Accounting Business Reporting for Decision Making

128 Accounting: Business Reporting for Decision Making

•   It is important to distinguish between business transactions and personal transactions. Personal

transactions are transactions of the owners of the business and do not relate to the business;

consequently, they have no impact on the entity’s financial records. Business events have the

potential to affect the entity in some way, but will not be recorded as a business transaction until an

exchange of goods or services occurs between the business entity and another entity or individual.

•   The accounting equation expresses the relationship between the assets of an entity and how the

assets are financed. Assets are financed either by liabilities or by contributions by the owner.

•   For each business transaction, there will be at least two effects on the accounting equation. This is

known as the application of duality.

•   The balance sheet of an entity is an expression of the accounting equation as it reports the entity’s

asset, liability and equity accounts. The equity section of the equation can be expanded to show the

impact of income and expenses for the entity, which will determine the entity’s profit or loss for the

reporting period. A profit increases equity and a loss decreases equity.

4.4 Analysis of business transactions

LEARNING OBJECTIVE 4.4 Identify the impact of business transactions on the accounting equation.

The following illustrative examples (4.1 to 4.3) illustrate the analysis of business transactions using the

accounting equation.

ILLUSTRATIVE EXAMPLE 4.1

Analysis of business transactions (capital contribution)

Nicholas Cash recently set up his own tennis coaching academy, Advantage Tennis Coaching (ATC). He con-

tributes $20 000 of his personal savings into a business bank account under the name of Advantage Tennis

Coaching. The impact of the initial transaction is that the business will have assets of $20 000 in cash and also

$20 000 in equity, which represents $20 000 owed to the owner, Nicholas. This would be shown as an increase

in the cash account and an increase in the equity account. At this stage there are no liabilities against the assets.

The accounting equation would record the impact of the transaction as follows:

Assets (A) = Liabilities (L) + Equity (E)

Cash $20 000 = $0 + Capital $20 000

Note that the total of the assets always equals the claims on the assets.

ILLUSTRATIVE EXAMPLE 4.2

Analysis of business transactions (asset purchase)

ATC purchases a new iPad for $500 from JB Teck Supplies for cash. The iPad will be classified as an

item of office equipment for the business. Therefore, this transaction will result in the cash account

going down by $500 and the office equipment account going up by $500:

Assets (A) = Liabilities (L) + Equity (E)

Cash $500

Office equipment $500

Note that this transaction affects only the asset side; it has no impact on the liability and equity side

(the claims against the assets). The effects on the asset side cancel each other out. Note also that trans-

actions can result in changes to accounts on one or both sides of the equation.

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