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In the previous lesson, we have learned the basic accounting equation and have identified its components. But how does it work? Let’s take a look at these examples.

Transaction #1 – Initial Investment

Mr. Sparrow starts a plumbing business which he named Sparrow Pumps on January 1, 2017, with an initial investment of $35,000 in cash.

Analysis:

Cash increased by $35,000

Owner’s Capital increased by $35,000

Using the basic equation, let us take a look at the effects of the transaction.

Equation Analysis:

Transaction #2 – Supplies Purchases

For the business to run properly, Mr. Sparrow purchased some shop supplies for cash, $3,000.

Analysis:

Cash decreased by $3,000

Shop Supplies increased by $3,000

Equation Analysis:

The transaction has resulted to a decrease in cash but was equally replaced by another asset. Therefore, the amount of the asset remains the same and so does the owner’s equity.

Transaction #3 – Acquisition of an Equipment on Credit

Mr. Sparrow then decided to purchase some equipment on credit amounting to $15,000. 

Analysis:

Equipment increased by $15,000

Accounts Payable increased by $15,000

Equation Analysis

Transaction #4 – Revenue

The business rendered services for cash, $1,000

Analysis:

Cash increased by $1,000

Revenue increased by $1,000

Equation Analysis:

Transaction #5 – Expenses

Paid utilities expense of $500.

Analysis:

Cash decreased by $500.

Expense increased by $500.

Equation Analysis:

Transaction #6 – Payment of Accounts

The business paid the previous credit of $15,000 for their equipment.

Analysis:

Cash decreased by $15,000

Accounts Payable decreased by $15,000

Equation Analysis:

Transaction #7 – Performed Services for Cash and Credit

Rendered services worth $3,000. They received $2,000 in cash and billed the customer for $1,000 on account.

Analysis

Cash increased by $2,000

Accounts Receivable increased by $1,000

Revenue increased by $3,000

Equation Analysis

Transaction #8 – Withdrawal by the Owner

For his wife’s birthday, Mr. Sparrow withdraws $5,000 for the Capital.

Analysis:

Cash decreased by $5,000

Owner's Drawing increased by $5,000

Equation Analysis:

Previous Lessons:

• Accounting 101 – The Accounting Process: Identify, Record, And Communicate

• Accounting 101 – Generally Accepted Accounting Principles (GAAP)

• Accounting 101 -- The Basic Accounting Equation

References:

• Accounting Principles 12^th Edition (p.12-14), by J.J. Weygandt, P.D. Kimmel, D.E. Kieso

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