Accounting Equation Transaction Effects
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UserAccounting Equation Transaction Effects
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UserExercise 2
1. Describe how the following business transactions affect the three elements of the accounting
equation.
a. Received cash for services performed.
When a business receives cash for services performed, it affects the three elements of the
accounting equation in the following ways:
1. Assets: The cash received increases the assets of the business. Cash is considered an asset
because it represents the amount of money that the business owns and has at its disposal to use
for various purposes. So, the increase in cash due to receiving payment for services performed
would increase the overall asset position of the business.
2. Liabilities: There is no direct impact on liabilities in this transaction. Liabilities represent the
obligations or debts that a business owes to external parties. Receiving cash for services does not
create any new liabilities or change the existing ones, as it does not involve borrowing or owing
money to others.
3. Owner's Equity: The owner's equity, also known as the owner's capital or net worth, represents
the residual interest in the assets of the business after deducting liabilities. When a business
receives cash for services performed, it increases the owner's equity. This increase occurs
because the revenue generated from providing services adds to the overall profitability and value
of the business, increasing the owner's claim on the assets.
In summary, receiving cash for services performed increases the assets of the business while
leaving liabilities unaffected. It also contributes to the growth of the owner's equity by adding to
the overall profitability of the business..
b. Invested cash in business.
When you invest cash in a business, it affects the three elements of the accounting equation -
assets, liabilities, and owner's equity.
1. Assets: The cash invested in the business increases the asset value. Cash is considered an asset
because it holds value and can be used to acquire other resources or settle obligations.
2. Liabilities: In this transaction, there is no direct impact on liabilities unless the business has
outstanding loans or debts. If there are existing liabilities, the cash injection might be used to
reduce or pay off those liabilities, resulting in a decrease in liabilities.
3. Owner's Equity: The investment of cash by the owner increases the owner's equity. Owner's
equity represents the ownership interest in the business, and when cash is injected, it
demonstrates the owner's financial stake or capital contribution.
Overall, the investment of cash in the business increases both the asset and owner's equity
values, while typically not directly affecting liabilities unless they are used to settle existing
obligations.
c. Paid for utilities used in the business.
d. Purchased supplies on account.
Paid for utilities used in the business:
This business transaction affects both the assets and liabilities of the company. When the
business pays for utilities, it reduces its cash (an asset) as the payment is made. At the same time,
it decreases its liability (if any) related to unpaid utility bills. Therefore, the accounting equation
is affected as follows:
Assets: Cash decreases.
Liabilities: Utility Payable (if any) decreases.
Purchased supplies on account:
This business transaction also impacts both the assets and liabilities of the company. When
supplies are purchased on account, it means that the company acquires inventory or supplies but
does not make an immediate payment. Thus, it increases the company's liability to the supplier
while increasing its assets by adding inventory or supplies. As a result, the accounting equation
is affected as follows:
Assets: Inventory or Supplies increase.
Liabilities: Accounts Payable (to the supplier) increases.
e. Purchased supplies for cash.
2. Suppose Mr Boris establishes a sole proprietorship to be known as Effective Garage, on
September1, 2020. During September, the business engages in the following transactions:
Transaction (1): Mr Boris starts business by depositing Br. 100,000 in a bank account opened in
the name of Effective Garage.
Transaction (2): Effective Garage bought land for Birr 20,000 in cash, to be used as a future site
for the business.
Transaction (3): Mr Boris bought office supplies for birr 2,500 on credit, to be used by the
business.
Transaction (4): Effective Garage paid Birr. 1,500 to creditors on account.
Transaction (5): During the first month of operation, Effective Garage earned service Fees of
Birr 30,000 receiving the amount in cash for the garage services it rendered.
Transaction (6): During the month of September, Effective Garage paid Birr 15,000 for different
types of expenses (birr 10,000 to salary of employees, birr 3000 Telephone, birr 1,500 for rent,
and birr 500 for advertisement).
Transaction (7): Mr Boris, the owner, withdrew Birr 3000 for his personal from the business.
Required:
A. Show the effect of every transaction in terms of increases and /or decreases in one or
more of the elements of the accounting equation so that the equality of the two sides of
the accounting equation is maintained.
B. Prepare the Income statements of Effective Garage for the year ended September 30,
2020.
C. Prepare statements of owners’ equity of Effective Garage for the year ended September
30, 2020.
D. Prepare the Balance sheet of Effective Garage on September 30, 2020.
E. Prepare the statements of cash flows of Effective Garage for the year ended September
30, 2020.
Common questions
Powered by AIReceiving cash from the owner as an investment increases the company's assets and also increases owner's equity. On the statement of owner's equity, this transaction would be reflected as an increase in capital contributions, thus enhancing the overall equity position of the business .
Purchasing equipment for cash results in a decrease in cash (an asset) and an increase in equipment (also an asset). The overall effect on the accounting equation is neutral regarding the sum of assets, though the composition changes. Liabilities and owner's equity remain unaffected by this transaction .
Paying for utilities decreases the cash asset since it is used to pay the bills. If there are outstanding utility bills, liabilities decrease as well because the payment reduces the amount owed under liabilities (Utility Payable). Overall, the asset and liability changes maintain the balance in the accounting equation .
Paying off a creditor's outstanding balance reduces liabilities, as the obligation to pay is settled. While this affects cash (reduces assets), owner's equity remains unchanged directly, although the decrease in liabilities could enhance the solidity of the owner's equity by reducing the debt burden of the business .
Mr. Boris's initial investment improved the asset base and equity of Effective Garage. Subsequent transactions, such as land purchase, increased fixed assets and depleted cash, while earning and receiving service fees boosted cash and equity through profit generation. Expense payments decreased cash without affecting equity. The net effect by September 30 is an overall stronger financial position with increased assets, no new liabilities, and fortified owner's equity despite cash reductions from purchases and expenses .
The net cash flow for Effective Garage in September includes cash inflows from Mr. Boris's initial deposit (Birr 100,000) and service fees received (Birr 30,000), totaling Birr 130,000. Cash outflows include land purchase (Birr 20,000), payments to creditors (Birr 1,500), expenses (Birr 15,000 total), and owner's withdrawal (Birr 3,000), totaling Birr 39,500. Thus, the net cash flow for the month is an increase of Birr 90,500 .
Investing cash in a business increases both assets and owner's equity as the cash is added to the company's assets and represents a contribution to owner's equity. It does not directly affect liabilities unless the cash is used to pay off existing debts, which would result in a decrease in liabilities .
Purchasing supplies on account increases the assets by adding inventory or supplies while also increasing liabilities because the purchase creates an obligation (Accounts Payable) to the supplier. This change impacts the balance sheet by reflecting higher assets and liabilities without affecting owner's equity .
Receiving cash for services performed increases the assets of the business as cash is an asset, and it also increases the owner's equity because the revenue from services adds to the profitability and value of the business. There is no impact on liabilities since this transaction does not involve borrowing or owing money to others .
When a business owner withdraws cash for personal use, it decreases the assets (cash) and reduces the owner's equity because the withdrawal represents a distribution of resources from the business to the owner, thus reducing the owner's claim on the business assets .