Week Three Flashcards
Describe the characteristics of business transactions.
A business transaction involves the exchange of resources between an entity and another entity or individual, and must be at an arm’s length distance.
Differentiate between a business transaction, a personal transaction and a business event
For a business transaction to be recognised there must be an exchange of resources between an entity and another entity or individual (e.g. the purchase of office equipment for cash). Personal transactions do not involve an exchange of goods between the entity and another party. Similarly, no exchange of resources takes place when a business event occurs, such as when the contract of a new employee is being negotiated or when the entity is being advised that the loan interest rate will increase from 1 July in the current year. These two events will become business transactions at some later stage, when the exchange of resources takes place.
Explain the accounting equation process of the double-entry system of recording
The accounting equation expresses the relationship between the assets controlled and owned by the entity, and the claims on those assets – whether it is by outside funds (known as liabilities) or through inside funds (known as the equity of the business). The expanded accounting equation includes the profit or loss of the entity, which is represented by the entity’s income less expenses.
Identify the impact of business transactions on the accounting equation.
Every business transaction will have a dual effect. As a result, the accounting equation remains in balance after each business transaction is recorded in the journals or ledgers of the entity. For the contribution of capital, the dual effect would be an increase in the cash account and an increase in the capital account. In the accounting equation, this would be illustrated by assets increasing and equity increasing, that is:
↑ Cash (assets) = ↑ Capital (equity)
Prepare an accounting worksheet and a simplified income statement and balance sheet.
The accounting worksheet summarises the duality associated with each of the business transactions. The column totals provide the basis for the preparation of the financial statements. The information in the profit or loss column will be used to prepare the income statement, and the profit or loss will be transferred to the equity section of the balance sheet at the end of the reporting period. The information in the asset, liability and equity columns will form the basis of the balance sheet.
Apply debit and credit rules, and record simple transactions in the journals and ledgers of the business.
A debit entry is used to increase assets and expenses; and to decrease liabilities, equity and revenue. A credit entry is used to increase liabilities, equity and income; and to decrease assets and expenses. Each journal or ledger entry will consist of a debit entry and a credit entry to at least two separate accounts.
Explain the purpose of a trial balance.
A trial balance assists in the preparation of the financial statements, and checks the accuracy of the ledger or journal entries. If the trial balance does not balance, then the preparer needs to retrace the transactions to ensure that the double-entry rules were correctly followed and the correct amounts were entered.
Detect errors in transaction analysis and investigate the origin of the errors.
The common recording errors are transposition errors, single-entry errors and incorrect entries. Transposition errors are easily identified if the difference between the total assets and total claims on those assets (liabilities plus equity) is divisible by 9.
Business Transactions
occurrences that affect the assets. Liabilities and equity items in an entity and must be recognized (recorded)
Arm’s length distance
parties deal from equal bargaining positions neither party is subject to the others control or dominant influence, and the transaction is treated with fairness, integrity and legality
Entity concept
separation of business transactions from any personal transactions of the owner(s)
Balance Sheet
statement that reports on the assets, liabilities and equity of an entity at a particular point in time
Income statement
statement that reports on the income and expenses of an entity for a period and the resulting profit or loss
Drawings
withdrawals of assets from the entity by the owners that are recorded as decreases in equity
Source Documents
original documents verifying the business transaction
Cash transactions
business transactions involving the exchange of cash for goods or services
Credit transactions
business transactions of goods and services on the proviso that cash will be paid at a later date
Personal transactions
transactions of the owner unrelated to the operations of the business
Business events
events that will probably affect the entity without any immediate exchange of goods and services between the entity and another entity
Accounting equation
expresses the relationship between the assets controlled by the entity and the claims on those assets
Asset
a resource controlled by the entity as a result of past events and from which future economic benefits are expected to flow to the entity
Liability
present obligation of the entity arising from past events, the settlement of which is expected to result in an outflow from the entities of resources embodying economic benefits
Duality
describes how every business transaction has at least two effects on the accounting equation
Income
increases in economic benefits during the accounting period in the form of inflows or enhancements of assets or decreases of liabilities that result in increases in equity other than those relations to contributions from equity participants
Expenses
decreases in economic benefit during the accounting period in the form of outflows or depletions of assets or incurrences of liabilities that result in decreases in equity, other than those relations to distributions to equity participants
