Analyzing Transactions Flashcards
4.1: Analyze the effect of transactions on the accounting equation.
What is the accounting information system?
The system of collecting and processing transaction data and communicating financial information to decision makers
Can range from basic to complex
What is the accounting cycle?
A series of nine steps used to account for, and report, transactions: analyze transactions (step 1), journalize transactions (step 2), post transactions (step 3), prepare a trial balance (step 4), journalize and post adjusting entries (step 5), prepare an adjusted trial balance (step 6), prepare financial statements (step 7), journalize and post closing entries (step 8), and prepare a post-closing trial balance.
What are the 9 steps of the accounting cycle?
- Analyze transactions
- Journalize transactions
- Post transactions
- Prepare a trial balance
- Journalize and post adjusting entries
- Prepare an adjusted trial balance
- Prepare financial statements
- Journalize and post closing entries
- Prepare a post-closing trial balance
What factors shape an accounting information system?
Type of business, size, transaction volume, and information needs of users.
Why do small businesses often start without a formal accounting system?
They have fewer transactions and simpler needs at the beginning.
When does an organized accounting system become essential?
As the business grows and transactions become more numerous and complex.
What does the accounting information system rely on?
The accounting cycle
Where does the accounting cycle begin and end?
It starts with transaction analysis and ends with a post-closing trial balance.
What is an accounting transactions?
An economic event that is recorded in the financial statements because it involves an exchange that affects assets, liabilities, and/or shareholders’ equity
What is the first step in the accounting cycle?
Analyzing transactions to determine their effect on the accounting equation.
Are all events affecting a company recorded in its accounting system?
No, only those events that result in a measurable change in financial position.
What constitutes an accounting transaction?
An economic event that results in a change in assets, liabilities, or shareholders’ equity.
Why wouldn’t hiring a new employee be recorded as a transaction?
Because no asset, liability, or equity item is affected simply by hiring the employee.
How can the accounting equation help determine if a transaction has occurred?
By checking if there’s a change in the accounting equation: assets = liabilities + shareholders’ equity.
What types of transactions must be recorded in the accounting records?
Economic events that affect the company’s financial position in measurable amounts, like purchasing a computer or paying rent.
Why is a discussion with a potential customer not recorded as a transaction?
May affect a company’s future financial performance if they actually purchase goods or services but has no immediate effect on the company’s current financial position until a purchase is made.
Why isn’t simply agreeing to hire a player recorded as an accounting transaction?
It doesn’t change the team’s assets, liabilities, or shareholders’ equity until the player starts playing and earns a salary.
When does and accounting transaction occur in the case of hiring a hockey player?
Despite the team’s perceived value rising by the hiring of top talent, an accounting transaction does not occur until the player starts playing and earns his salary and hopefully generates additional revenue for the team.
How can signing bonuses affect accounting transactions in the NHL?
If part of the signing bonus is paid upfront, it affects the team’s assets, liabilities, and equity, triggering an accounting transaction.
Why might signing bonuses be paid over time in the NHL?
To comply with salary cap limitations imposed by the league.
What is the basic accounting equation?
Assets = Liabilities + Shareholder’s Equity
All public company’s shareholder’s equity is made up of at least what 2 things?
- Common shares
- Retained earnings
How are retained earnings calculated?
Net income (revenues - expenses) - Any dividends declared
What decreases retained earnings?
- A net loss
- Dividends declared (distribution of retained earnings)
What happens when dividends are declared?
Are a distribution of retained earnings to shareholders and result in a decrease to retained earnings
What does the expanded accounting equation include?
The expanded accounting equation incorporates elements from the financial statements: assets, liabilities, shareholders’ equity, revenues, and expenses.
Why does the accounting equation need to balance?
Because each recorded transaction affects the equation in a dual way, maintaining the balance of assets = liabilities + shareholders’ equity.
What are the effects of an increase in an asset?
There must be a corresponding:
- Decrease in another asset
- Increase in a specific liability
- Increase in common shares or revenues, which will increase shareholders’ equity.
How would a $200 service fee with part paid in cash affect the equation and effect 2 or more items?
- Cash (asset) increases by $50.
- Accounts Receivable (asset) increases by $150.
- Service Revenue (equity) increases by $200.
What is basic analysis?
Where the affected accounts and amounts are identified.
What is equation analysis in accounting?
Used after basic analysis is done to demonstrate the effect that each transaction has on the financial statements
Statement of financial position (yellow)
Statement of income (blue)
Statement of equity (grey)
What happens when shareholders invest cash in a corporation for common shares?
The transaction results in an equal increase in assets (cash) and shareholders’ equity (common shares), keeping the accounting equation in balance.
Why are investments by shareholders recorded as common shares and not revenue?
Shareholder investments are not part of regular operations; they are classified as equity (common shares), not revenue.
How does taking out a loan of $5000 affect the accounting equation?
The loan increases both assets (cash) and liabilities (bank loan payable), keeping the accounting equation balanced. Ex, an increase of $5,000 in both assets and liabilities would balance the equation.
What happens when a company takes out a bank loan and why is interest not recorded immediately?
When a company takes out a bank loan, it increases its cash (asset) and records a bank loan payable (liability). Interest is not recorded immediately because it will accumulate over time (e.g., over the next few months). Interest will be recorded later as it accrues.
What accounts would be affected if equipment is bought with cash?
Assets (cash decrease)
Assets (equipment increase)
What accounts does payment of rent affect?
Assets (cash decrease)
Shareholder’s equity (rent expense increase, which decreases shareholder’s equity)
Why is an increase in an expense account represented as a negative in the equation analysis?
Because expenses decrease retained earnings, which in turn decrease shareholders’ equity
What accounts does paying for prepaid insurance affect?
Assets (cash decrease)
Assets (prepaid insurance or expenses increase)
How do I know if a prepaid expense should be recorded as an asset or not?
If it benefits more than one accounting period, it’s recorded as an asset, if not it’s an expense
When do salaries for new employees become a transaction?
Not an actual transaction until they actually start working or when they first receive payment
What does purchasing goods or services “on account” or “on credit” mean?
That the company receives goods or services that it will pay for at a later date
How does purchasing goods on account affect the equation analysis?
Assets (supplies increase)
Liabilities (accounts payable increase)
Instead of paying cash now, the company incurs a liability, an account payable, by promising to pay cash in the future
How does selling goods on account affect the equation analysis?
Assets (accounts receivable increase)
Shareholder’s equity (revenue increase which increases overall income = increasing retained earnings)
Is revenue recorded when a service hasn’t been performed/goods haven’t been delivered?
No, ex: client prepaying for a service would go under deferred revenue vs doing a service for them on account would be a revenue
How does receiving a receipt of cash in advance affect the equation analysis?
Assets (cash increase)
Liabilities (deferred revenue increase = service to be performed later)
SHOULD NOT record revenue until it has performed the work
If cash is prepaid by a client in advance what obligation/liability does the company have? What is this called?
A liability/obligation to either perform the service or return the cash. We call this type of liability deferred revenue because recognition of the revenue is deferred (or delayed) until the company has performed the service
What does placement of the word “deferred” in front of revenue account indicate?
This is a liability account rather than a revenue account
How does paying for a past purchase made on account affect the equation analysis?
Assets (cash decrease)
Liabilities (a/p decrease)
How does paying for the salary of 4 employees who’s rate is $500 a week and who have worked 2 weeks affect the equation analysis?
Assets (cash decrease $4000)
Shareholder’s equity (expense increase $4000, decreasing retained earnings which overall DECREASES shareholder’s equity by $4000)
Are dividends an expense?
NOT an expense and are NOT included in the company’s calculation of net income
How does declaring dividends affect the equation analysis?
Assets (cash decrease)
Shareholder’s equity (dividends declared increase, which decreases retained earnings and overall decreases SE)
How does collecting amount owing from another company affect the equation analysis?
Assets (cash increase)
Assets (A/R decrease)
Most companies pay _____ income tax instalments based on their prior year’s ________?
Monthly, income tax payable
How do most companies pay for income taxes?
Most companies pay monthly income tax instalments based on their prior year’s income tax payable. They subsequently calculate the exact amount owed at year end when they prepare their income tax return
What happens if additional payments need to be made/returned to/from the CRA when paying income taxes?
Pay monthly installment:
Assets (cash decrease)
Shareholder’s equity (expenses increase = retained earnings decrease = SE decreases)
What are 2 important points for the equation analysis?
- Each transaction must be analyzed for its effect on the three primary components of the accounting equation (assets, liabilities, and shareholders’ equity), as well as the specific effects within shareholders’ equity items (revenues, expenses, and dividends).
- The two sides of the equation must always be equal (assets = liabilities + shareholders’ equity).
What does it mean if a company has no opening balances?
It’s the first month of operations meaning all starting balances are 0
How are opening balances handled in the accounting equation for future periods?
When a company has prior period balances, a line for opening balances is added in the equation analysis, and a separate column for Retained Earnings (Beg. Bal.) is included to track changes in revenues, expenses, and dividends.
How is retained earnings calculated at the beginning of a new period?
Retained earnings at the beginning of a period equals the previous period’s ending retained earnings:
Beginning Retained Earnings = Prior Revenues - Prior Expenses - Dividends Declared
When are revenue, expense, and dividend balances transferred to retained earnings?
These balances are transferred to retained earnings only at the end of a company’s fiscal year.
What is the purpose of equation analysis in accounting?
It helps track how transactions impact assets, liabilities, and shareholders’ equity to ensure the accounting equation remains balanced.
Do equation analyses represent the actual method of recording transactions?
Do equation analyses represent the actual method of recording transactions?
What is the next step after equation analysis?
The next step is recording transactions
