So this is part 2 in our series of introduction to financial
accounting, and in this part we're going to be specifically talking about the
accounting equation. So first let's look at the actual accounting equation. So
we're going to start with assets, and we'll talk about these in detail here in
just a second. So this is the actual equation assets are equal to liabilities
plus owner's equity. Assets can be defined as economic resources or future
economic benefits. So let's look at some examples of assets. These are some common
examples cash, accounts receivable inventory, equipment and land. Most of
those probably sound pretty familiar to you. Maybe accounts receivable may be a
little bit new to you. Accounts receivable is when you sell
something or perform a service and the customer doesn't pay you immediately so
they owe you that money. That's called an account receivable when
you are owed the money for performing a service or selling a product. Now think
about the definition of assets we called it a future economic benefit. Cash seems
to be the more difficult one for students to understand how that's a
future economic benefit because I've got the cash in my hand right now. But the
cash isn't really doing anything until I pay a bill or purchase some inventory
with it. Therefore it becomes a benefit when I use it
therefore cash in hand is a future economic benefit. So the second part of
our equation is liabilities. Liabilities is defined as creditors claims on our
assets again notice the equation. Assets equal liabilities plus owner's
equity. So this is the creditors part of our assets more commonly known as our
debt. Some examples of liabilities would be accounts payable, salaries payable,
rent payable, utilities payable, and notes payable. Notice a common theme there the
word payable. So anytime you see the word payable that means you owe something to
someone. The other side of the equation is owner's equity. This is the owners
claims on the assets, and it is made up of for our purposes right now we're
going to specifically talk about two things it's made up of stock and
retained earnings. Now most of you know what stock is and later on we'll be
talking about another form of stock other than common. But what I want to
focus on really quickly is retained earnings, and what that is. Retained
earnings are earnings that a company retains and does not pay out in the form
of dividends. So therefore retained earnings is affected by net income and
dividends. Net income will make retained earnings go up and dividends would make
retained earnings go down. So that's very important at this point in the
discussion that you understand that. So let's look at a little practice with our
accounting equation. So let's remember our accounting equation is assets equal
liabilities plus owner's equity. So the first example let's look at cougar
rentals. So in this case we don't know our assets, but we know liabilities and
owner's equity. Can you find assets? Sure! Very simple equation assets which we
don't know that's our unknown is equal to 60,000 dollars in liabilities plus
$21,000 in owner's equity. That makes our assets equal to
$81,000, and we'll look at Washington photo. In this case we don't know
liabilities but we know assets and we know owner's equity. So a simple moving
around of the equation, I can find liabilities. And then we'll look at
Portland Nautilus. We know assets are a $100,000, liabilities are $79,000,
but I don't know owner's equity. Can I find owner's equity? Sure.
Again we'll move the equation around and locate owner's equity. So try that right
now. Try Washington photo and Portland
Nautilus and see what you get. So again we found $81,000 for cougar
rentals. You should have gotten $32,000 for Washington photo, and $21,000 for
Portland Nautilus. Now here's a little more complicated example. So what I'd
like you to do is pause the video here, work on this example, and then come back.
And we'll review it together. So I hope that you have worked this problem out
you paused the video and now you've you're back to see how you did. So we'll
take a look at this Ruth's landscaping started 2007 with total assets of
$22,000 and total liabilities of $10,000. At the end of 2007,
Ruth's total assets stood at $30,000 and total liabilities
were $14,000. Did stockholders equity of Ruth's
landscaping increase or decrease during 2007 and by how much?
So the first thing you should have started with is your accounting equation.
You should have set it up assets equal liabilities plus owner's equity. Now they
tell me a little bit of beginning and they tell me a little bit of ending. So
you should have labeled everything so we'll start with beginning
and we end with our ending. So they tell me my beginning assets for $22,000 and my
beginning liabilities or $10,000. So again I'm just filling in my equation. They
tell me my ending assets for $30,000 and my ending liabilities were $14,000. Were
you able to find your beginning owner's equity and your ending owner's equity?
Just like we did before beginning owner's equity is $22,000 in assets is
equal to $10,000 in liabilities plus something. That something must be $12,000.
If we rearrange the equation where owner's equity is equal to assets minus
liabilities. So $12,000 is equal to $22,000 minus $10,000. Now were you able to find
ending owner's equity? Again something is equal to $30,000 dollars in assets minus
$14,000 in liabilities. Again just moving my equation around a little bit
algebraically. You should have got ending owner's equity of $16,000. Now that's not
the answer to the question. The question is wanting to know how to donors equity
change during 2007? Well we started with $12,000 in owner's equity and we ended
with $16,000 in owner's equity. That's a $4,000 increase in owner's
equity. Now I'd like for you to think how or what could have made owner's equity
change? So identify two possible reasons for this $4,000 increase
in owner's equity or stockholders equity during the year.
Net income as we stated before could have made owner's equity go up, in
addition we could have issued stock. Issuing stock would have made owner's
equity go up as well.