( Week 3 ) Accounting Basics: The Accounting Equation

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Questions and Answers

What does the accounting equation express?

The relationship between assets and how they are financed (correct)

The relationship between an entity's revenue and expenses

The relationship between cash inflows and outflows

The total profit earned versus the total losses incurred

If an entity has $1,200,000 in assets and $750,000 in liabilities, what is the owner's equity?

$450,000 (correct)

$750,000

$1,950,000

$2,000,000

Which of the following is a business transaction?

Withdrawing personal cash for a vacation

Purchasing new office equipment (correct)

Selling a personal car

Receiving a gift from a friend

What is the effect of an owner providing $50,000 in cash to start a business?

Increase in assets and increase in owner’s equity Signup and view all the answers

What defines a personal transaction?

Transactions related to the owners that do not impact the business Signup and view all the answers

When a bank loan is secured to purchase a motor vehicle, which components of the accounting equation are affected?

Increase in assets and increase in liabilities Signup and view all the answers

What effect does paying $3,500 towards a loan principal have on the accounting equation?

Decrease in cash and decrease in liabilities Signup and view all the answers

What is an example of a business event?

Negotiating a property lease for the business Signup and view all the answers

According to the accounting entity concept, which of the following should be recorded in the business's accounting system?

Capital contributions made by the owner Signup and view all the answers

How does recording a $220 cash sale impact the accounting equation?

Increases assets and increases income Signup and view all the answers

If liabilities amount to $300,000 and owners' equity is $200,000, what are the total assets?

$500,000 Signup and view all the answers

What is the impact of accrued wages of $990 on the accounting equation?

Increase in liabilities and increase in expenses Signup and view all the answers

Which component does the accounting equation add for additional capital contributions?

Owner’s Equity Signup and view all the answers

Which transaction would NOT be recorded in a business's accounting system?

Payment of personal bills by the owner Signup and view all the answers

What happens to owner’s equity when an owner withdraws $5,000 for personal use?

Decreases due to drawings Signup and view all the answers

Which formula can be derived from the basic accounting equation?

Liabilities = Assets - Owners' Equity Signup and view all the answers

If a business purchases supplies on credit for $200, what effects will this transaction have?

Increase in assets and increase in liabilities Signup and view all the answers

What must be kept separate from business transactions according to accounting principles?

Personal financial deals of the owners Signup and view all the answers

Which of the following describes the overall effect of income and additional capital on owner’s equity?

Increase owner’s equity Signup and view all the answers

When using cash to purchase a laptop for $1,000, what is the accounting effect?

Decrease in cash, increase in another asset Signup and view all the answers

What is the primary purpose of source documents in the accounting cycle?

They serve as evidence of transactions. Signup and view all the answers

What must businesses ensure when preparing journal entries?

Every debit must have a corresponding credit. Signup and view all the answers

What does the process of journalising include?

Entering transaction data into the journal. Signup and view all the answers

Which of the following statements accurately describes a ledger account?

It records increases and decreases in specific accounts. Signup and view all the answers

What does posting refer to in the accounting cycle?

Transferring journal entries to the ledger accounts. Signup and view all the answers

What is the main function of a trial balance?

To ensure that debits equal credits after posting. Signup and view all the answers

In the context of ledger accounts, what does a debit (Dr) balance indicate?

The total of debit amounts exceeds total credits. Signup and view all the answers

Which of the following is NOT a requirement for a complete journal entry?

The transaction analysis breakdown. Signup and view all the answers

What primary information does a trial balance provide?

The correctness of the ledger accounts. Signup and view all the answers

Which of these is an example of a source document?

Sales invoice duplicate Signup and view all the answers

Study Notes

Understanding the Accounting Equation

Basic accounting equation: Assets = Liabilities + Owner's Equity.
Rearranged equation: Owner's Equity = Assets - Liabilities.
Example: If assets total 960,000andliabilitiestotal960,000 and liabilities total 960,000andliabilitiestotal400,000, then owner's equity is $560,000.

Business Transactions, Personal Transactions, and Business Events

Business Transactions: Exchanges impacting assets, liabilities, or equity, including:
- Capital contributions, wage payments, interest receipts, and goods sale.
Personal Transactions: Transactions of owners unrelated to business operations; not recorded in accounting system.
Business Events: Occurrences that may affect the entity but aren't recorded until an exchange happens.
Accounting Entity Concept: Distinction between business and personal transactions is critical; only business transactions are recorded.

Transaction Analysis

Maintain balance: Assets = Liabilities + Owner's Equity.
Every transaction must affect the equation in at least two ways.
Example Transactions:
- Owner’s investment increases both assets (cash) and equity (capital).
- Purchase of a vehicle increases assets (vehicle) and liabilities (loan).
- Loan repayment decreases both assets (cash) and liabilities (loan).
- Purchasing with cash affects one asset (increases computer) while decreasing another (decreases cash).

Extended Accounting Equation

Expanded for income and expenses: Assets = Liabilities + Owner’s Equity + Income - Expenses.
Income from sales increases assets (cash) and income.
Accrued wages increase liabilities (wages payable) and expenses.

Fully Expanded Accounting Equation

Includes additional capital contributions and owner’s drawings:
Assets = Liabilities + Owner’s Equity + Income - Expenses + Additional Capital - Drawings*.
Additional capital increases both assets (cash) and owner’s equity.
Owner's drawings decrease both assets and equity.

Accounting Cycle

Step 1: Source Documents

Evidence of transactions, essential for recording.
Examples: EFT receipts, invoices, cash register records.

Step 2: Journal Entries

Record transactions chronologically in the General Journal.
Follow the double-entry system: each entry has a corresponding debit and credit.
A complete journal entry includes date, accounts affected, amounts, and narration.

Step 3: The Ledger Account

Records increases and decreases in specific accounts (assets, liabilities, equity, income, expenses).
Cash at bank account shows all cash movements, indicating total cash on hand.

Posting

Procedure of transferring journal entries to the ledger accounts.
Involves documenting the amount, date, and corresponding accounts.

Step 4: The Trial Balance

A list of accounts and balances at a specific point in time.
Purpose: to verify that total debits equal total credits after posting.
Helpful for identifying errors in journal entries or postings if debits and credits do not match.

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Description

Explore the fundamental concept of the accounting equation through this quiz. Understand how the relationship between assets, liabilities, and owners' equity forms the foundation of financial accounting. Test your knowledge with practical examples and scenarios.