The document discusses the accounting equation and its components - assets, liabilities, and owner's equity. It defines each term and provides examples. It also summarizes 10 sample transactions to demonstrate how the accounting equation is impacted by business activities like purchases, sales, expenses and owner withdrawals. Understanding the accounting equation and how it is affected is important for financial analysis, decision making, and regulatory compliance.

1. UNDERSTANDING ACCOUNTING EQUATION AND
ITS APPLICATIONS IN FINANCIALANALYSIS
Financial statements are formal records of the financial activities and
position of a business, person, or other entity. They give a clear overview
of the financial health and performance of an organization.
ma by mohamed Garane Sanei

2. Assets: Definition and Examples
Definition
Assets are resources with economic value that an
individual, corporation, or country owns or
controls with the expectation that it will provide
future benefit.
Examples
Common examples of assets include cash,
accounts receivable, inventory, investments, and
property.

3. Cash: Physical currency or money in a bank account that a company uses to
conduct its business.
Accounts Receivable: Amounts owed to the company by customers for goods
or services provided on credit.
Allowance for Doubtful Accounts: A contra-asset account that represents the
estimated amount of uncollectible accounts receivable.
Interest Receivable: Interest income that has been earned but not yet
received.
Prepaid Insurance: Insurance premiums that have been paid in advance and
are recorded as an asset until the coverage period expires.
Prepaid Rent: Rent that has been paid in advance and is recorded as an asset
until the rental period expires.

4. Land: The cost of land owned by the company, which is recorded at
its original purchase price.
Equipment: Physical assets used in the operations of a business,
such as machinery, vehicles, and computers.
Accumulated Depreciation—Equipment: A contra-asset account
that represents the total depreciation expense recognized on
equipment since it was acquired.
Goodwill: The excess of the purchase price of a business over the
fair value of its identifiable net assets.
Patents: Exclusive rights granted to the inventor of a new product or
process to use and profit from the invention for a specified period

5. Liabilities: Definition and Examples
Definition
Liabilities are legal obligations or debt, arising
from past transactions, that are settled by the
transfer of economic benefits like money or
goods.
Examples
Examples of liabilities include loans, accounts
payable, bonds, and mortgages.

6. Notes Payable: Written promises to pay a specified amount of money at a
future date.
Accounts Payable: Amounts owed by the company to suppliers for goods or
services purchased on credit.
Unearned Service Revenue: Revenue received in advance for services that
have not yet been provided.
Salaries and Wages Payable: Amounts owed by the company to employees
for work performed but not yet paid.
Interest Payable: Interest expense that has been incurred but not yet paid.
Dividends Payable: Dividends declared by a company's board of directors but
not yet paid to shareholders.
Mortgage Payable: Long-term debt secured by a mortgage on the company's
assets

7. Owner's Equity: Definition and
Examples
1 Definition
Owner's equity represents the
owner's investment in the business.
It's the portion of the total value of a
company’s assets that can be
claimed by the owners.
2 Examples
Examples of items included in
owner's equity are owner's capital,
retained earnings, and stock.

8. Owner’s Capital: The owner's equity in the business, representing
the owner's investment in the company.
Owner’s Drawings: Withdrawals of cash or other assets made by the
owner of a business for personal use.
Common Stock: The capital stock of a corporation that represents
ownership in the company.
Preferred Stock: A class of stock that typically has preferential rights
over common stock, such as priority in dividend payments.
Dividends: Distributions of earnings to shareholders, usually in the
form of cash or additional shares of stock.

9. Revenue: Definition and Examples
Definition
Revenue is the income generated from normal
business operations. It's the total amount of
money received from the sale of goods or
services.
Examples
Examples of revenue include sales revenue,
service revenue, and interest revenue.

10. Service Revenue: Revenue generated by providing services to
customers.
Sales Revenue: Revenue generated by selling goods to
customers.
Sales Discounts: Discounts given to customers for early
payment of invoices.
Sales Returns and Allowances: Reductions in sales revenue for
returned goods or allowances granted to customers for damaged
or defective goods.

11. Expense: Definition and Examples
Definition
Expenses represent the cost of doing
business. It includes all costs incurred
to generate revenue such as wages,
rent, utilities, and supplies.
Examples
Common examples of expenses are
rent, utilities, salaries, advertising, and
insurance.

12. Advertising Expense: The cost of advertising and promoting a company's products or
services.
Bad Debt Expense: An expense incurred when a company is unable to collect on accounts
receivable.
Cost of Goods Sold: The direct costs attributable to the production of goods sold by a
company.
Freight-Out: The cost of shipping goods to customers.
Interest Expense: The cost of borrowing money, typically on loans or bonds.
Maintenance and Repairs Expense: The cost of maintaining and repairing the company's
assets.
Rent Expense: The cost of renting or leasing property for the company's operations.
Salaries and Wages Expense: The cost of paying employees for their work.
Supplies Expense: The cost of supplies used in the company's operations.
Utilities Expense: The cost of utilities, such as electricity, water, and gas, used in the
company's operations.

13. Relationship between Assets,
Liabilities, and Owner's Equity
Assets
Assets are financed by both liabilities and owner's equity.
Liabilities
Liabilities represent the debts and obligations a company owes.
Owner's Equity
Owner's equity reflects the value of the business to its owners.

14. Importance of Understanding
Financial Statements
1 Decision Making
Financial statements provide vital
information for decision-making and
strategic planning.
2 Investor Confidence
Understanding financial statements
can attract potential investors and
shareholders.
3 Compliance
Understanding financial statements is essential for regulatory compliance and tax
requirements.

15. TRANSACTION (1). INVESTMENT BY OWNER Ali starts a smartphone app
development company which he names soft byte. On September 1, 2017, he
invests $15,000 cash in the business. This transaction results in an equal increase
in assets and owner’s equity.
TRANSACTION (2). PURCHASE OF EQUIPMENT FOR CASH Soft byte
purchases computer equipment for $7,000 cash. This transaction results in an
equal increase and decrease in total assets, though the composition of assets
changes.

16. TRANSACTION (3). PURCHASE OF SUPPLIES ON CREDIT Soft byte
purchases for $1,600 from Mobile Solutions headsets and other computer
accessories expected to last several months. Mobile Solutions agrees to allow soft
byte to pay this bill in October.

17. TRANSACTION (4). SERVICES PERFORMED FOR CASH Soft byte receives
$1,200 cash from customers for app development services it has performed. This
transaction represents Soft byte’s principal revenue-producing activity. Recall that
revenue increases owner’s equity.
TRANSACTION (5). PURCHASE OFADVERTISING ON CREDIT Soft byte
receives a bill for $250 from the Daily News for advertising on its online website but
postpones payment until a later date. This transaction results in an increase in
liabilities and a decrease in owner’s equity.

18. TRANSACTION (6). SERVICES PERFORMED FOR CASH AND CREDIT
Soft byte performs $app development services for customers. The company
receives cash of $1,500 from customers, and it bills the balance of $2,000 on
account. This transaction results in an equal increase in assets and owner’s
equity3,500 of.
TRANSACTION (7). PAYMENT OF EXPENSES Soft byte pays
the following expenses in cash for September: office rent $600,
salaries and wages of employees $900, and utilities $200. These
payments result in an equal decrease in assets and owner’s equity

19. TRANSACTION (8). PAYMENT OFACCOUNTS PAYABLE
Soft byte pays its $250 Daily News bill in cash. The company
previously [in Transaction (5)] recorded the bill as an increase in
Accounts Payable and a decrease in owner’s equity.

20. TRANSACTION (9). RECEIPT OF CASH ON ACCOUNT Soft byte
receives $600 in cash from customers who had been billed for services [in
Transaction (6)]. Transaction (9) does not change total assets, but it changes the
composition of those assets.

21. TRANSACTION (10). WITHDRAWAL OF CASH BY OWNER
ALI withdraws $1,300 in cash from the business for his personal use.
This transaction results in an equal decrease in assets and owner’s
equity.