.
 TRANSACTION C

On November 10, 2013, NetSolutions

purchased supplies for $1,350 and agreed to
pay the supplier in the near future.

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review. The final version of this teacher’s resource manual will be published as soon as the review has been completed.
 Transaction C

o The liability created by a purchase on account

is called an account payable.
o Items such as supplies that will be used in the
business in the future are called prepaid
expenses, which are assets.

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review. The final version of this teacher’s resource manual will be published as soon as the review has been completed.
 TRANSACTION D

On November 18, 2013, NetSolutions received cash of

$7,500 for providing services to customers. A business
earns money by selling goods or services to its
customers. This amount is called revenue.

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review. The final version of this teacher’s resource manual will be published as soon as the review has been completed.
 Transaction D

o Revenue from providing services is recorded

as fees earned.
o Revenue from the sale of merchandise is
recorded as sales.
o Other examples of revenue include rent, which
is recorded as rent revenue, and interest, which
is recorded as interest revenue.
o An account receivable is a claim against a
customer, which is an asset.

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review. The final version of this teacher’s resource manual will be published as soon as the review has been completed.
 TRANSACTION E

During the month, NetSolutions spent cash or

used up other assets in earning revenue.
Assets used in this process of earning revenue
are called expenses.

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review. The final version of this teacher’s resource manual will be published as soon as the review has been completed.
 TRANSACTION E

On November 30, 2013, NetSolutions paid the

following expenses: wages, $2,125; rent, $800;
utilities, $450; and miscellaneous, $275.

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review. The final version of this teacher’s resource manual will be published as soon as the review has been completed.
 TRANSACTION F

On November 30, 2013, NetSolutions paid

creditors on account, $950.

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review. The final version of this teacher’s resource manual will be published as soon as the review has been completed.
 TRANSACTION G

On November 30, 2013, Chris Clark

determined that the cost of supplies on
hand at the end of the period was $550.

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review. The final version of this teacher’s resource manual will be published as soon as the review has been completed.
 TRANSACTION H

On November 30, 2013, Chris Clark

withdrew $2,000 from NetSolutions for
personal use.

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review. The final version of this teacher’s resource manual will be published as soon as the review has been completed.
 SUMMARY

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review. The final version of this teacher’s resource manual will be published as soon as the review has been completed.
 Types of Transactions Affecting Owner’s Equity

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DISCLAIMER: This document is a draft and the information contained herein is subject to change as this document is currently undergoing
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 Financial Statements

o After transactions have been recorded and

summarized, reports are prepared for users.
The accounting reports providing this
information are called financial statements.

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review. The final version of this teacher’s resource manual will be published as soon as the review has been completed.
 FINANCIAL
STATEMENTS

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review. The final version of this teacher’s resource manual will be published as soon as the review has been completed.
 Income Statement

o The income statement reports the revenues and

expenses for a period of time, based on the
matching concept.
o The matching concept is applied by “matching”
the expenses incurred during a period with the
revenue that those expenses generated.
o The excess of the revenue over the expenses is
called net income, net profit, or earnings. If
expenses exceed revenue, the excess is a net loss.

DISCLAIMER: This document is a draft and the information contained herein is subject to change as this document is currently undergoing
review. The final version of this teacher’s resource manual will be published as soon as the review has been completed.
 Statement of Owner’s Equity

o The statement of owner’s equity reports the

changes in the owner’s equity for a period of
time.
o It is prepared after the income statement
because the net income or net loss for the
period must be reported in this statement.

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review. The final version of this teacher’s resource manual will be published as soon as the review has been completed.
 Financial Statements – Income Statement

Net income is carried to

the statement of
owner’s equity.

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review. The final version of this teacher’s resource manual will be published as soon as the review has been completed.
 Financial Statements – Statement of Owner’s Equity

From the income statement

To the balance sheet

(continued)
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review. The final version of this teacher’s resource manual will be published as soon as the review has been completed.
 Balance Sheet

o A balance sheet is a list of the assets,

liabilities, and owner’s equity as of a specific
date.

DISCLAIMER: This document is a draft and the information contained herein is subject to change as this document is currently undergoing
review. The final version of this teacher’s resource manual will be published as soon as the review has been completed.
 Account Form

o The account form of a balance sheet lists the

assets on the left and the liabilities and
owner’s equity on the right. It resembles the
basic format of the accounting equation.

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review. The final version of this teacher’s resource manual will be published as soon as the review has been completed.
 Financial Statements – Balance Sheet

This amount is
compared to the From the statement
net cash flow on of owner’s equity
the statement of
cash flows.
(continued)
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review. The final version of this teacher’s resource manual will be published as soon as the review has been completed.
 Statement of Cash Flows

o A statement of cash flows is a summary of the

cash receipts and cash payments for a specific
period of time.
 It consists of three sections:
(1) operating activities
(2) investing activities
(3) financing activities

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review. The final version of this teacher’s resource manual will be published as soon as the review has been completed.
 Financial Statements – Statement of Cash Flows

This amount should match

Cash on the balance sheet
(concluded)
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review. The final version of this teacher’s resource manual will be published as soon as the review has been completed.
 Cash Flows from Operating Activities
o The cash flows from operating activities
section reports a summary of cash receipts
and cash payments from operations.

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review. The final version of this teacher’s resource manual will be published as soon as the review has been completed.
 Cash Flows from Investing Activities

o The cash flows from investing activities section

reports the cash transactions for the
acquisition and sale of relatively permanent
assets.

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review. The final version of this teacher’s resource manual will be published as soon as the review has been completed.
 Cash Flows from Financing Activities

o The cash flows from financing activities

section reports the cash transactions related to
cash investments by the owner, borrowings,
and withdrawals by the owner.

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review. The final version of this teacher’s resource manual will be published as soon as the review has been completed.
 INTERRELATIONSHIPS AMONG
FINANCIAL STATEMENTS
Income Statement and  Net income or net
Statement of loss reported on
Owner’s Equity the income
statement is also
reported on the
statement of
owner’s equity and
any additional
investments by the
owner during the
year.

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review. The final version of this teacher’s resource manual will be published as soon as the review has been completed.
 Interrelationships Among Financial Statements

o In Exhibit 6, NetSolutions’ net income of $3,050

for November is added to Chris Clark’s
investment of $25,000 in the statement of
owner’s equity.

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review. The final version of this teacher’s resource manual will be published as soon as the review has been completed.
 INTERRELATIONSHIPS AMONG
FINANCIAL STATEMENTS
Statement of Owner’s  The owner’s
Equity and Balance capital at the end
Sheet of the period is
reported on the
statement of
owner’s equity
and is also
reported on the
balance sheet as
owner’s capital.

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review. The final version of this teacher’s resource manual will be published as soon as the review has been completed.
 Interrelationships Among Financial Statements

o In Exhibit 6, Chris Clark, Capital of $26,050 as of

November 30, 2013, on the statement of owner’s
equity also appears on the November 30, 2013,
balance sheet as Chris Clark, Capital.

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review. The final version of this teacher’s resource manual will be published as soon as the review has been completed.
 INTERRELATIONSHIPS AMONG
FINANCIAL STATEMENTS
Balance Sheet and  The cash
Statement of Cash reported on the
Flows balance sheet is
also reported as
the end-of-period
cash on the
statement of cash
flows.

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review. The final version of this teacher’s resource manual will be published as soon as the review has been completed.
 Interrelationships Among Financial Statements

o In Exhibit 6, cash of $5,900 reported on the

balance sheet as of November 30, 2013, is also
reported on the November statement of cash
flows as the end-of-period cash.

DISCLAIMER: This document is a draft and the information contained herein is subject to change as this document is currently undergoing
review. The final version of this teacher’s resource manual will be published as soon as the review has been completed.
DISCLAIMER: This document is a draft and the information contained herein is subject to change as this document is currently undergoing
review. The final version of this teacher’s resource manual will be published as soon as the review has been completed.
 RATIO OF
LIABILITIES TO
OWNER’S EQUITY
Ratio of Liabilities Total Liabilities
=
to Owner’s Equity Total Owner’s Equity (or Total
Stockholders’ Equity)

Ratio of Liabilities $400

= = 0.015
to Owner’s Equity $26,050

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review. The final version of this teacher’s resource manual will be published as soon as the review has been completed.
DISCLAIMER: This document is a draft and the information contained herein is subject to change as this document is currently undergoing
review. The final version of this teacher’s resource manual will be published as soon as the review has been completed.