The Accounting Equation

Question 1

What is the accounting equation?

Answer 1

Assets = Liabilities + Owners’ Equity

Question 2

A transaction =

Answer 2

Just an event that occurs during the course of starting a business or running a business. Some examples of these events are making an equity investment, taking a loan, purchasing inventory, selling goods, performing services, and ordering office supplies.

Question 3

What happens when a transaction takes place?

Answer 3

When any transaction takes place, we can see its impact on the accounting equation as it increases or decreases assets, liabilities, and/or owners’ equity.

Question 4

Accrual method of accounting =

Answer 4

transactions are recorded in the period to which they relate, regardless of when cash is exchanged.

Question 5

Assets =

Answer 5

resources owned or controlled by an entity that will produce benefits in the future.

Assets: cash, inventory, buildings, computers

Question 6

Liabilities =

Answer 6

obligations to pay a third party for resources provided to an entity

Examples: Bank Loan, Accounts Payable, Wages Payable;

Question 7

Owners’ Equity =

Answer 7

Owners’ equity consists of funds contributed by owners as well as profits generated by the business.

contributed capital, retained earnings

Question 8

Revenue =

Answer 8

the money that a business receives from providing goods or services to a customer.

Question 9

Expenses =

Answer 9

the costs associated with providing goods or services to a customer.

Question 10

Matching principle requires

Answer 10

that a company match its expenses to the related revenues in the accounting period to which they relate.

E.g. This means that when Cardullo’s sells a package of Turkish Delight, it records both the revenue from the sale and the expense associated with the sale (the cost of purchasing inventory) in the same accounting period, when the Turkish Delight is sold.

Question 11

Buying on Credit - how does it influence?

Answer 11

At the time of the purchase, inventory is an asset, so assets increase by $500. The obligation to pay within 30 days is a liability, so liabilities increase by $500.

Question 12

Selling on Credit - how does it influence?

Answer 12

First, the sale increases assets (accounts receivable) by $700. The sale also increases revenue, which increases owners’ equity by $700.

At the same time, the sale decreases assets (inventory) by $400. The cost of goods sold is an expense, so it decreases owners’ equity by $400.

Finally, the receipt of payment increases assets (cash) by $700. The receipt of payment also decreases assets (accounts receivable) by $700.

Question 13

Deferred Revenue - how does it influence?

Answer 13

Assets & liabilities increase

Question 14

Prepaid expenses =

Answer 14

asset that business pays for expecting for the benefit in the future.

Question 15

Conservatism =

Answer 15

An asset should not be recorded because businesses should anticipate and record future losses, but not future gains. Record Losses, but NOT Gains

Question 16

Historical Cost Principle =

Answer 16

Transactions are recorded at the actual prices that existed at a time of a transaction.

Example: Land typically appreciates in value. We would not take a carrying value of land unless the action takes place.

Question 17

Consistency =

Answer 17

making consistent account choices. E.g. Depreciation requires estimating the useful life of an item. However, the rules require being consistent, and businesses can’t adjust the values.

Question 18

Materiality

Answer 18

We say something is ‘material’ if it is important or significant, while on the other hand something is ‘not material’ if it is not important or significant.

Question 19

Entity Concept

Answer 19

Transfer pricing, tax planning and consolidation are at the core of the entity concept

Question 20

Money Measurement

Answer 20

The Money Measurement principle refers to the fact that only values that can be measured in monetary terms get recorded in the financial statements. A relationship is not something whose value can be measured in monetary terms.

E.g. Relationship with media is valuable, but it cant be valued.

Question 21

Going Concern

Answer 21

‘concern’ is a synonym for a business establishment or company. So if we were to say that Acme Toy Store is a going concern, we mean that it is a business that we expect to continue to operate for the foreseeable future.

Question 22

Accounting standards state that to be considered an asset, an item must:

Answer 22

1) Be purchased at a cost that is measurable
2) Produce probable economic benefit in the future
3) Result from a past event
Be owned or controlled by the entity
4) Under these standards, businesses will not record some items as assets though they may initially appear to be.

Question 23

Accounting standards state that to be considered a liability, an item must:

Answer 23

1) It must impose a probable economic obligation on economic resources in the future
2) The obligation has to be to another entity
3) The event that created the obligation must have occurred in the past
4) Think about some of the liabilities we have introduced and how they fit this definition.

Question 24

Equity =

Answer 24

equity is simply the resources of the business that belong to the owners. If you add up all of the resources of the business (assets), and subtract all of the claims that third parties (such as lenders and suppliers) have against those assets, you’ll end up with what is left for the owners (equity).