I'm Larry Walther, and this is principlesofaccounting.com Chapter 1.
In this particular module,
we will look at how transactions impact the fundamental accounting equation.
Recall from a previous video, the fundamental of accounting equation,
assets equals liabilities plus owners equity.
Now, thinking about how transactions identifies with the accounting equation,
let me begin by saying that business activity impacts assets, liabilities, and
stockholder's equity accounts in unique ways depending on the particular
transaction.
Activity will not disturb the fundamental accounting equation.
After a transaction we would expect assets to equal liabilities plus owner's equity.
We will look at four examples to show how this is true.
The first one is fairly simple,
Edelweiss Corporation collects $10,000 on an existing account receivable.
An account receivable is an amount that is owed to a company by a customer for
goods or services that were provided in the past.
So in this particular case, looking in the balance sheet,
we can see that cash goes up $10,000 with the collection of the account receivables
and account receivables goes down $10,000.
Before the transaction cash was $25,000,
after the indicated transaction cash was $35,000.
In accounts receivable before the transaction was 50,000,
after the indicated transaction it's only 40,000.
But notice total assets are not effected by that particular transaction,
895 before and 895,000 after.
There's no effect on liabilities or equity in this particular case so
the fundamental accounting equation is preserved.
Moving on to another example,
Edelweiss Corporation purchases $30,000 of equipment and agrees to pay for it later.
Now looking at the complete balance sheet, notice that equipment,
which was 250,000 is now 280,000, an increase of $30,000.
And notice that loans payable that were $125,000 are now
$155,000 an increase of $30,000.
That describes the effect of the transaction on the balance sheet, but
what's most important to note is, now total assets are $925,000,
total liabilities and total equity equal $925,000, the equality was maintained.
Now, Edelweiss Corporation did work for a customer in exchange for
the customers promise to pay $5,000 at a later date.
In this case, we say that Edelweiss has generated revenues of $5,000.
Revenues are the enhancements or the in-flows from providing goods and
services to customers.
Revenues contributed to income, Income contributes to retained earnings,
part of the stockholder's equity.
So the net effect on the balance sheet of this particular transaction,
notice that accounts receivable, which was forty thousands, now is $45,000,
and retained earnings, which was $600,000, is now $605,000.
The equality again, is maintained that the assets are now 930,
as is the liabilities owners plus equity.
Finally let's look at Edelweiss Corporation which paid $3,000 for
expenses.
Expenses are the cost incurred in producing revenues.
So in this particular case, $3,000 was paid out,
cash-dropped by $3,000 from $35,000 to $32,000 that resource
consumption caused income to go down which also caused retained earnings to go down.
So, the retained earnings are the corporation instead of being $605,000,
is now only $602,000.
But, once again, the fundamental accounting equation after the indication
transaction total assets, Nine hundred-twenty seven thousand,
still equal to total liabilities plus stockholders' equity.
Finally, let me review the terms revenue and income.
I've already used those in this lecture,
I've introduced the terms, they are not synonymous.
Oftentimes people will mistakenly]y use them in similar ways but actually,
revenue is the top line, is the gross amount that's provided, the total amount
that's generated from providing goods and services to customers, whereas income is
the bottom line or the amount that results after subtracting expenses from revenues.
Which gives rise to another accounting equation,
revenues minus expenses equal income.
So we want to begin to use those terms in their precise context as we move forward
in our study of accounting.
Let me close this lecture by saying I well remember going through this
many years ago as a student myself.
And although I could understand the fundamental accounting equation in theory,
it took me quite some time to begin to grasp how specific transactions occur.
And affect the financial status in a way that does not dislodge
that relationship that's present in the fundamental accounting equation.
So don't be frustrated if it takes you a while to get your arms around
this in total.
It's simply part of the learning process for this subject matter.