Financial Accounting: In an Economic Context

BUSINESS TRANSACTIONS, THE ACCOUNTING EQUATION, AND THE FINANCIAL STATEMENTS

Companies conduct operations by exchanging assets and liabilities with other entities (e.g., individuals and businesses). These economic events are referred to as business transactions. Exchanging cash for a piece of equipment, for example, is a transaction that represents the purchase of equipment. Borrowing money is a transaction in which a promise to pay in the future (i.e., note payable) is exchanged for cash. The sale of a service on account is a transaction in which the service is exchanged for a receivable. In each of these exchanges, and in all business transactions, something is received and something is given up. These receipts and disbursements affect the financial condition of a company in a way that always maintains the equality of the fundamental accounting equation. That is, each business transaction is recorded in the books so that the dollar values of a company's assets always equal the dollar values of its liabilities and shareholders' equity.

Transactions and the Accounting Equation

The six transactions described here were entered into by Joe's Landscaping Service during 2011, its first year of operations. Figure 4–1 shows how each transaction affects the accounting equation. Study it carefully and read the following discussion of each transaction.

FIGURE 4-1 Business transactions and the accounting equation

TRANSACTION (1). Joe, the owner of the company, contributes $10,000. This dollar ...