Overview
This lecture introduces the basic accounting equation, demonstrates how transactions impact it, and covers creating and analyzing a simple balance sheet.
The Accounting Equation
- The fundamental accounting equation is: Assets = Liabilities + Owner's Equity.
- Assets are resources owned by the business, such as cash, equipment, and inventory.
- Liabilities are amounts the business owes to others, like loans or accounts payable.
- Owner’s Equity represents the owner's claims to the assets after liabilities are deducted.
Transaction Effects on the Accounting Equation
- Every business transaction affects at least two accounts, keeping the equation in balance.
- Investing $10,000 into the business increases assets (cash) and owner’s equity.
- Buying equipment for $10,000 using cash increases equipment (an asset) and decreases cash (another asset), total assets remain unchanged.
- Purchasing supplies on credit increases assets (supplies) and liabilities (accounts payable).
- Earning revenue increases assets (cash or accounts receivable) and owner’s equity (revenue).
- Paying expenses (such as rent) decreases assets (cash) and owner’s equity (expenses reduce equity).
- Paying off a liability reduces both cash (asset) and the corresponding liability.
Preparing the Balance Sheet
- The balance sheet lists assets, liabilities, and owner’s equity at a specific point in time to show the company’s financial position.
- Total assets should equal total liabilities plus owner’s equity after all transactions.
Sample Transaction Summary
- Owner invests $50,000: increases cash and owner’s equity.
- Equipment bought for $5,000 cash: decreases cash, increases equipment.
- Supplies bought on account for $2,000: increases supplies and liabilities.
- Revenue earned ($4,000): increases cash or accounts receivable, and owner’s equity.
- Expense paid ($1,000): decreases cash and owner’s equity.
- Balance sheet totals assets at $62,000, which must equal liabilities plus owner’s equity.
Key Terms & Definitions
- Assets — resources owned by a business (e.g., cash, equipment).
- Liabilities — obligations or debts owed by a business to creditors.
- Owner’s Equity — owner’s claim to the business assets after liabilities.
- Accounting Equation — Assets = Liabilities + Owner’s Equity.
- Transaction — any business activity that changes assets, liabilities, or owner’s equity.
- Balance Sheet — a financial statement showing assets, liabilities, and owner’s equity at a point in time.
Action Items / Next Steps
- Practice analyzing transactions and recording their impact on the accounting equation.
- Prepare a sample balance sheet using provided transactions.
- Review key definitions to reinforce understanding.