Hi, Else here.
And in this video, we'll be analyzing and recording
business activities using the accounting equations.
We'll use both the basic and expanded accounting equations
so you get a good idea what the difference is.
If you have not as yet memorized the definition
of the financial reporting elements
or you don't know the expanded accounting equation flowchart,
you're going to be lost in this video.
So please, go back to the chapter in my past videos
to get a handle on that before continuing here.
Remember, that we are going to record business activities
into the accounting system so that we can eventually produce
the financial statements.
The financial statements tell the story
of the business, its financial position, and profitability.
They are used by external users to make
decisions about their interactions with the business.
The first step then is to record the business activities
into the accounting system.
In order to do that, we have to have a set
way to analyze transactions.
The best way to do that is to have a series of questions
that you can ask yourself every time you analyze a business
activity.
Let's remind ourselves of the critical and enhancing
questions that you should use every time
you read a transaction.
The critical questions are the ones you should ask first.
The critical questions are what did the business get?
What did the business give away?
If you're still having problems determining
the impact of the business activity,
move on to the enhancing questions
in order to clarify your thinking.
The enhancing questions are what did the business earn?
What did the business use, consume, or incur?
What did the business owe?
Liabilities?
Always start with the critical questions
and then move on to the enhancing questions
so you're sure of the impact of the activity on the accounting
equations before you record them.
OK, let's look at the list of Independent Business activities
that we'll be analyzing in this video.
Remember that you can download this list from my website
or you can pause the video here and write the questions down.
A screenshot will also work.
As always, I recommend that you stop the video,
analyze the transactions, and record them
in both the basic and expanded accounting equation
before you watch me do it.
This is the only way you can test your ability
to recall these concepts.
Here again are all the transactions
we'll be analyzing and recording.
Let's start at the top and move down.
One, the owner invests $500 of cash to start the business.
What did the business get?
Cash of $500, which is an asset because its own,
has future benefit for the business because it
can be used to help generate revenue,
and is due to a past transaction.
What did the business give away?
Well, they gave away part of the business.
But it's not really clear, so let's move
on to the enhancing questions.
What did the business earn?
Nothing, as they have not done anything for customers yet.
So no revenues.
What did the business use, consume, or incur?
Nothing.
We have not generated revenue, so we have not used, consumed,
or incurred anything either.
What does the business owe?
The business now owes equity to the owners
in the form of owner's capital.
So $500 is owed to the owners.
Let's record this business activity
in the expanded accounting equation.
As it's increased by $500, owner's capital
increases by $500.
Now, often students put this number in as a negative
because they think it's bad to owe something.
How can you quickly confirm what signs
should be in front of the $500?
Check out the equal sign.
Right now it does not work, because we have a positive 500
on the left side of the equal sign
and a negative on the right.
We have to have a positive 500 on the right
side of the equal sign.
Owner's capital, the amount the business owes to the owner,
is going up because we owe more.
Let's record this activity in the basic accounting equation.
Assets increase $500, equity increases $500.
This is because equity is made up of owner's capital
and retained earnings.
If either of those sub elements increase,
then equity increases also.
Next transaction, 2, borrow $250 from your parents
to help start the business.
What did the business get?
Cash of $250, which we know is an asset.
And we know why it's an asset, so we won't go over that again.
Assets increase by $250.
What did the business give away?
It's hard to think about what the business gave away
because we didn't give away anything physical.
Let's go to the enhancing questions.
What did the business earn?
Nothing, as they have not done anything for the customers yet.
What did the business use, consume, or incur?
Nothing was used or consumed to generate revenue,
so expenses do not apply.
What does the business owe?
The business now owes a third party-- your parents-- cash
at some point in the future.
This is all due to a past transaction,
something that has already happened,
the loaning of the money.
Liabilities increased by $250.
Let's go back to the question, what
did the business give away?
The business gave away an IOU.
They gave away a promise to pay in the future.
When a business gives away an IOU,
rerecord it as a liability, because it
meets the definition of a liability-- owed,
settled in the future from a past transaction.
In future transactions, you should therefore
be able to answer the question, what
did the business give away when the business takes out a loan?
Let's record this business activity
in the expanded accounting equation.
Assets increased by $250, liabilities increased by $250.
Notice that the equation balances.
Again, students often record liabilities as negative numbers
because they think that it's bad to owe something.
Remember that the business is recording what they hope,
not how they feel about owing something.
When a business owes more, the number
has to be recorded as a positive number.
Again, confirm this by ensuring that the equations equal sign
works.
Let's record this activity in the basic accounting equation.
Assets increase $250.
Liabilities increase $250.
Next transaction.
3, using a credit card registered a business name
with Service Ontario.
$60.
What did the business get?
They got a business name.
Is that an asset?
Yes, because having a name will help
us to run our business in the future.
The name is now owned by the business.
And it is due to a past transaction.
Assets increased by $60.
What did the business give away?
The business paid by credit card.
So it's not really clear what they gave away.
What did the business earn?
Nothing, as they have not done anything for customers yet.
What did the business use, consume, or incur?
Nothing was used or consumed to generate revenue.
So this doesn't apply.
What does the business owe?
When the business pays using a credit card,
they don't owe Service Ontario, because Service Ontario has
received the money from the credit card company.
Instead, the business now owes the credit card company--
a third party-- cash in the future,
which is due to a past transaction--
liabilities increased by $60.
Let's go back to the critical question,
what did the business give away?
When a business pays using a credit card,
they give away an IOU to the credit card
company a promise to pay at some future date, a liability.
In future you should be able to answer the question,
what did the business give away when the business pays
by credit card?
Let's record this business activity
in the expanded accounting equation.
Assets increased by $60.
Liabilities increased by $60.
Let's record this activity in the basic accounting equation.
It's the same entry because assets and liabilities do not
have any sub elements under them.
Next transaction.
4, paid $150 for supplies that will be used in the future.
Note that the word paid always means cash,
so there's no need for the transaction
to say with cash because it's already clear.
What did the business get?
They got supplies.
Are they an asset?
Yes, because they'll help the business in the future.
They're owned by the business, and it
was due to a past transaction.
What did the business give away?
They gave away cash, which is an asset.
It is no longer owned.
It has no further future value for the business.
And this decrease is due to a past transaction.
Therefore, assets decrease by $150.
Let's record this business activity
in the expanded accounting equation.
Assets increased by $150, assets decreased by $150.
Transactions don't have to affect both sides
of the accounting equation.
As long as both sides balance, then we're good to go.
Let's record this activity in the basic accounting equation.
Assets increase $150, assets decreased by $150,
and the equation is still in balance.
Next transaction.
5, receive cash from customers for services provided.
$1,450.
What did the business get?
They got cash.
Assets increased by $1,450.
What did the business give away?
They gave away a service.
But what does that mean regarding the accounting
equation?
It's not clear, so let's move on to the enhancing questions.
What did the business earn?
Remember that revenue is earned only
when a service has been provided or a good delivered--
past tense.
Here the business has earned $1,450
because they provided a service to their customers.
So revenue increases by $1,450.
Let's record this business activity
in the expanded accounting equation.
Assets increased by $1,450.
Revenues increased by $1,450.
Let's record this activity in the basic accounting equation.
Assets increased by $1,450.
Equity increases by $1,450.
Why does equity increase?
Because revenues increase profit, which increases
retained earnings, and then increases equity.
Next transaction.
6, used up half of the supplies that we purchased previously.
What did the business get?
We did not get any more supplies?
Actually, it's really not clear what we did get.
What did the business give away?
We gave away our supplies, which are right now recorded
as an asset.
We have to reduce the asset for the amount
that we no longer have, because it
has no future benefit for us.
And we don't own the supplies anymore, because they're gone.
This reduction in assets is due to a past transaction.
Assets decreased by $75.
What did the business earn?
Nothing, as they haven't done anything for the customer yet.
What did the business use, consume, or incur?
The business used up 50% of their supplies
to help them generate revenue in the business.
We therefore record a $75 expense.
Let's record this business activity
in the expanded accounting equation.
Assets decrease by $75.
Expenses increase by $75.
Wait, that means that the expanded accounting equation
is not in balance, because we have a negative on the left
side of the equal sign, and a positive on the right
side of the equal sign.
We have to flow expenses up into their impact on equity
to see if the equation balances.
Expenses have increased and the impact of higher expenses
is a lower profit.
A lower retained earnings, and therefore a lower equity.
If you follow the impact all the way up to equity,
you can see that the positive expenses
equal negative equity, which then is
equal to the negative assets.
The equation is in balance.
Let's record this activity in the basic accounting equation.
Assets decrease by $75.
Equity decreases by $75.
Why does equity decrease?
Because expenses decrease profit, which decrease
retained earnings, and that decreases equity.
Perfect balance.
Next transaction.
7, paid off the credit card bill for the $60
we charged for the purchase of the business name.
What did the business get?
Actually, I don't think the business got anything.
What did the business give away?
The business gave away cash.
We've done this before.
Assets decreased by $60.
What did the business earn?
Nothing, as they have not done anything for the customer yet.
What did the business use, consume, or incur?
Have we used up our business name?
Is it gone and has no future benefit?
No, the business name still has future value for the company.
And therefore there is no impact on expenses.
What does the business owe?
Well, actually, what we owed is now gone.
We have to reduce our liabilities because we
no longer owe a liability.
We are paying it off, and therefore the liability
is no longer owed in the future.
Liabilities decreased by $60 because we paid off
the debt we recorded in transaction number 3.
Let's go back to the critical question,
what did the business get?
The business got back their IOU--
the one they gave away in transaction number 3.
They got back their promise to pay in the future,
because they paid it off.
So this question also indicates that liabilities
decreased by $60.
Let's record this business activity
in the expanded accounting equation.
Assets decrease by $60.
Liabilities decrease by $60.
Let's record this activity in the basic accounting equation.
It's the same entry because assets and liabilities
don't have any sub elements under them.
Last transaction.
8, paid dividends of $150 to the owner.
What did the business get?
They got nothing that I can see.
So it's not really clear.
What did the business give away?
They gave away cash, which means that they no longer have
a future benefit, and they don't own the cash anymore,
all due to a past transaction.
Assets decreased by $150.
What did the business earn?
Nothing, as they haven't done anything for the customer yet.
What did the business use, consume, or incur?
It's important to realize that dividends, distributions
to owners, do not generate revenue.
So they are never recorded as an expense.
Nothing was used or consumed to generate revenue,
so no change to expenses.
What does the business owe?
The business owes nothing in the future,
as they have already paid the dividends.
Wait a minute, our questions didn't help us out.
That's because dividends are an exception to all
of the questions we have.
Dividends are a distribution of the wealth
a business owes to the owners, and therefore
does not fall under any of the above noted questions.
How do we record dividends then?
Dividends are recorded as an increase in dividends.
When dividends increase, they reduce retained earnings,
and therefore they reduce equity.
So recording this activity on the expanding accounting
equation, assets decrease, and dividends increase.
Again, it looks like the equation doesn't balance,
but we know that the negative sign in front
of the word dividends in the equation
indicates the impact on equity.
So equity will decrease, matching the negative impact
on assets.
Let's record this activity in the basic accounting equation.
Assets decrease by $150.
Equity decreases by $150.
Why does equity decrease?
Because dividends decrease retained earnings,
and that decreases equity.
Let's look at the summary of all the activities impact
on the expanded accounting equation.
The total impact on assets, liabilities, owner's capital,
revenue expenses, and dividends is shown
at the bottom of the chart.
If we follow mathematically through on the equation,
we see that the increase on the left side of the equal sign
is exactly the same as the changes on the right hand side.
Let's look at a summary of those transactions
on the basic accounting equation.
Here, it's clear that the left hand side of the equation
is equal to the right hand side of the equation.
As you can see, using the critical
and enhancing questions to analyze business activities
before you record them is really important.
Don't get lazy.
Always think about the questions before you record a business
activity into the accounting records.
Although we have not analyzed every business activity
possible, we have analyzed at least one activity
for every element and sub element.
The only way to get better at analyzing business activities
is to practice.
By the time the test or exam rolls around,
you should be proficient at it regardless of what the business
activity is.
That's it for this video.
See you in the next one.