Acct 2301 1st Edition Lecture 3 Outline of Last Lecture I Introducing Accounting in Business cont Outline of Current Lecture II Introducing Accounting in Business cont Current Lecture 5 Basic accounting equation A company s assets belong to the resource providers who are said to have claims on the assets In other words each asset has its own source provided by an owner or creditor So there can t be a claim without an appropriate asset and vice versa Based on this statement we can define the basic accounting equation as Assets Claims Claims are divided into two categories Creditors claims that are called liabilities Owners claims that are called equity Taking this into account the basic accounting equation can also be presented as follows Assets Claims These notes represent a detailed interpretation of the professor s lecture GradeBuddy is best used as a supplement to your own notes not as a substitute Liabilities Equity Assets Liabilities are debts and obligations of a company Equity is what the company owes to owners Equity is also called net assets or residual equity The amount of total assets minus total liabilities equals equity Because equity equals the difference between assets and liabilities it is also called net assets If a company goes bankrupt liabilities are paid off first to creditors while equity is the last to be distributed Therefore owners equity is also called residual equity Let us look at an example of the basic accounting equation Suppose a company has assets of 800 liabilities of 300 and equity of 500 These amounts will be shown in the basic accounting equation as follows Illustration 2 Example of basic accounting equation Asset s Claims Asset s Liabilitie Equit s y 800 300 500 6 Effects of transactions on the basic accounting equation Let us know examine how different transactions affect the basic accounting equation We will take a look at several transactions separately 1 Friends Company is created when the owners pool 5 000 into the business The effect of the contributions on the accounting equation is as follows Illustration 3 Effect of cash contribution Assets 5 000 Claims Liabilities Equity 5 000 Note that the amount of this single transaction is recorded twice The first time it is recorded as an asset and the second time it is recorded as equity the asset source In accounting any transaction is recorded at least twice as a rule This rule is known as double entry bookkeeping The double entry bookkeeping rule states that any transaction is recorded at least twice Because this transaction provided assets to the company it is called an asset source transaction An asset source transaction is one of the four types of accounting transactions Asset source transactions result in an increase in an asset account and in one of the claim accounts liability or equity accounts 2 Next assume that Friends Company acquires an additional 2 000 of assets by borrowing cash from creditors e g taking a loan from a bank This is also an asset source transaction In the table below the beginning balances are derived from the ending balances of the previous transaction Illustration 4 Effect of borrowing Claims Beginning balance Effect of borrowing Ending balance Assets 5 000 2 000 7 000 Liabilities 2 000 2 000 Equity 5 000 5 000 Equity is usually viewed as a source of assets and that s why it is necessary to subdivide the owner s interest into two components First owners claims are established when a business acquires assets from owners These claims result from the contributions of capital resources by the owners therefore they are frequently called contributed capital Contributed capital is a component of equity resulting from contributions of capital resources by owners The second source of assets associated with equity occurs when a business obtains assets through its earnings activities This source is called retained earnings Retained earnings are a component of equity resulting from earnings activities Taking into account the definitions above the basic accounting equation can be presented like this Equity Asset s Liabilitie s Contributed Capital Retained Earning s
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