Accounting Basics Part 3-The Effect of Business Transactions on the Accounting Equation Okay, today we’re going to talk about the effect of business transactions on the accounting equation. In an earlier video in this series, we looked at account types and the accounting equation and today we are going to further build on that. So, let’s go back and just kind of review what we know about account types and the accounting equation. As you can see up here, the basic accounting equation is assets equal liabilities plus stockholders’ equity. But what is an asset? An asset is a resource owned by the business. Probably one we will be using a lot today is cash, a very important asset, one that the balance is constantly changing, in my personal bank account and in the business, constantly changing. Liabilities, in one word, are debts. Anybody that the company owes money to is a liability and, stockholders’ equity is the stockholders’ rights to the assets of the business. We also talked about two other types of accounts: revenue accounts, which is sales of services or products to customers, depending on what type of business you have and that increases the stockholders’ equity and also looked at expenses. Expenses are just those regular ongoing, day-to-day expenses of being in business. They are consumed or used up in the process of generating revenue. So, again, as we, businesses go through lots of business transactions, they spend lots of cash, buy things on credit, take in payments, and so, we’re going to take a look at how that effects the accounting equation, knowing that it always will stay in balance. Each line we do here, it should stay in balance. If you’ll look at the handouts, I hope you downloaded the handouts that go with this particular video. There is a problem to work. It says on September the first, Lee Laundry, M.D., organized a professional corporation to practice medicine, and we are going to analyze how these transactions effected the accounting equation. The first one says that Lee Laundry, or Dr. Laundry, deposits $6,000 in a bank account in the name of Family Health Care, P.C. in return for shares of stock in the corporation. Alright, so what is happening here? He’s depositing money in a bank account in exchange for stock. So what accounts would be effected here? Well, it sounds like the business is getting cash. You have to start out with cash to have cash to spend, right? So we would be increasing cash, which is over here on the asset side. Okay, what other account is effected here? He’s purchasing shares of stock in the corporation, so that is increasing our capital stock account so that would increase $6,000. Okay, going on down to the next line, it says that the business borrows $10.000 from First National Bank to finance it’s operations. What happens here? They are borrowing money so we would be getting money, right, cash? It looks like $10,000, so cash is coming in for $10,000. Okay, when we are borrowing money from the bank, we are going to owe them. Right? So, that would be a liability. So, liabilities over here are going to be increased by $10,000. So in effect what we’ve done here is we’ve increased cash and we’ve increased, I’m sorry, we’ve increased the asset cash and we’ve increased our liabilities and if you’ll put the equal sign in there, you will see that that equals. Going back and reviewing the first line, we increased cash and we also increased stockholders’ equity so you can see that those equal. Alright, on the transaction sheet it says here that Family Health Care buys land for $12,000 cash. Cash is over here with our assets. So we’re going to increase cash by $12,000. I’m sorry, we’re going to decrease cash by $12,000. And what are we getting in exchange for that asset? We’re getting land which

is also an asset. Again we have our equal sign here. This is a perfect example of something that only effected this side of the equation. You don’t have to have something on both sides. We decreased the asset cash and we increased the asset land. So, we decreased one asset and increased another. Okay., the next one, it says during the first month of operations Family Health care earned patient fees of $5,500, receiving the fees in cash. Okay, so, Family Health Care is increasing their cash. My favorite kinds of patients are those that pay cash. So we would increase cash which is an asset by $5,500. Okay, what else increases here? When we earn patient fees, that would actually be going into the account fees earned. How do fees earned, that’s a revenue account, right, because we’re in the business of selling services to patients when we’re a doctor, and all revenue accounts, when we increase our revenues we also increase the stockholders’ rights to the assets of the business. So, we have $5,500 over here. So here we increased the asset cash and we increased the stockholders’ equity account as well. Again, it continues to stay in balance. In transaction E, it says Family Health Care paid expenses during September as follows: wages $1,125, they paid utilities, interest, and miscellaneous. Okay, it sounds like they just sat down and wrote out all their monthly bills. What happens when you sit down and write out your monthly bills? You spend money. Right? You’re spending your cash. So, actually, if you add all of those up, they should add up to $2,900 in cash. So, we are going to decrease cash by $2,900. What happens with all these expenses? Expenses also come out of retained earnings because we’re actually decreasing the earnings in the business when we pay expenses and so, we could list each one of these separately. We have wages expense, rent; the wages were $1,125, rent is $950, utilities is $450, interest $100. Again, all of these are decreasing the retained earnings and if you can’t see what I’m writing, these are all coming from your handout, so if it’s getting too small. Okay, and the last one down here is $275 for miscellaneous expense, another one of those questionable categories I try to stay away from. Okay, if you add up all those expenses again they should add up to the $2,900 that we decreased over here on the cash side and the last transaction for this month was that they paid $1,500 to the stockholders as dividends. Alright, what happens when we pay dividends? What accounts are effected here? Well, if we’re paying, cash is always involved and we would decrease it by $1,500. Okay, what else is involved here? Paying dividends. Paying, the process of paying dividends actually decreases retained earnings, because the stockholders don’t have as much right, as many rights to the assets of the business when they’ve paid out in dividends. So, we would decrease over on this side the $1,500 and, if we take time to add all of these down, you’ll find that they should, they should all balance. Okay. $5,100 down here for cash is all we have left of that original $6,000. Land $12,000; liabilities here, should be $10,000 when we add them down, that’s pretty easy, there is only one and capital stock stayed at $6,000. That’s over here from the first transaction and, over here adding down all our expenses. Can we prepare financial statements from here? Absolutely. You could go back through here and figure out , I believe this was our fees earned, these are all of our expenses, and that would enable us to prepare an income statement. If you’ll notice the accounting equation is kind of a reflection of what’s on the balance sheet, so if we looked at the bottom, we’d have the total for cash and land and accounts payable, stockholders’ equity and retained earnings, and we can also prepare a statement of retained earnings. So actually, just from

analyzing the transactions here we have the information to complete the financial statement, but I’m not going to take the time to do that today.