Lesson 2
Business Transactions
and Accounting Equation
Task Team of
FUNDAMENTAL ACCOUNTING
School of Business,Sun Yat-sen University
2
Outline
Enterprises
Accounting Transactions,Accounting
Events,and Accounting Circumstances
Economic Activities and Accounting
Elements
Accounting Equation
3
Opening Story
Funding and Spending at College
Assets of a college student
→ Cash
→ CD player
→ Computer
Funding these assets
→ Sponsored by parents
→ Sponsored by relatives
→ Borrowed from relatives and acquaintance
4
Opening Story (continued）
We could deal with the above-mentioned financial
issues from the following perspectives：
How do we fund our daily expenditures and possessions？
How do we spend the,funds” which we have sourced？
What about the relationship between the,funds”which
we have sourced and our daily expenditures and
possessions？
5
Enterprises
Concept of Enterprise
Definition of,enterprise”
Functions of an enterprise
Characteristics of an enterprise
6
Forms of Enterprise
There are three major forms of enterprise:
Sole-proprietorship
Partnership
Corporations
7
Sole proprietorships
Single person owns the business
Not separate from its owner in terms of
responsibility and liability
The business is the owner and the owner is
the business
8
Partnership
Owned by two or more people
Similar to a sole proprietorship
Not separate from the owners in terms of
responsibility and liability
9
Corporations
Legally separate and financially separate
from the owners
Ownership in a corporation is divided into
units called shares of capital stock
Owners are called shareholders or
stockholders
Corporations are separate legal entities
10
Characteristics of Enterprise
C h a r a c t e r i s t i c s Pr o p r i e t o r s h i p Pa r t n e r s h i p C o r p o r a t i o n
B u s i n e s s e n t i t y y e s y e s y e s
L e g a l e n t i t y no no y e s
L i m i t e d l i a b i l i t y no n o y e s
U n l i m i t e d l i f e no no y e s
B u s i n e s s t a x e d no no y e s
O n e o w n e r a l l o w e d y e s no y e s
11
Four Types of Enterprise
Service organization – provides services (does
something for you) rather than selling something
Merchandising business – buys goods,adds value
to them,then sells them to customers
Manufacturer – makes the products it sells
Financial services company –doesn’t make
tangible products and doesn’t sell products made
by other companies; deals in services related to
money
12
Resources in an Enterprise
Major resources：
Human resources
Properties,plant and equipment,supplies,raw
materials,finished products or inventories
Financing
→ In cash or bank deposits
→ In material forms
13
An example-Beauty Photo Store
Movements of Material
Resources in an Enterprise
14
Movements of Material
Resources in an Enterprise
Movements in a manufacturing
enterprise
→ cash/bank deposit→raw materials →work -in-
process→finished products→fin→cash/bank
deposit
Movements in a merchandising
enterprise
→ cash/bank deposit→inventory→ cash/bank
deposit
15
Activities of Enterprise
Three major phases of business
activities:
Inception
Operating
Liquidation
16
Inception and investment of funds
→ External funding
State,legal persons,privates or foreign investors；
Financing from banking institutions,other legal
persons or privates
→ Owners’equity and liabilities
Inception of Enterprise
Investment
of owners
Financing of
creditors Total funds of a firm
17
Inception of Enterprise
Forms of Investment
→ Monetary(cash/bank deposits)
→ Property,plants and equipment
→ Raw materials and goods,etc.
Sources and changes of funds
→ Increase of owners’equity or liabilities
→ Increase of assets
18
Operating activities and changes of asset
Changes of assets in Beauty Photo Store
Connections between Beauty Photo Store and
Suppliers,clients,etc.
Operating Activities
cash
2 cameras
lens
＋ producing
equipment
＋
supplies
photos cash
19
Liquidation of Enterprise
Liquidation of enterprise and payoff of
funds
Payment of taxes
Distribution of profits
Declaration of dividends
Payoff of borrowings
Withdrawals and changes of funds
Decrease of assets
Decrease of liabilities or owners’equity
20
Accounting Transactions
A business transaction is an event that
affects the financial position of a business
and may be reliably recorded
21
Economic Activities and
Accounting Elements
Accounting element：
Uses of funds and assets
→ cash
→ equipment,etc.
Resources of funds and equity
→ Borrowings and equity of creditors-
liabilities
→ Investments and owners’equity
22
Uses of Funds
Uses and changes of funds
Beauty Photo Store
→ From cash to equipment
→ Using equipment to produce photos
→ From photos to cash
23
Circulation of Funds
Circulation of funds:
Uses of funds
→ Beauty Photo Store
Cost of equipment
Cost of supplies
Human costs？
Uses and payoff of funds
→ What are the operating purposes for Beauty
Photo Store？
24
Payoff of Funds
Payoff of Funds and Revenues
→ Cash receptions and revenues by Beauty
Photo Store
Net increase of funds and profit
→ Difference between uses and payoff of cash？
→ Nature of profit?
25
Accounting Transactions
Accounting transactions-Economic
exchange between two different accounting
entities
Mutual exchange
→ A purchases an asset,paying cash or bearing the
responsibility of paying cash in future
→ B sells the asset,earning the rights of receiving or
collecting cash
One-way transaction
→ Investments or donations to another accounting
entity
26
Accounting Events
Accounting events-internal transferring of
resources among departments of a same
entity
allotments of raw materials for plants
Damages caused by earthquakes
External versus internal events
Between different entities
Within a same entity
27
Accounting Circumstances
Accounting circumstances-usually an outcome of
collaboration of multiple events
Circumstances and their impacts
→ Changes in prices,exchange rates
How to determine these changes？
E.g,uncollectability of receivables due to the
liquidation of the debtor
Unpredictability
28
Accounting Elements
Assets
Liabilities
Owners’equity
Revenues
Expenses
Profits
29
Assets are economic resources owned
by a business that are expected to be of
benefit in the future,
Assets
30
Further Thoughts on Assets
Human resources as an asset？
Value and labor of Manager of Beauty Photo
Store？
Cameramen and shop
assistants？
Natural resources as an asset?
31
Liabilities
Liabilities are creditor’s claims to the
assets,Liabilities are obligations to
outsiders
32
Owners’Equity
Owner’s Equity is the owner’s claim to
the assets,It is the amount of assets
that remains after subtracting the
liabilities,
33
Changes in Owners’Equity
Investments by owners and revenues,
amounts earned by delivering goods or
services to customers,increase owner’s
equity.
Withdrawals of assets from the business by
owners and expenses decrease owner’s
equity,Expenses occur when assets are
used or liabilities increase as a result of
earning revenues.
34
Revenue
Revenues (sales) are increases in owners'
equity arising from increases in assets
received in exchange for the delivery of
goods or services to customers.
Revenues are increases in economic
resources,either through increases to assets
or reductions to liabilities
35
Revenue Recognition
Revenue should be recognized in the financial
statement when:
the performance has been achieved
there is reasonable assurance regarding the
measurement and collectability of the
consideration
36
Expense
Expenses are decreases in owners' equity that
arise because goods or services are delivered to
customers,
Expenses are decreases in economic resources,
either through outflows or the using-up of assets
or incurrence of liabilities from delivering or
producing goods,rendering services,or carrying
out other activities that constitute the entity’s
normal business
37
Expense Recognition
Cost,expenditure,and expense
General recognition criteria
Approaches to expense recognition
38
Cost,Expenditure,and Expense
When we agree to pay out cash (or other assets)
for goods or services received,we have incurred a
cost
When we actually pay the cash,we have an
expenditure
When the benefits of the cost have been used and
we put that cost (or a portion thereof) on the
income statement,we have recognized an expense
39
General Recognition Criteria
Recognized items must:
meet the definition of a financial statement
element
have a valid measurement basis and amount
Financial statement elements are based on
future economic benefits or sacrifices; these
must be probable for recognition to be
appropriate
40
General Recognition Criteria (cont)
Expenses are decreases in economic
resources,either by way of outflows or
reductions of assets or incurrences of
liabilities,resulting from an entity’s
ordinary revenue generating or service
delivery activities [CICA 1000.38]
Asset or expense? if the asset recognition
criteria are met,an asset is recorded,If not,
an expense is recorded
41
Approaches to
Expense Recognition
Definitional approach,expenses are created
either through the reduction of an asset or
the increase in a liability
Matching approach,once revenues are
determined in conformity with the revenue
principle for any reporting period,the
expenses incurred in generating the revenue
should be recognized in that period
42
Profit / Loss
Income (profit or earnings) is the excess of
revenues over expenses
43
Accounting Equation
Assets – Liabilities = Owners Equity
Net Assets = Owners’ Equity
Every accounting transaction has an equal affect
on both sides of the equation.
Purchase a $20,000 car for cash.
Increase asset car and decrease asset cash by
$20,000,No net change to assets.
Purchase a $20,000 car on credit.
Increase asset car and increase liabilities by
$20,000,
44
Dual Aspect of
Accounting Equation
Assets = Liabilities + Owners’ equity.
LHS = RHS.
First view:
→ Resources = Obligations to creditors or claims on
resources + Residual claim.
Second view:
→ Amounts invested in resources = how these amounts
were financed.
→ Resources = financed by creditors + financed by
owners.
45
Changes to the accounting equation of
Beauty Photo Store：
Beauty Photo Store
-- An Illustration
Asset:130000 Liability:30000 Equity:100000
Liabilities30000 Owners’ equity100000＋ 6000Assets130000＋ 15000－ 9000
Profit:6000Revenue:15000 Expense:9000
＋ ＝
＋ ＝
＋ ＝
46
Summary
Economic resources in the enterprise-
human,financial and material resources
Economic transactions derive from the operating
activities of an enterprise
Accounting elements are basic components of
economic transactions
Accounting elements comprise of assets,liabilities,
owners’equity,revenues,expenses and profit
Economic transactions are viewed in the forms of
increase or decrease in accounting elements
Accounting equation,A＝ L＋ OE
47
Case for Discussion
Marks and Spencer
In 1882,a Russian refugee named Michael Marks came to
the North East of England,Needing work,he put a tray
round his neck and started selling haberdashery in the
villages around Leeds,Two years later he borrowed ￡ 5
from his friend Isaac Dewhirst to buy stock,and was able
to open a stall in Leeds market,
Within ten years Marks’s success as a trader had enabled
him to establish a chain of stalls in markets throughout
North East England,In 1894,Marks realized that his
business was getting too large for him to manage
effectively on his own,He decided
to form a partnership with
Tom Spencer – and Marks
& Spencer was born,
48
Case for Discussion (cont)
The business continued to thrive and grow,so in 1903 Marks
and Spencer registered their partnership as a private limited
company,This allowed more people to become involved with
managing the growing company and increase its finances by
buying shares in the company,One shareholder was Israel Sieff,
who became chairman of the company in 1917,Sieff can be
credited with shaping the future of Marks & Spencer,By 1926,
Marks & Spencer had opened 125 stores,In order to continue
its successful development the company finally registered as a
public limited company (plc) in order to obtain as much capital
as possible to finance its continued growth.
And the rest,as they say,
is history.
49
Suggested Questions
How many people started the original business
that eventually became Marks & Spencer?
Who owned the original business?
Who owns Marks & Spencer plc?
Why do you think Marks & Spencer became a
public limited company?
Do you think the business would have developed
in the way it has if it was still owned by one person?
The End of Lesson 2
Business Transactions
and Accounting Equation
Task Team of
FUNDAMENTAL ACCOUNTING
School of Business,Sun Yat-sen University
2
Outline
Enterprises
Accounting Transactions,Accounting
Events,and Accounting Circumstances
Economic Activities and Accounting
Elements
Accounting Equation
3
Opening Story
Funding and Spending at College
Assets of a college student
→ Cash
→ CD player
→ Computer
Funding these assets
→ Sponsored by parents
→ Sponsored by relatives
→ Borrowed from relatives and acquaintance
4
Opening Story (continued）
We could deal with the above-mentioned financial
issues from the following perspectives：
How do we fund our daily expenditures and possessions？
How do we spend the,funds” which we have sourced？
What about the relationship between the,funds”which
we have sourced and our daily expenditures and
possessions？
5
Enterprises
Concept of Enterprise
Definition of,enterprise”
Functions of an enterprise
Characteristics of an enterprise
6
Forms of Enterprise
There are three major forms of enterprise:
Sole-proprietorship
Partnership
Corporations
7
Sole proprietorships
Single person owns the business
Not separate from its owner in terms of
responsibility and liability
The business is the owner and the owner is
the business
8
Partnership
Owned by two or more people
Similar to a sole proprietorship
Not separate from the owners in terms of
responsibility and liability
9
Corporations
Legally separate and financially separate
from the owners
Ownership in a corporation is divided into
units called shares of capital stock
Owners are called shareholders or
stockholders
Corporations are separate legal entities
10
Characteristics of Enterprise
C h a r a c t e r i s t i c s Pr o p r i e t o r s h i p Pa r t n e r s h i p C o r p o r a t i o n
B u s i n e s s e n t i t y y e s y e s y e s
L e g a l e n t i t y no no y e s
L i m i t e d l i a b i l i t y no n o y e s
U n l i m i t e d l i f e no no y e s
B u s i n e s s t a x e d no no y e s
O n e o w n e r a l l o w e d y e s no y e s
11
Four Types of Enterprise
Service organization – provides services (does
something for you) rather than selling something
Merchandising business – buys goods,adds value
to them,then sells them to customers
Manufacturer – makes the products it sells
Financial services company –doesn’t make
tangible products and doesn’t sell products made
by other companies; deals in services related to
money
12
Resources in an Enterprise
Major resources：
Human resources
Properties,plant and equipment,supplies,raw
materials,finished products or inventories
Financing
→ In cash or bank deposits
→ In material forms
13
An example-Beauty Photo Store
Movements of Material
Resources in an Enterprise
14
Movements of Material
Resources in an Enterprise
Movements in a manufacturing
enterprise
→ cash/bank deposit→raw materials →work -in-
process→finished products→fin→cash/bank
deposit
Movements in a merchandising
enterprise
→ cash/bank deposit→inventory→ cash/bank
deposit
15
Activities of Enterprise
Three major phases of business
activities:
Inception
Operating
Liquidation
16
Inception and investment of funds
→ External funding
State,legal persons,privates or foreign investors；
Financing from banking institutions,other legal
persons or privates
→ Owners’equity and liabilities
Inception of Enterprise
Investment
of owners
Financing of
creditors Total funds of a firm
17
Inception of Enterprise
Forms of Investment
→ Monetary(cash/bank deposits)
→ Property,plants and equipment
→ Raw materials and goods,etc.
Sources and changes of funds
→ Increase of owners’equity or liabilities
→ Increase of assets
18
Operating activities and changes of asset
Changes of assets in Beauty Photo Store
Connections between Beauty Photo Store and
Suppliers,clients,etc.
Operating Activities
cash
2 cameras
lens
＋ producing
equipment
＋
supplies
photos cash
19
Liquidation of Enterprise
Liquidation of enterprise and payoff of
funds
Payment of taxes
Distribution of profits
Declaration of dividends
Payoff of borrowings
Withdrawals and changes of funds
Decrease of assets
Decrease of liabilities or owners’equity
20
Accounting Transactions
A business transaction is an event that
affects the financial position of a business
and may be reliably recorded
21
Economic Activities and
Accounting Elements
Accounting element：
Uses of funds and assets
→ cash
→ equipment,etc.
Resources of funds and equity
→ Borrowings and equity of creditors-
liabilities
→ Investments and owners’equity
22
Uses of Funds
Uses and changes of funds
Beauty Photo Store
→ From cash to equipment
→ Using equipment to produce photos
→ From photos to cash
23
Circulation of Funds
Circulation of funds:
Uses of funds
→ Beauty Photo Store
Cost of equipment
Cost of supplies
Human costs？
Uses and payoff of funds
→ What are the operating purposes for Beauty
Photo Store？
24
Payoff of Funds
Payoff of Funds and Revenues
→ Cash receptions and revenues by Beauty
Photo Store
Net increase of funds and profit
→ Difference between uses and payoff of cash？
→ Nature of profit?
25
Accounting Transactions
Accounting transactions-Economic
exchange between two different accounting
entities
Mutual exchange
→ A purchases an asset,paying cash or bearing the
responsibility of paying cash in future
→ B sells the asset,earning the rights of receiving or
collecting cash
One-way transaction
→ Investments or donations to another accounting
entity
26
Accounting Events
Accounting events-internal transferring of
resources among departments of a same
entity
allotments of raw materials for plants
Damages caused by earthquakes
External versus internal events
Between different entities
Within a same entity
27
Accounting Circumstances
Accounting circumstances-usually an outcome of
collaboration of multiple events
Circumstances and their impacts
→ Changes in prices,exchange rates
How to determine these changes？
E.g,uncollectability of receivables due to the
liquidation of the debtor
Unpredictability
28
Accounting Elements
Assets
Liabilities
Owners’equity
Revenues
Expenses
Profits
29
Assets are economic resources owned
by a business that are expected to be of
benefit in the future,
Assets
30
Further Thoughts on Assets
Human resources as an asset？
Value and labor of Manager of Beauty Photo
Store？
Cameramen and shop
assistants？
Natural resources as an asset?
31
Liabilities
Liabilities are creditor’s claims to the
assets,Liabilities are obligations to
outsiders
32
Owners’Equity
Owner’s Equity is the owner’s claim to
the assets,It is the amount of assets
that remains after subtracting the
liabilities,
33
Changes in Owners’Equity
Investments by owners and revenues,
amounts earned by delivering goods or
services to customers,increase owner’s
equity.
Withdrawals of assets from the business by
owners and expenses decrease owner’s
equity,Expenses occur when assets are
used or liabilities increase as a result of
earning revenues.
34
Revenue
Revenues (sales) are increases in owners'
equity arising from increases in assets
received in exchange for the delivery of
goods or services to customers.
Revenues are increases in economic
resources,either through increases to assets
or reductions to liabilities
35
Revenue Recognition
Revenue should be recognized in the financial
statement when:
the performance has been achieved
there is reasonable assurance regarding the
measurement and collectability of the
consideration
36
Expense
Expenses are decreases in owners' equity that
arise because goods or services are delivered to
customers,
Expenses are decreases in economic resources,
either through outflows or the using-up of assets
or incurrence of liabilities from delivering or
producing goods,rendering services,or carrying
out other activities that constitute the entity’s
normal business
37
Expense Recognition
Cost,expenditure,and expense
General recognition criteria
Approaches to expense recognition
38
Cost,Expenditure,and Expense
When we agree to pay out cash (or other assets)
for goods or services received,we have incurred a
cost
When we actually pay the cash,we have an
expenditure
When the benefits of the cost have been used and
we put that cost (or a portion thereof) on the
income statement,we have recognized an expense
39
General Recognition Criteria
Recognized items must:
meet the definition of a financial statement
element
have a valid measurement basis and amount
Financial statement elements are based on
future economic benefits or sacrifices; these
must be probable for recognition to be
appropriate
40
General Recognition Criteria (cont)
Expenses are decreases in economic
resources,either by way of outflows or
reductions of assets or incurrences of
liabilities,resulting from an entity’s
ordinary revenue generating or service
delivery activities [CICA 1000.38]
Asset or expense? if the asset recognition
criteria are met,an asset is recorded,If not,
an expense is recorded
41
Approaches to
Expense Recognition
Definitional approach,expenses are created
either through the reduction of an asset or
the increase in a liability
Matching approach,once revenues are
determined in conformity with the revenue
principle for any reporting period,the
expenses incurred in generating the revenue
should be recognized in that period
42
Profit / Loss
Income (profit or earnings) is the excess of
revenues over expenses
43
Accounting Equation
Assets – Liabilities = Owners Equity
Net Assets = Owners’ Equity
Every accounting transaction has an equal affect
on both sides of the equation.
Purchase a $20,000 car for cash.
Increase asset car and decrease asset cash by
$20,000,No net change to assets.
Purchase a $20,000 car on credit.
Increase asset car and increase liabilities by
$20,000,
44
Dual Aspect of
Accounting Equation
Assets = Liabilities + Owners’ equity.
LHS = RHS.
First view:
→ Resources = Obligations to creditors or claims on
resources + Residual claim.
Second view:
→ Amounts invested in resources = how these amounts
were financed.
→ Resources = financed by creditors + financed by
owners.
45
Changes to the accounting equation of
Beauty Photo Store：
Beauty Photo Store
-- An Illustration
Asset:130000 Liability:30000 Equity:100000
Liabilities30000 Owners’ equity100000＋ 6000Assets130000＋ 15000－ 9000
Profit:6000Revenue:15000 Expense:9000
＋ ＝
＋ ＝
＋ ＝
46
Summary
Economic resources in the enterprise-
human,financial and material resources
Economic transactions derive from the operating
activities of an enterprise
Accounting elements are basic components of
economic transactions
Accounting elements comprise of assets,liabilities,
owners’equity,revenues,expenses and profit
Economic transactions are viewed in the forms of
increase or decrease in accounting elements
Accounting equation,A＝ L＋ OE
47
Case for Discussion
Marks and Spencer
In 1882,a Russian refugee named Michael Marks came to
the North East of England,Needing work,he put a tray
round his neck and started selling haberdashery in the
villages around Leeds,Two years later he borrowed ￡ 5
from his friend Isaac Dewhirst to buy stock,and was able
to open a stall in Leeds market,
Within ten years Marks’s success as a trader had enabled
him to establish a chain of stalls in markets throughout
North East England,In 1894,Marks realized that his
business was getting too large for him to manage
effectively on his own,He decided
to form a partnership with
Tom Spencer – and Marks
& Spencer was born,
48
Case for Discussion (cont)
The business continued to thrive and grow,so in 1903 Marks
and Spencer registered their partnership as a private limited
company,This allowed more people to become involved with
managing the growing company and increase its finances by
buying shares in the company,One shareholder was Israel Sieff,
who became chairman of the company in 1917,Sieff can be
credited with shaping the future of Marks & Spencer,By 1926,
Marks & Spencer had opened 125 stores,In order to continue
its successful development the company finally registered as a
public limited company (plc) in order to obtain as much capital
as possible to finance its continued growth.
And the rest,as they say,
is history.
49
Suggested Questions
How many people started the original business
that eventually became Marks & Spencer?
Who owned the original business?
Who owns Marks & Spencer plc?
Why do you think Marks & Spencer became a
public limited company?
Do you think the business would have developed
in the way it has if it was still owned by one person?
The End of Lesson 2
