Name ______________________________________ CHAPTER 2 SG-5

CHAPTER 2
ANALYZING TRANSACTIONS:
THE ACCOUNTING EQUATION

LEARNING OBJECTIVES
Chapter 2 continues the introductory discussion of accounting—its elements, equation, and transactions. The
accounting equation provides a structure for analyzing transactions. After all transactions have been analyzed, the
financial statements—income statement, statement of owner’s equity, and balance sheet—are prepared. Let’s look
at each of these learning objectives in detail.

Objective 1. Define the accounting elements.

Accounting elements are the parts that make up the accounting equation: assets, liabilities, and owner’s
equity. Assets are items owned by the business that will provide future benefits. Liabilities are debts owed by the
business and will require a future outflow of assets. Owner’s equity (also called net worth or capital) is the
difference between assets and liabilities. Revenues represent the amount a business charges customers for
products sold or services provided. Revenues create an inflow of assets. Expenses represent an outflow of assets
(or increase in liabilities) as a result of the efforts made to generate revenues.

Objective 2. Construct the accounting equation.

The accounting equation shows the relationship among assets, liabilities, and owner’s equity (the accounting
elements).

Assets = Liabilities + Owner’s

Equity

When given two of the numbers for the equation above, you can calculate the missing number by adding or
subtracting.
The accounting equation may be expanded to include revenues, expenses, and drawing. Although drawing is
not considered a major element in the accounting equation, it is a very special type of owner’s equity account. It
represents the withdrawals of assets from the business by the owner.
ASSETS LIABILITIES OWNER’S EQUITY
(Owner’s
(Items Owned) (Amts. Investment)
= Owed) + Earnings) (Earnings)
Mitchell Mitchell
Delivery Accounts Williams, Williams,
Cash + Equipment = Payable + Capital – Drawing + Revenues – Expenses

Objective 3. Analyze business transactions.

Analyzing is the first step in the accounting process. Three questions must be answered: (1) What happened?
(2) Which accounts are affected, and what kind of accounts are they (asset, liability, owner’s equity)? (3) How is
the accounting equation affected? (Accounts will increase or decrease, but the equation always remains in
balance.)

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SG-6 CHAPTER 2

Objective 4. Show the effects of business transactions on the accounting equation.

Each transaction will affect asset, liability, owner’s equity, revenue, or expense accounts. For example, when
an owner invests cash in the business, the asset account called Cash increases, and the owner’s equity account
Capital also increases.
For each transaction, you must decide what accounts are affected and whether the accounts increase or
decrease. After each transaction, the equation must still be in balance.

Objective 5. Prepare and describe the purposes of a simple income statement, statement of owner’s
equity, and balance sheet.
After the transactions are completed, the financial statements are prepared to show the results of those
transactions. As shown on page 7, all financial statements have a heading that indicates the name of the firm, title
of the statement, and time period or date covered by the statement. The income statement reports revenues,
expenses, and the net income for the period. The statement of owner’s equity shows the beginning balance of the
owner’s capital account, plus investments and net income, less withdrawals to compute the ending capital
balance. The balance sheet reports all assets, liabilities, and the owner’s capital on a certain date and confirms that
the accounting equation has remained in balance.

Note that net income computed on the income statement is transferred to the statement of owner’s equity to
compute Patty V’s capital at the end of the month. Patty V’s capital on December 31, 20--, is then transferred to
the balance sheet to compute total liabilities and owner’s equity.

Objective 6. Define the three basic phases of the accounting process.

The three basic phases of the accounting process are input, processing, and output. The inputs to the
accounting process are the business transactions. These transactions are processed to recognize their effects on the
assets, liabilities, owner’s equity, revenues, and expenses of the business. The results of these events are then
reported as outputs of the accounting process in the financial statements.

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Name ______________________________________ CHAPTER 2 SG-7

Patty V’s Consulting

Income Statement
For Month Ended December 31, 20--
Revenues
Consulting fees $10,000
Expenses
Wages expense $5,000
Rent expense 1,500
Phone expense 500
Total expenses 7,000
Net income $ 3,000

Patty V’s Consulting

Statement of Owner’s Equity
For Month Ended December 31, 20--
Patty V, capital, December 1, 20-- $20,000
Investment in December 20,000
Total investment $20,000
Net income for December $3,000
Less withdrawals for December 1,000
Increase in capital 2,000
Patty V, capital, December 31, 20-- $22,000

Patty V’s Consulting

Balance Sheet
December 31, 20--
Assets Liabilities
Cash $ 500 Accounts payable $ 6,500
Accounts receivable 8,000
Computer equipment 20,000 Owner’s Equity
Patty V, capital 22,000
Total liabilities and
Total assets $28,500 owner’s equity $28,500

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SG-8 CHAPTER 2

REVIEW QUESTIONS
Instructions: Analyze each of the following items carefully before writing your answer in the column at the
right.
Question Answer
LO 2 1. The entire accounting process is based on one simple equation
called the ________. ........................................................................... __________________________
LO 1 2. An individual, association, or organization that engages in business
activities is called a(n) ________. ...................................................... __________________________
LO 1 3. An item owned by a business that will provide future benefits
is a(n) ________. ................................................................................ __________________________
LO 1 4. Something owed to another business entity is a(n) ________. .......... __________________________
LO 1 5. A(n) ________ is an unwritten promise to pay a supplier for assets
purchased or a service rendered. ........................................................ __________________________
LO 2 6. The amount by which assets exceed the liabilities of a business is
called ________. ................................................................................ __________________________
LO 1 7. According to the ________ concept, nonbusiness assets and
liabilities are not included in the business entity’s records. ............... __________________________
LO 2 8. Assets – Liabilities = ________. ........................................................ __________________________
LO 2 9. Assets – Owner’s Equity = ________. .............................................. __________________________
LO 2 10. Assets = Liabilities + ________. ........................................................ __________________________
LO 4 11. The outflow of assets (or increase in liabilities) as the result
of efforts to produce revenue is called a(n) ________. ..................... __________________________
LO 4 12. When total revenues exceed total expenses, the difference
is called ________. ............................................................................. __________________________
LO 4 13. When expenses are greater than revenues, the difference is called
__________. ....................................................................................... __________________________
LO 4 14. Any accounting period of 12 months’ duration is called a(n)
__________. ....................................................................................... __________________________
LO 4 15. Withdrawals, or ______, represent a reduction in owner’s equity
because the owner takes cash or other assets for personal use. .......... __________________________
LO 5 16. The financial statement that reports the profitability of the
business for a period of time is the ________. ................................... __________________________
LO 5 17. The financial statement that shows investments and withdrawals by
the owner, as well as profit or loss generated by the business, is the
__________. ....................................................................................... __________________________
LO 5 18. The financial statement that reports the assets, liabilities, and
owner’s equity on a specific date is the ________. ........................... __________________________

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Name ______________________________________ CHAPTER 2 SG-9

LO 5 19. On the balance sheet, assets are listed in order of ________, or the
ease with which they can be converted to cash. ................................. __________________________

EXERCISES
Exercise 1 (LO 2) THE ACCOUNTING EQUATION
Using the accounting equation provided below, compute the missing amounts.
ASSETS = LIABILITIES + OWNER’S EQUITY
(a) _________________ = $4,000 + $20,000
(b) $25,000 = $8,000 + _________________
(c) $50,000 = _________________ + $10,000

Exercise 2 (LO 2/4) THE EXPANDED ACCOUNTING EQUATION

Using the accounting equation provided below, compute the missing amounts.
ASSETS = LIABILITIES+ OWNER’S EQUITY
(Items Owned) (Amts. Owed) (Owner’s Investment) (Earnings)
Accounts
Cash Payable Capital – Drawing + Revenues – Expenses
(a) ______ = $60,000 + $20,000 – $10,000 + $80,000 – $60,000
(b) $80,000 = ______ + $35,000 – $ 5,000 + $70,000 – $55,000
(c) $90,000 = $25,000 + ______ – $ 2,000 + $57,000 – $50,000
(d) $60,000 = $20,000 + $30,000 – $ 5,000 + ______ – $40,000
(e) $40,000 = $25,000 + $40,000 – $ 5,000 + $30,000 – ______
(f) $75,000 = $20,000 + $50,000 – ______ + $40,000 – $25,000

Exercise 3 (LO 5) STATEMENT OF OWNER’S EQUITY

If owner’s equity was $38,000 at the beginning of the period and $45,000 at the end of the period, compute
the net income or loss for the period. (There were no investments or withdrawals during the period.)

Exercise 4 (LO 2) ACCOUNTING EQUATION

If Irma Elkton, a dentist, owns office equipment amounting to $3,500, laboratory equipment amounting to
$10,000, and other property that is used in the business amounting to $4,620, and owes business suppliers a total
of $5,000, what is the owner’s equity in the business?

Exercise 5 (LO 2) ACCOUNTING EQUATION

This is an extension of Exercise 4. One year later, the amount of Dr. Elkton’s business assets has increased to
a total of $22,000, and the amount of business liabilities has increased to a total of $6,000. Assuming that
Dr. Elkton has not made any additional investments or withdrawals, compute the following:
(a) Owner’s equity at year-end $ ___________________________
(b) Net income or loss for the year $ ___________________________

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SG-10 CHAPTER 2

Exercise 6 (LO 3/4) EFFECTS OF TRANSACTIONS (BALANCE SHEET ACCOUNTS)

Rich Brite has started his own business. During the first month, the following transactions occurred:
(a) Invested $15,000 cash in the business, which was used to open a bank account.
(b) Purchased office equipment for cash, $4,000.
(c) Purchased a computer on account for $9,000.
(d) Paid $2,000 on account for the computer.
Using the lines provided below, show the effect of each transaction on the basic elements of the accounting
equation: assets, liabilities, and owner’s equity. Compute the new amounts for each element after each transaction
to satisfy yourself that the accounting equation has remained in balance.

ASSETS = LIABILITIES + OWNER’S EQUITY

(a)
Bal.
(b)

Bal.
(c)
Bal.
(d)
Bal.

Exercise 7 (LO 3/4) EFFECTS OF TRANSACTIONS (REVENUE, EXPENSE, WITHDRAWALS)

In late May, Glen Ross opened a business by investing $20,000 cash and purchasing office equipment on
account for $8,000. These events were properly entered in the accounting records. In June, the following
transactions took place:
(a) Received $4,000 from a client for professional services rendered.
(b) Paid $1,200 office rent for the month.
(c) Paid $200 to the power company for the month’s utility bill.
(d) Withdrew $600 cash for personal use.
On the first Balance (Bal.) line provided on the following page, record the amount of assets, liabilities, and
owner’s equity as the result of Ross’s investment and purchase of office equipment in May. Then, record the
effect of transactions (a) to (d) on the expanded accounting equation: Assets = Liabilities + Owner’s Equity
(Capital – Drawing + Revenues – Expenses). Following transaction (d), compute the new balances for each
category to satisfy yourself that the accounting equation has remained in balance.

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Name ______________________________________ CHAPTER 2 SG-11

Exercise 7 (Concluded)

ASSETS = LIABILITIES + OWNER’S EQUITY

(Items Owned) (Amts. Owed) (Owner’s Investment) (Earnings)
Accounts Glen Ross, Glen Ross,
Cash Payable Capital – Drawing + Revenues – Expenses Description
Bal. _________ _________ _________ _________ _________ _________ _________
(a) _________ _________ _________ _________ _________ _________ _________
(b) _________ _________ _________ _________ _________ _________ _________
(c) _________ _________ _________ _________ _________ _________ _________
(d) _________ _________ _________ _________ _________ _________ _________
Bal.

Exercise 8 (LO 3/4) EFFECTS OF TRANSACTIONS (ALL ACCOUNTS)

Judith Moore started her own business. During the month of July, the following transactions occurred:
(a) Invested $10,000 cash in the business.
(b) Purchased office equipment on account, $5,500.
(c) Received $900 cash from a client for services rendered.
(d) Purchased computer equipment for cash, $6,000.
(e) Received $1,500 cash from a client for services rendered.
(f) Paid $800 office rent for the month.
(g) Paid the phone bill for the month, $75.
(h) Paid $100 on account, for office equipment previously purchased.
(i) Withdrew $500 for personal use.
Required:
1. Record the effect of each of the transactions listed above on the accounting equation provided in the chart on
the following page. Following transaction (i), compute the new balances for the accounts to satisfy yourself
that the equation has remained in balance.

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SG-12 CHAPTER 2

Exercise 8 (Concluded)

ASSETS = LIABILITIES + OWNER’S EQUITY

(Items Owned) (Amts. Owed) (Owner’s Investment) (Earnings)

Office Accounts J. Moore, J. Moore,

Cash + Equipment = Payable + Capital – Drawing + Revenues – Expenses Description

(a) ________ ________ ________ ________ ________ ________ ________ ________

(b) ________ ________ ________ ________ ________ ________ ________ ________
(c) ________ ________ ________ ________ ________ ________ ________ ________
(d) ________ ________ ________ ________ ________ ________ ________ ________
(e) ________ ________ ________ ________ ________ ________ ________ ________
(f) ________ ________ ________ ________ ________ ________ ________ ________
(g) ________ ________ ________ ________ ________ ________ ________ ________
(h) ________ ________ ________ ________ ________ ________ ________ ________
(i) ________ ________ ________ ________ ________ ________ ________ ________
Bal.

2. After recording the transactions in part (1), compute the following:

Total assets.................................................................................. $ ___________________________
Total liabilities............................................................................ $ ___________________________
Owner’s equity............................................................................ $ ___________________________
Owner’s equity in excess of original investment........................ $ ___________________________
Total revenues............................................................................. $ ___________________________
Total expenses............................................................................. $ ___________________________
Net income.................................................................................. $ ___________________________

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Name ______________________________________ CHAPTER 2 SG-13

Exercise 9 (LO 5) PREPARATION OF AN INCOME STATEMENT

Based on the transactions reported in Exercise 8, prepare an income statement for Judith Moore Enterprises
for the month ended July 31, 20--, in the space provided below.

Exercise 10 (LO 5) PREPARATION OF THE STATEMENT OF OWNER’S EQUITY

Based on the transactions reported in Exercise 8, prepare a statement of owner’s equity for Judith Moore
Enterprises for the month ended July 31, 20--, in the space provided below.

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SG-14 CHAPTER 2

Exercise 11 (LO 5) PREPARATION OF A BALANCE SHEET

Based on the transactions reported in Exercise 8, prepare a balance sheet for Judith Moore Enterprises as of
July 31, 20--, in the space provided below.

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Name ______________________________________ CHAPTER 2 SG-15

PROBLEMS
Problem 12 (LO 2) THE ACCOUNTING EQUATION
Dr. Abe Miller is a general practitioner. As of December 31, Miller owned the following assets related to the
professional practice:
Cash $3,300 X-ray equipment $7,000
Office equipment 4,500 Laboratory equipment 4,000

As of that date, Miller owed business suppliers as follows:

General Office Equipment Inc. $2,000
Young Medical Supply Company 1,500
Buck Gas Company 1,200

Required:
1. Compute the amount of assets, liabilities, and owner’s equity as of December 31.
ASSETS = LIABILITIES + OWNER’S EQUITY
_________________ _________________ _________________
2. Assuming that during January there is an increase of $4,600 in Dr. Miller’s business assets and an increase
of $2,500 in business liabilities, compute the resulting accounting equation as of January 31.
ASSETS = LIABILITIES + OWNER’S EQUITY
_________________ _________________ _________________
3. Assuming that during February there is a decrease of $1,500 in assets and a decrease of $1,200 in liabilities,
compute the resulting accounting equation as of February 28.
ASSETS = LIABILITIES + OWNER’S EQUITY
_________________ _________________ _________________
4. Assuming that Dr. Miller made no additional investments or withdrawals, compute the net income or loss
for each month.

Problem 13 (LO 3/4) EFFECT OF TRANSACTIONS ON ACCOUNTING EQUATION

Susan Cole started her own consulting business in October 20--. During the first month, the following
transactions occurred:
(a) Invested $12,000 cash in the business.
(b) Purchased office equipment on account, $7,500.
(c) Purchased computer equipment for cash, $800.
(d) Received $700 cash from a client for services rendered.
(e) Paid $600 office rent for the month.
(f) Paid student assistant wages for the month, $150.
(g) Paid one-year insurance premium, $200.
(h) Paid $3,000 on account for the office equipment purchased in transaction (b).

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SG-16 CHAPTER 2

(i) Withdrew cash for personal use, $100.

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Name ______________________________________ CHAPTER 2 SG-17

Problem 13 (Concluded)
Required:
1. Record the effect of each of the transactions from the previous page on the accounting equation chart
provided below. Following transaction (i), compute the new amounts in the accounts.
ASSETS = LIABILITIES + OWNER’S EQUITY
(Amts.
(Items Owned) Owed) (Owner’s Investment) (Earnings)
Office Prepaid Accounts S. Cole, S. Cole,
Cash + Equip. + Insur. = Payable + Capital – Drawing + Revenues – Expenses Description
(a) _______ _______ _______ _______ _______ _______ _______ _______ _______
(b) _______ _______ _______ _______ _______ _______ _______ _______ _______
(c) _______ _______ _______ _______ _______ _______ _______ _______ _______
(d) _______ _______ _______ _______ _______ _______ _______ _______ _______
(e) _______ _______ _______ _______ _______ _______ _______ _______ _______
(f) _______ _______ _______ _______ _______ _______ _______ _______ _______
(g) _______ _______ _______ _______ _______ _______ _______ _______ _______
(h) _______ _______ _______ _______ _______ _______ _______ _______ _______
(i) _______ _______ _______ _______ _______ _______ _______ _______ _______
Bal.

2. After recording the transactions, compute the following:

Total assets.................................................................................. $ __________________________
Total liabilities............................................................................ $ __________________________
Owner’s equity............................................................................ $ __________________________
Change in owner’s equity from original investment................... $ __________________________
Total revenues............................................................................. $ __________________________
Total expenses............................................................................. $ __________________________
Net income (loss)........................................................................ $ __________________________

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SG-18 CHAPTER 2

Problem 14 (LO 5) INCOME STATEMENT

Based on the transactions in Problem 13, prepare an income statement for Susan Cole Consulting Services
for the month ended October 31, 20--, in the space provided below.

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Name ______________________________________ CHAPTER 2 SG-19

Problem 15 (LO 5) STATEMENT OF OWNER’S EQUITY

Based on the transactions in Problem 13, prepare a statement of owner’s equity for Susan Cole Consulting
Services for the month ended October 31, 20--, in the space provided below.

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SG-20 CHAPTER 2

Problem 16 (LO 5) BALANCE SHEET

Based on the transactions in Problem 13, prepare a balance sheet for Susan Cole Consulting Services as of
October 31, 20--, in the space provided below.

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Name ______________________________________ CHAPTER 2 SG-21

Problem 17 (LO 3/4/5) ANALYZE THE EFFECTS OF BUSINESS TRANSACTIONS ON THE

ACCOUNTING EQUATION AND PREPARE FINANCIAL STATEMENTS
Stuart Cassady is opening a word processing service. During the first month (April 20--), the following
transactions occurred:
(a) Invested $10,000 in the business.
(b) Purchased office supplies for $200 cash.
(c) Purchased office supplies for $800, $400 on account and $400 in cash.
(d) Received typing fees of $300 cash.
(e) Paid the rent, $600.
(f) Withdrew $100 for personal use.
(g) Earned typing fees of $600, $200 in cash and $400 on account.
(h) Made partial payment for office supplies in transaction (c) of $200.
(i) Received $200 cash for typing fees earned on account in transaction (g).
Required:
1. Record the effect of each transaction on the accounting equation below. Following transaction (i), compute
new amounts for each account.
ASSETS = LIABILITIES + OWNER’S EQUITY
(Amts.
(Items Owned) Owed) (Owner’s Investment) (Earnings)
Accounts Office Accounts S. Cassady, S. Cassady,
Cash + Receivable + Supplies = Payable + Capital – Drawing + Revenues – Expenses Description

(a) _______ _______ _______ _______ _______ _______ _______ _______ _______
(b) _______ _______ _______ _______ _______ _______ _______ _______ _______
(c) _______ _______ _______ _______ _______ _______ _______ _______ _______
(d) _______ _______ _______ _______ _______ _______ _______ _______ _______
(e) _______ _______ _______ _______ _______ _______ _______ _______ _______
(f) _______ _______ _______ _______ _______ _______ _______ _______ _______
(g) _______ _______ _______ _______ _______ _______ _______ _______ _______
(h) _______ _______ _______ _______ _______ _______ _______ _______ _______
(i) _______ _______ _______ _______ _______ _______ _______ _______ _______
Bal.

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SG-22 CHAPTER 2

Problem 17 (Concluded)
2. Based on the transactions in part (1) of Problem 17, prepare an income statement, statement of owner’s
equity, and balance sheet for Stuart Cassady Typing Service.

Income Statement

Statement of Owner’s Equity

Balance Sheet

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Name ______________________________________ CHAPTER 2 SG-23

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