Chapter 2: How do transactions affect accounts?

Question 1

How do business decisions made by managers often affect financial statements?

Answer 1

Business decisions made by managers can result in transactions that affect financial statements.

For example, decisions to expand, advertise, change employee benefits, or invest excess cash can impact financial statements.

Question 2

Can business decisions have unintended consequences on financial statements?

Answer 2

: Yes, business decisions can have unintended consequences on financial statements.

For example, purchasing additional inventory for cash may increase inventory but decrease cash. If there’s no demand for the inventory, it may affect the company’s ability to meet other obligations.

Question 3

Why should business managers understand how transactions impact financial statements?

Answer 3

Business managers should understand this because many business decisions involve risk or uncertainty. Knowing how transactions affect accounts on financial statements helps in making informed decisions.

Question 4

What is the process for determining the effects of transactions in accounting called?

Answer 4

The process for determining the effects of transactions on financial statements is called transaction analysis.

Question 5

What are the specific standards accountants follow in transaction analysis?

Answer 5

Accountants follow specific standards in transaction analysis, including:

recognizing business transactions,

identifying and correctly classifying the affected accounts,

accurately recording the transaction,

and reporting the account balances on the appropriate financial statements at the end of the accounting period.

Question 6

What is the first concept underlying transaction analysis?

Answer 6

The first concept is that every transaction affects at least two accounts, and it’s crucial to correctly identify and classify these accounts and determine the direction of the effect (whether they increase or decrease).

Question 7

What is the second concept underlying transaction analysis?

Answer 7

The second concept is that the accounting equation must remain in balance after each transaction is analyzed, and the affected accounts must be correctly classified.

Question 8

Why is it important to correctly identify and classify the accounts affected by a transaction?

Answer 8

It’s important to do this to ensure accurate financial reporting and to maintain the integrity of the accounting records.

Question 9

What is the significance of the accounting equation in transaction analysis?

Answer 9

What is the significance of the accounting equation in transaction analysis?

Answer 4: The accounting equation (Assets = Liabilities + Shareholders’ Equity) must remain in balance after each transaction.

This equation helps ensure that the financial statements are accurate and complete.

Question 10

What does success in performing transaction analysis depend on?

Answer 10

Success in performing transaction analysis depends on having a clear understanding of how the transaction analysis model is constructed based on the concepts mentioned.

It also requires the ability to apply these concepts accurately.

Question 11

What is the recommended approach when studying these concepts?

Answer 11

It’s recommended to thoroughly study and understand these concepts before moving on to new concepts in accounting.

A strong foundation in transaction analysis is crucial for more advanced accounting topics.

Question 12

What is the dual effects concept in accounting?

Answer 12

The dual effects concept in accounting refers to the idea that every transaction has at least two effects on the basic accounting equation.

Question 13

What is the dual effects concept in accounting, and how does it relate to transactions with external parties?

Answer 13

The dual effects concept in accounting means that every transaction has at least two effects on the basic accounting equation.

In transactions with external parties, the business entity both receives something and gives something in return.

For example, when Gildan purchases office supplies for cash, it receives office supplies (an increase in an asset) and gives cash (a decrease in an asset).

Question 14

How are transactions involving credit purchases typically structured?

Answer 14

In credit purchases, there are two transactions:

(1) acquiring an asset (receiving supplies and increasing an asset)

(2) eventual payment (eliminating accounts payable, decreasing a liability, and giving cash, decreasing an asset).

Question 15

Why do all important business events not necessarily result in transactions affecting financial statements?

Answer 15

Not all important business events result in recorded transactions because some events involve the exchange of promises for future business transactions, which are uncertain and not recorded immediately.

Question 16

Provide an example of a situation where a contract involving promises does not result in an immediate transaction.

Answer 16

If Gildan sends an order to its paper supplier without making any payment, and the supplier accepts the order but doesn’t immediately fill it, no transaction is recorded. This is because only promises have been exchanged, and both the acquisition of an asset and payment are uncertain.

A transaction occurs when the paper is shipped to Gildan. At that point, the supplier provides inventory in exchange for a promise from Gildan to pay for the paper it receives, and Gildan exchanges its promise to pay for the paper it receives.

Question 17

Why are financial statements affected when a promise is exchanged for goods?

Answer 17

Financial statements are affected because, at that point, a transaction has taken place, and it needs to be recorded. Both Gildan’s and the supplier’s financial statements will reflect this transaction.

Question 18

What are the systematic steps for transaction analysis for investing and financing activities?

Answer 18

Step 1: Ask - What was received?
- Identify the affected account(s) and classify them as assets (A), liabilities (L), or shareholders’ equity (SE). Determine the direction and amount of the effect (+ or -).

**Step 2: Ask - What was given? **
- Repeat the process for the accounts affected, identifying, classifying, and determining the direction and amount of the change.

Step 3: Verify
- Is the accounting equation in balance (A = L + SE)?

Question 19

What are the two main categories of business activities presented in this context (investing and financing)?

Answer 19

In this context, the two main categories of business activities are investing activities (buying or selling non-current assets and investments) and financing activities (borrowing or repaying loans, selling or repurchasing shares, and paying dividends).

Question 20

What happens when a corporation issues shares to new investors?

Answer 20

When a corporation issues shares to new investors, it affects two separate accounts: Cash (an increase in assets) and Contributed capital (an increase in shareholders’ equity).

Question 21

What was Gildan’s transaction when it borrowed $45 from its local bank?

Answer 21

Gildan’s transaction involved borrowing $45 from its local bank, and it signed a note to be paid in two years. This is considered a financing activity.

When Gildan borrows $45, the transaction affects two accounts:

Cash (an increase in assets) and Long-term debt (an increase in liabilities).

Question 22

What are financing activities for companies, and what are the common forms of financing in such activities?

Answer 22

Financing activities for companies involve raising funds to meet their financial needs. Common forms of financing in such activities include selling shares to investors and borrowing from creditors, usually banks.

Question 23

What transactions typically fall under financing activities with shareholders?

Answer 23

Transactions with shareholders in financing activities typically include issuing additional shares and paying dividends.

Question 24

What transactions usually fall under financing activities with banks?

Answer 24

Transactions with banks in financing activities usually involve borrowing funds from banks and repaying loans to them.

Question 25

How did Gildan expand its distribution centers, and what type of activity is this?

Answer 25

Gildan expanded its distribution centers by buying new equipment for $22. This is an investing activity.

Impact on Accounts:

Assets: Property, plant, and equipment (+A) increased by $22.
Cash: Decreased by $15.
Long-term debt: Increased by $7.

Accounting Equation Balance: After the transaction, Assets ($7) equal Liabilities ($7), and Shareholders’ Equity remains at $0.