STOCKBYTE/GETTY IMAGES - Amazon S31+pages.pdfTechKnow Consulting will own items such as cash and supplies that will be used to conduct daily operations. Anything of value that is owned

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3. Classify accounts as assets, liabilities, or owner’s equity and demonstrate their relationships in the accounting equation.

4. Analyze how transactions affect accounts in an accounting equation.

After studying Chapter 1, you will be able to:

1. Define accounting terms related to starting a ser-vice business organized as a proprietorship and to changes that affect the accounting equation.

2. Identify accounting concepts and practices related to starting a service business organized as a proprietorship and to changes that affect the accounting equation.

C H A P T E R 1 Starting a Proprietorship: Changes That Affect the Accounting Equation

O B J E C T I V E S

K E Y T E R M S

• accounting• accounting system• accounting records• financial statements• service business• proprietorship• asset• equities

• liability• owner’s equity• accounting equation• ethics• business ethics• transaction• account

• account title• account balance• capital• revenue• sale on account• expense • withdrawals

www.C21accounting.comPoint Your Browser( )

4

Small Business AdministrationGo to the homepage for the

Small Business Administration,

a government organization

designed to help small busi-

nesses in the United States.

Search the site for advice

about starting a business. Use

the link www.sba.gov, or do a

search for the Small Business

Administration if the link is no

longer accurate.

Instructions

1. List at least five aids

that the Small Business

Administration site pro-

vides to help a person

start a business.

2. Briefly explain which aid

you feel is most helpful.

A C C O U N T I N G I N T H E R E A L W O R L D

I N T E R N E T A C T I V I T Y

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Gold’s Gym

Gold’s Gym and the Importance of LocationAre you ready for a good workout? With so many labor-saving devices avail-

able today, many people look to fitness facilities for their daily physical

exercise. For a fee, a member can make use of a variety of cardiovascular

machines, weightlifting/resistance equipment, free weights, and indoor

tracks. Many facilities offer classes and personal trainers. You can even shop

for specialty food and workout clothing.

Gold’s Gym is a franchise operation, meaning that individuals or groups

buy the right to open and operate a Gold’s Gym. The first Gold’s Gym opened

in 1965 in Venice, California. Since then, more than

650 Gold’s Gyms have opened in the United

States and in 23 countries around the

world.

When considering the pos-

sibility of opening a new

Gold’s Gym, there are many

decisions that have to be

made. These decisions

include where to locate

the gym, how big the

facility should be, what

equipment to include,

and how to let people

know about the new

facility.

Critical Thinking

1. Why is the location of a business important to the success of that

business?

2. What things would you consider when deciding where to locate

a business such as Gold’s Gym?

Source: www.goldsgym.com

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L E S S O N

1-1The Accounting Equation

Planning, recording, analyzing, and interpreting finan-cial information is called accounting. A planned process for providing financial information that will be useful to management is called an accounting system. Organized summaries of a business’s financial activities are called accounting records. Accounting is the language of business. Many individ-uals in a business complete accounting forms and prepare accounting reports. Owners, managers, and accounting personnel use their knowledge of accounting to under-stand the information provided in the accounting reports. Regardless of their responsibilities within an organization, individuals can perform their jobs more efficiently if they know the language of business—accounting. Suppliers that are considering extending credit to a business and institutions that are considering extend-

T H E B U S I N E S S T E C H K N O W C O N S U LT I N G

A business that performs an activity for a fee is called a service business. Kim Park decided to start her own busi-ness, helping set up and troubleshoot computer networks. A business owned by one person is called a proprietorship. A proprietorship is also referred to as a sole proprietorship. Kim named her new proprietorship “TechKnow Consult-ing.” TechKnow Consulting will rent office space and the equipment needed to troubleshoot network problems. Since TechKnow Consulting is a new business, Kim must design the accounting system that will be used to keep TechKnow Consulting’s accounting records. Kim

must be careful to keep these accounting records separate from her own personal financial records. For example, Kim owns a house and a personal car. TechKnow Con-sulting’s financial records must not include information about Kim’s house, car, or other personal belongings. Kim must use one checking account for her personal expenses and another checking account for TechKnow Consulting. The accounting concept Business Entity is applied when a business’s financial information is recorded and reported separately from the owner’s personal financial informa-tion. [CONCEPT: Business Entity]

W H AT I S A C C O U N T I N G ?

ing loans to a business are also interested in a business’s financial activities. Financial reports that summarize the financial condition and operations of a business are called financial statements. Business owners and managers also use financial statements to make business decisions. Inaccurate accounting records often contribute to business failure and bankruptcy. Failure to understand accounting information can result in poor business deci-sions for both businesses and nonprofit organizations. Understanding accounting helps managers and owners make better business decisions. In addition, nearly everyone in the United States earns money and must submit income tax reports to the federal and state governments. Everyone must plan ways to keep spending within available income in both their personal and business lives.

6 Chapter 1 Starting a Proprietorship: Changes That Affect the Accounting Equation

Accounting concepts are described throughout this textbook

when an application of a concept first occurs. When addi-

tional applications occur, a concept reference, such as [CON-

CEPT: Business Entity], indicates an application of a specific

accounting concept. A brief description of each accounting

concept used in this text is also provided on the Century 21 Accounting web site at www.C21accounting.com.

After completing a computer networking program at a local community college, Kim decided to start her own business so she would have more control over her daily schedule. After only two months, she has made all the arrangements and is ready to begin. Kim enjoys both helping schools, businesses, and indi-viduals set up a computer network and troubleshooting a network that is not working properly. She also enjoys being her own boss. She gets satisfaction from keeping her own accounting records and seeing that she is making money every month.

A proprietorship is a business owned and controlled by

one person. The advantages of a proprietorship include:

• Ease of formation.

• Total control by the owner.

• Profits that are not shared.

However, there are some disadvantages of organizing a

proprietorship:

• Limited resources. The owner is the only person who

can invest cash and other assets in the business.

• Unlimited liability. The owner is totally responsible for

the liabilities of the business. Personal assets, such as

a car, can be claimed by creditors to pay the business’s

liabilities.

• Limited expertise. Limited time, energy, and experience

can be put into the business by the owner.

• Limited life. A proprietorship must be dissolved when

the owner dies or decides to stop doing business.

• Obligation to follow the laws of both the federal govern-

ment and the state and city in which the business is

formed. Most cities and states have few, if any, legal

procedures to follow. Once any legal requirements are

met, the proprietorship can begin business. Should

the owner decide to dissolve

the proprietorship, he or

she merely needs to

stop doing business.

Noncash assets

can be sold, with

the cash used

to pay any

outstanding

liabilities.

Critical Thinking

1. Why do you

think more busi-

nesses are organized

as proprietorships than

any other form of business

organization?

2. What kinds of people do you think would

be most successful as owners of a proprietorship?

Forming and Di s so lving a Propr ie tor ship

B U S I N E S S S T R U C T U R E S

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The Accounting Equation Lesson 1-1 7

Assets

Left side amount$0

Liabilities � Owner’s Equity�

Right side amounts$0 $0��

T H E A C C O U N T I N G E Q U AT I O N

TechKnow Consulting will own items such as cash and supplies that will be used to conduct daily operations. Anything of value that is owned is called an asset. Assets have value because they can be used either to acquire other assets or to operate a business. For example, TechKnow Consulting will use cash to buy supplies for the business. TechKnow Consulting will then use the asset—supplies—in the operation of the computer consulting business. Financial rights to the assets of a business are called equities. A business has two types of equities: (1) Equity of those to whom money is owed. For example, TechKnow Consulting may buy some supplies and agree to pay for the supplies at a later date. The business from whom sup-plies are bought will have a right to some of TechKnow’s assets until TechKnow pays for the supplies. An amount owed by a business is called a liability. (2) Equity of the

owner. Kim will own TechKnow Consulting and invest in the assets of the business. Therefore, she will have a right to decide how the assets will be used. The amount remain-ing after the value of all liabilities is subtracted from the value of all assets is called owner’s equity. The relationship among assets, liabilities, and owner’s equity can be written as an equation. An equation show-ing the relationship among assets, liabilities, and owner’s equity is called the accounting equation. The accounting equation is most often stated as:

Assets � Liabilities � Owner’s Equity

The accounting equation must be in balance. The total of the amounts on the left side must always equal the total of the amounts on the right side. Before a business starts, its accounting equation would show all zeros.

Entering the 21st century, Enron, World-

Com, and Andersen were three of the

most celebrated names in corpo-

rate America. But the actions of

a few individuals forced finan-

cial mammoths Enron and

WorldCom into bankruptcy.

Andersen, once one of the

prestigious “Big 5” account-

ing firms, was forced out of

business. These accounting

scandals caused hundreds of

thousands of employees to lose

their jobs and millions of individu-

als to lose billions of dollars in invest-

ment and retirement accounts. The

scandals rocked the public’s confidence in

the accounting profession and the stock markets.

The principles of right and wrong that guide an individ-

ual in making decisions are called ethics. The use of ethics

in making business decisions is called business ethics.

Making ethical business decisions is a skill you can learn.

Each chapter of this textbook contains a feature on busi-

ness ethics. In Part 1, you will explore a model that guides

your evaluation of business decisions. In later chapters,

you will apply that model to make ethical business deci-

sions. You will also be exposed to sources that will enable

you to continue learning about business ethics long after

you have completed this accounting course.

InstructionsObtain an article that describes an accounting scandal

such as Enron, WorldCom, Adelphia, Healthcorp South, or

Parmalat. Write a one-paragraph summary that describes

what happened and the individuals involved.

Account ing Scandal s Rock the Financ ia l World

C H A R A C T E R C O U N T S

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E n d o f L e s s o n

REVIEWT E R M S R E V I E W

accounting

accounting system

accounting records

financial statements

service business

proprietorship

asset

equities

liability

owner’s equity

accounting equation

ethics

business ethics

Completing the accounting equation

Write the answers to the following problem in the Working Papers. Your instructor will guide you through the following example.

1. For each line, fill in the missing amount to complete the accounting equation.


? 3,000 8,000

10,000 ? 6,000

63,000 35,000 ?

Completing the accounting equation

Write the answers to the following problem in the Working Papers. Work this problem independently.

1. For each line, fill in the missing amount to complete the accounting equation.


30,000 ? 13,000

? 60,000 20,000

51,000 25,000 ?

O N Y O U R O W N 1 1

1. What is accounting?

2. Give two examples of service businesses.

3. What is a proprietorship?

4. State the accounting equation.

A U D I T Y O U R U N D E R S T A N D I N G

W O R K T O G E T H E R 1 1

The Accounting Equation Lesson 1-1 9

L E S S O N

1-2

Business activities change the amounts in the accounting equation. A business activity that changes assets, liabilities, or owner’s equity is called a transaction. For example, a business that pays cash for supplies is engaging in a trans-action. After each transaction, the accounting equation must remain in balance. The accounting concept Unit of Measurement is applied when business transactions are stated in numbers that have common values—that is, using a common unit of measurement. [CONCEPT: Unit of Measurement] For example, in the United States, business transactions are recorded in dollars. The unit of measurement concept is followed so that the financial reports of businesses can be clearly stated and understood in numbers that have com-parable values.

Received Cash Investment from Owner Ms. Park uses $5,000.00 of her own money to invest in TechKnow Consulting. TechKnow Consulting should be concerned only with the effect of this transaction on TechKnow Consulting’s records. The business should not be concerned about Ms. Park’s personal records. [CON-CEPT: Business Entity]

Transaction 1 August 1. Received cash from owner as an investment, $5,000.00.

How Business Activities Change the Accounting Equation

R E C E I V I N G C A S H

A record summarizing all the information pertain-ing to a single item in the accounting equation is called an account. The name given to an account is called an account title. Each part of the accounting equation con-sists of one or more accounts. In the accounting equation shown above, the asset account, Cash, is increased by $5,000.00, the amount of cash received by the business. This increase is on the left side of the accounting equation. The amount in an account is called the account balance. Before the owner’s investment, the account balance of Cash was zero. After the owner’s investment, the account balance of Cash is $5,000.00. The account used to summarize the owner’s equity in a business is called capital. The capital account is an owner’s equity account. In the accounting equation shown above, the owner’s equity account, Kim Park, Capital, is increased by $5,000.00. This increase is on the right side of the accounting equation. Before the owner’s investment, the account balance of Kim Park, Capital was zero. After the owner’s investment, the account balance of Kim Park, Capi-tal is $5,000.00. The accounting equation has changed as a result of the receipt of cash. However, both sides of the equation are changed by the same amount. The $5,000.00 increase on the left side of the equation equals the $5,000.00 increase on the right side of the equation. Therefore, the account-ing equation is still in balance.

Assets Liabilities Owner’s Equity� �

Kim Park,Capital

$0

$0

�Cash

$0

�5,000

$5,000

Beginning BalancesReceived cash from owner as an investment

New Balances

$0

�5,000

$5,000


P AY I N G C A S H

TechKnow Consulting pays cash for supplies and insurance.

Paid Cash for SuppliesTechKnow Consulting needs supplies to operate the busi-ness. Kim Park uses some of TechKnow Consulting’s cash to buy supplies.

Transaction 2 August 3. Paid cash for supplies, $275.00.

In this transaction, two asset accounts are changed. One asset, cash, has been exchanged for another asset, supplies. The asset account, Cash, is decreased by $275.00, the amount of cash paid out. This decrease is on the left side of the accounting equation. The asset account, Supplies, is increased by $275.00, the amount of supplies bought. This increase is also on the left side of the accounting equation. For this transaction, two assets are changed. There-fore, the two changes are both on the left side of the accounting equation. When changes are made on only one side of the accounting equation, the equation must still be in balance. Therefore, if one account is increased, another account on the same side of the equation must be decreased. After this transaction, the new account balance of Cash is $4,725.00. The new account balance of Sup-plies is $275.00. The sum of the amounts on the left side is $5,000.00 (Cash, $4,725.00 + Supplies, $275.00). The amount on the right side is also $5,000.00. Therefore, the accounting equation is still in balance.

Paid Cash for InsuranceInsurance premiums must be paid in advance. For exam-ple, TechKnow Consulting pays a $1,200.00 insurance premium for future insurance coverage.

Transaction 3 August 4. Paid cash for insurance, $1,200.00.

In return for this payment, TechKnow Consulting is entitled to insurance coverage for the length of the policy. The insurance coverage is something of value owned by TechKnow Consulting. Therefore, the insurance cover-age is an asset. Because insurance premiums are paid in advance, or prepaid, the premiums are recorded in an asset account titled Prepaid Insurance. In this transaction, two assets are changed. One asset, cash, has been exchanged for another asset, prepaid insur-ance. The asset account, Cash, is decreased by $1,200.00, the amount of cash paid out. The asset account, Prepaid Insurance, is increased by $1,200.00, the amount of insur-ance bought. After this transaction, the new account balance of Cash is $3,525.00. The new account balance of Prepaid Insur-ance is $1,200.00. The sum of the amounts on the left side is $5,000.00 (Cash, $3,525.00 � Supplies, $275.00 � Prepaid Insurance, $1,200.00). The amount on the right side is also $5,000.00. Therefore, the accounting equation is still in balance.


Kim Park,Capital

$0

$0

Supplies �Cash �

BalancesPaid cash for insurance

New Balances

$4,725�1,200

$3,525

$275

$275

$5,000

$5,000

PrepaidInsurance

$0�1,200

$1,200

�

$0BalancesPaid cash for supplies

$5,000�275

$0 �275

$5,000$0

How Business Activities Change the Accounting Equation Lesson 1-2 11

T R A N S A C T I O N S O N A C C O U N T

Bought Supplies on AccountTechKnow Consulting needs to buy additional supplies. The supplies are obtained from Supply Depot, and Tech-Know arranges to pay for them at the end of the month. It is a common business practice to buy items and pay for them at a future date. Another way to state this activity is to say that these items are bought on account.

Transaction 4 August 7. Bought supplies on account from Supply Depot, $500.00.

In this transaction, one asset and one liability are changed. The asset account, Supplies, is increased by $500.00, the amount of supplies bought. Supply Depot will have a claim against some of TechKnow Consulting’s assets until TechKnow Consulting pays for the supplies bought. Therefore, Accounts Payable—Supply Depot is a liability account. The liability account, Accounts Pay-able—Supply Depot, is increased by $500.00, the amount owed for the supplies. After this transaction, the new account balance of Sup-plies is $775.00. The new account balance of Accounts Payable—Supply Depot is $500.00. The sum of the amounts on the left side is $5,500.00 (Cash, $3,525.00 � Supplies, $775.00 � Prepaid Insurance, $1,200.00). The sum of the amounts on the right side is also $5,500.00 (Accounts Payable—Supply Depot, $500.00 � Kim Park, Capital, $5,000.00). Therefore, the accounting equation is still in balance.

Paid Cash on AccountSince TechKnow Consulting is a new business, Supply Depot has not done business with TechKnow Consult-ing before. Supply Depot allows TechKnow Consulting to buy supplies on account but requires TechKnow Consult-ing to send a check for $300.00 immediately. TechKnow Consulting will pay the remaining portion of this liability at a later date.

Transaction 5 August 11. Paid cash on account to Supply Depot, $300.00.

In this transaction, one asset and one liability are changed. The asset account, Cash, is decreased by $300.00, the amount of cash paid out. After this payment, Tech-Know Consulting owes less money to Supply Depot. Therefore, the liability account, Accounts Payable—Sup-ply Depot, is decreased by $300.00, the amount paid on account. After this transaction, the new account balance of Cashis $3,225.00. The new account balance of Accounts Pay-able—Supply Depot is $200.00. The sum of the amounts

on the left side is $5,200.00 (Cash, $3,225.00 � Supplies, $775.00 � Prepaid Insurance,

$1,200.00). The sum of the amounts on the right side is also $5,200.00

(Accounts Payable—Supply Depot, $200.00 � Kim Park, Capital, $5,000.00). Therefore, the account-ing equation is still in balance.


Kim Park,CapitalSupplies �Cash �

BalancesBought supplies on account

New Balances

$3,525

$3,525

$275�500

$775

$5,000

$5,000

PrepaidInsurance

$1,200

$1,200

�

Accts. Pay.—SupplyDepot

$0�500

$500

�

Paid cash on account

New Balances

�300

$3,225 $775 $5,000$1,200

�300

$200

R E M E M B E R

The left side of the accounting equation (assets) must always equal the right side (liabilities

plus owner’s equity).



REVIEW1. What must be done if a transaction increases the left side of the

accounting equation?

2. How can a transaction affect only one side of the accounting equation?

3. To what does the phrase on account refer?



transaction

account

account title

account balance

capital

Determining how transactions change an accounting equation


1. For each transaction, place a plus (�) in the appropriate column if the classification is increased. Place a minus (�) in the appropriate column if the classification is decreased.

Transactions:

1. Bought supplies on account. 3. Paid cash for insurance.

2. Received cash from owner as an investment. 4. Paid cash on account.

Owner’s EquityAssets

1.

LiabilitiesTrans.

No.� �




1. For each transaction, place a plus (�) in the appropriate column if the classification is increased. Place a minus (�) in the appropriate column if the classification is decreased.

Transactions:

1. Received cash from owner as an investment. 4. Paid cash for insurance.

2. Bought supplies on account. 5. Paid cash on account.

3. Paid cash for supplies.

Owner’s EquityAssets

1.

LiabilitiesTrans.

No.� �

T E R M S R E V I E W

How Business Activities Change the Accounting Equation Lesson 1-2 13

L E S S O N

1-3

Received Cash from Sales A transaction for the sale of goods or services results in an increase in owner’s equity. An increase in owner’s equity resulting from the operation of a business is called revenue. When cash is received from a sale, the total amount of both assets and owner’s equity is increased.

Transaction 6 August 12. Received cash from sales, $295.00.

When TechKnow Consulting receives cash for services performed, the asset account, Cash, is increased by the amount of cash received, $295.00. This increase is on the left side of the equation. The owner’s equity account, Kim Park, Capital, is also increased by $295.00. This increase is on the right side of the equation. After this transaction is recorded, the equation is still in balance. In this chapter, three different kinds of transactions that affect owner’s equity are described. Therefore, a descrip-tion of the transaction is shown in parentheses to the right of the amount in the accounting equation.

How Transactions Change Owner’s Equity in an Accounting Equation

R E V E N U E T R A N S A C T I O N S

Sold Services on AccountA sale for which cash will be received at a later date is called a sale on account, or a charge sale. TechKnow Con-sulting contracts with a school and an Internet cafe to provide consulting services for payment at a later date. All other customers must pay cash at the time of the service. Regardless of when payment is made, the revenue should be recorded at the time of a sale. The accounting concept Realization of Revenue is applied when revenue is recorded at the time goods or services are sold. [CONCEPT: Real-ization of Revenue]

Transaction 7 August 12. Sold services on account to Oakdale School, $350.00.

When TechKnow Consulting sells services on account, the asset account, Accounts Receivable—Oakdale School, is increased by $350.00, the amount of cash that will be received. This increase is on the left side of the equation. The owner’s equity account, Kim Park, Capital, is also increased by $350.00 on the right side of the equation. The equa-tion is still in balance.



BalancesReceived cash from sales

New BalancesSold services on account

New Balances

Total of right side:$200 � $5,645 � $5,845

Total of left side:$3,520 � $350 � $775 � $1,200 � $5,845

$3,225�295

$3,520

$3,520

$775

$775

$775

$5,000�295

$5,295�350

$5,645

PrepaidInsurance

$1,200

$1,200

$1,200

�


$200

$200

$200

�

(revenue)

Accts. Rec.— Oakdale

School �

$0

$0�350

$350

(revenue)


E X P E N S E T R A N S A C T I O N S

A transaction to pay for goods or services needed to oper-ate a business results in a decrease in owner’s equity. A decrease in owner’s equity resulting from the operation of a business is called an expense. When cash is paid for expenses, the business has less cash. Therefore, the asset account, Cash, is decreased. The owner’s equity account, Kim Park, Capital, is also decreased by the same amount.

Paid Cash for Rent

Transaction 8 August 12. Paid cash for rent, $300.00.

The asset account, Cash, is decreased by $300.00, the amount of cash paid out. This decrease is on the left side of the equation. The owner’s equity account, Kim Park, Capital, is also decreased by $300.00. This decrease is on the right side of the equation. After this transaction is recorded, the equation is still in balance.



BalancesPaid cash for rent

New BalancesPaid cash for telephone bill

New Balances



$3,520�300

$3,220�40

$3,180

$775

$775

$775

$5,645�300

$5,345�40

$5,305

PrepaidInsurance

$1,200

$1,200

$1,200

�


$200

$200

$200

�

(expense)

Accts. Rec.—OakdaleSchool �

$350

$350

$350

(expense)

PHOTODISC/GETTY IMAGES

Paid Cash for Telephone Bill

Transaction 9 August 12. Paid cash for telephone bill, $40.00.

The asset account, Cash, is decreased by $40.00, the amount of cash paid out. This decrease is on the left side of the equation. The owner’s equity account, Kim Park, Capital, is also decreased by $40.00. This decrease is on the right side of the equation. After this transaction is recorded, the equation is still in balance. Other expense transactions might be for advertising, equipment rental or repairs, charitable contributions, and other miscellaneous items. All expense transactions affect the accounting equation in the same way as in Transac-tions 8 and 9.

How Transactions Change Owner’s Equity in an Accounting Equation Lesson 1-3 15



BalancesReceived cash on account

New BalancesPaid cash to owner for personal use

New Balances



$3,180�200

$3,380

�125

$3,255

$775

$775

$775

$5,305

$5,305

�125

$5,180

PrepaidInsurance

$1,200

$1,200

$1,200

�


$200

$200

$200

�

Accts. Rec.—Oakdale

School �

$350�200

$150

$150

(withdrawal)

O T H E R C A S H T R A N S A C T I O N S

Received Cash on AccountWhen a business receives cash from a customer for a prior sale, the transaction increases the cash account balance and decreases the accounts receivable balance.

Transaction 10 August 18. Received cash on account from Oakdale School, $200.00.

The asset account, Cash, is increased by $200.00. This increase is on the left side of the equation. The asset account, Accounts Receivable—Oakdale School, is decreased by $200.00. This decrease is also on the left side of the equation. After this transaction is recorded, the equation is still in balance.

Paid Cash to Owner for Personal UseAssets taken out of a business for the owner’s personal use are called withdrawals. A withdrawal decreases owner’s equity. Although an owner may withdraw any kind of asset, usually an owner withdraws cash. The withdrawal decreases the account balance of the withdrawn asset, such as Cash.

Transaction 11 August 18. Paid cash to owner for personal use, $125.00.

The asset account, Cash, is decreased by $125.00. This decrease is on the left side of the accounting equation. The owner’s equity account, Kim Park, Capital, is also decreased by $125.00. This decrease is on the right side of the equa-tion. After this transaction is recorded, the equation is still in balance.

A decrease in owner’s equity because of a withdrawal is not

a result of the normal operations of a business. Therefore, a

withdrawal is not considered an expense.

Summary of Changes in Owner’s EquityImmediately after recording the beginning investment used to start TechKnow Consulting, the total owner’s equity was $5,000.00, which represented the investment by the owner, Kim Park. Since that initial investment, five additional transactions that changed owner’s equity were recorded in the accounting equation. These transactions increased owner’s equity by $180.00, from $5,000.00 to $5,180.00. Transaction 10, cash received on account, is not listed because it affects two accounts that are both on the left side of the account-ing equation.

Transaction Kind of Change in Number Transaction Owner’s Equity 6 Revenue (cash) �295.00 7 Revenue (on account) �350.00 8 Expense (rent) �300.00 9 Expense (telephone) � 40.00 11 Withdrawal �125.00 Net change in owner’s equity �180.00



REVIEW

1. How is owner’s equity affected when cash is received from sales?

2. How is owner’s equity affected when services are sold on account?

3. How is owner’s equity affected when cash is paid for expenses?

revenue

sale on account

expense

withdrawals





1. Place a plus (�) in the appropriate column if the account is increased. Place a minus (�) in the appropriate column if the account is decreased.

Transactions:

1. Sold services on account to Navarro Company. 4. Paid cash to owner for personal use.

2. Received cash from sales. 5. Paid cash for rent.

3. Received cash on account from Navarro Company.



1. Place a plus (�) in the appropriate column if the account is increased. Place a minus (�) in the appropriate column if the account is decreased.

Transactions:

1. Received cash from sales. 4. Received cash on account from Bowman Company.

2. Sold services on account to Bowman Company. 5. Paid cash to owner for personal use.

3. Paid cash for telephone bill.

Assets Liabilities

Accts. Pay.—

Maxwell Co.

1.

Owner’s Equity

Susan Sanders,

CapitalTrans.

No.Cash Supplies

Prepaid

Insurance

�

�

�

�� Accts. Rec.—

Bowman Co.�

Assets Liabilities

Accts. Pay.—

Barrett Co.

1.

Owner’s Equity

Vincent Orr,

CapitalTrans.

No.Cash Supplies

Prepaid

Insurance

�

�

�

�� Accts. Rec.—

Navarro Co.�


T E R M S R E V I E W

How Transactions Change Owner’s Equity in an Accounting Equation Lesson 1-3 17

After completing this chapter, you can:

1. Define accounting terms related to starting a service business organized as a proprietor-ship and to changes that affect the accounting equation.

2. Identify accounting concepts and practices related to starting a service business organized as a proprietorship and to changes that affect the accounting equation.

3. Classify accounts as assets, liabilities, or owner’s equity and demonstrate their relationships in the accounting equation.

4. Analyze how transactions affect accounts in an accounting equation.

S U M M A R Y

The standards and rules that accountants fol-

low while recording and reporting finan-

cial activities are commonly referred to as

generally accepted accounting principles,

or GAAP. These rules have not been devel-

oped by any one group of rule makers but

have instead evolved over time and from

many sources.

By law, the Securities and Exchange Com-

mission (SEC) has the authority to establish GAAP.

The SEC, however, has allowed a series of private organi-

zations to determine GAAP. Currently, the organization

that has the authority to set accounting standards is the

Financial Accounting Standards Board (FASB), which was

established in 1973.

The standard-setting process includes getting input

and feedback from many sources. FASB listens to this feed-

back and considers all sides of each issue.

Why Is GAAP Necessary?Users of financial statements rely on the information those

statements contain. If the preparers of financial state-

ments were allowed to follow any measure-

ment, recording, and reporting rules, the

users of the statements would have no way

to determine if the financial statements

present fairly the financial position of the

business.

By requiring the financial statement

preparers to consistently follow certain stan-

dards and rules—such as GAAP—the users are

able to compare the financial statements of several

companies and to track the results of one company over

several time periods.

Discussion: Why would a group of people disagree

with a proposed accounting standard?

Research: Using your local library or the Internet, find

additional information about the FASB. Write a one-page

report on your findings.

E X P L O R E A C C O U N T I N G

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Go Beyond the Book( )For more information go towww.C21accounting.com

11 APPLICATION PROBLEMCompleting the accounting equation

Instructions:For each line, fill in the missing amount to complete the accounting equation. Use the form in your Working Papers to complete this problem.

Assets � Liabilities � Owner’s Equity 95,000 51,000 ? ? 44,000 20,000 4,000 ? 2,500138,000 70,000 ? 19,000 ? 11,000 ? 4,000 12,000 35,000 13,000 ? ? 120,000 49,000 8,000 ? 3,200 86,000 48,000 ? 12,000 ? 7,000 ? 8,000 22,000 47,000 24,000 ? ? 29,000 13,000 57,000 ? 36,000125,000 69,000 ? 11,000 ? 6,000 ? 2,000 3,300

12 APPLICATION PROBLEMDetermining how transactions change an accounting equation

Calvin Parish is starting Parish Repair Shop, a small service business. Parish Repair Shop uses the accounts shown in the following accounting equation. Use the form in your Working Papers to complete this problem.

Assets

Accts. Pay.—

Riverland

Company

Beg. Bal.1.

New Bal.2.

0�3,000

3,000

Owner’s Equity

Calvin Parish,

Capital

Trans.

No. Cash SuppliesPrepaid

Insurance

�

�

�

��

0

0

0

0

0

0

0�3,000

3,000

Accts. Pay.—

Five Star

Supply

0

0

Liabilities

�

Starting a Proprietorship: Changes That Affect the Accounting Equation Chapter 1 19

Transactions:

1. Received cash from owner as an investment, $3,000.00.

2. Paid cash for insurance, $1,600.00.

3. Bought supplies on account from Five Star Supply, $700.00.

4. Bought supplies on account from Riverland Company, $300.00.

5. Paid cash on account to Five Star Supply, $700.00.

6. Paid cash on account to Riverland Company, $200.00.

7. Paid cash for supplies, $100.00.

8. Received cash from owner as an investment, $1,500.00.

Instructions:For each transaction, complete the following. Transaction 1 is given as an example.

a. Analyze the transaction to determine which accounts in the accounting equation are affected.

b. Write the amount in the appropriate columns using a plus (�) if the account increases or a minus (�) if the account decreases.

c. Calculate the new balance for each account in the accounting equation.

d. Before going on to the next transaction, determine that the accounting equation is still in balance.


13 APPLICATION PROBLEMDetermining how revenue, expense, and withdrawal transactions change an accounting equation

Peter Smith operates a service business called Peter’s Service Company. Peter’s Service Company uses the accounts shown in the following accounting equation. Use the form in your Working Papers to complete this problem.

Transactions:

1. Paid cash for rent, $300.00.

2. Paid cash to owner for personal use, $150.00.

3. Received cash from sales, $800.00.

4. Paid cash for equipment repairs, $100.00.

5. Sold services on account to Lisa Lee, $400.00.

6. Received cash from sales, $650.00.

7. Paid cash for charitable contributions, $35.00.

8. Received cash on account from Lisa Lee, $300.00.

Assets Liabilities

Accts. Pay.—

Kline Co.

Beg. Bal.1.

New Bal.2.

625�300

325

Owner’s Equity

Peter Smith,

Capital

Trans.

No. Cash SuppliesPrepaid

Insurance

�

�

�

��

375

375

300

300

200

200

1,100�300

800

(expense)

Accts. Rec.—

Lisa Lee

0

0



b. Write the amount in the appropriate columns, using a plus (�) if the account increases or a minus (�) if the account decreases.

c. For transactions that change owner’s equity, write in parentheses a description of the transaction to the right of the amount.

d. Calculate the new balance for each account in the accounting equation.

e. Before going on to the next transaction, determine that the accounting equation is still in balance.

14 MASTERY PROBLEMDetermining how transactions change an accounting equation

Marion Cassidy operates a service business called Cassidy Company. Cassidy Company uses the accounts shown in the following accounting equation. Use the form in your Working Papers to complete this problem.

Transactions:

1. Paid cash for rent, $400.00. 2. Received cash from owner as an investment, $500.00. 3. Paid cash for telephone bill, $50.00. 4. Received cash from sales, $1,025.00. 5. Bought supplies on account from Delta Company, $450.00. 6. Sold services on account to Ana Santiago, $730.00. 7. Paid cash for advertising, $660.00. 8. Paid cash for supplies, $150.00. 9. Received cash on account from Ana Santiago, $400.00.10. Paid cash on account to Delta Company, $1,500.00.11. Paid cash for one month of insurance, $100.00.12. Received cash from sales, $1,230.00.13. Paid cash to owner for personal use, $1,200.00.







Assets Liabilities

Accts. Pay.—

Delta Co.

Beg. Bal.1.

New Bal.2.

2,300�400

1,900

Owner’s Equity

Marion Cassidy,

Capital

Trans.

No.Cash Supplies

Prepaid

Insurance

�

�

�

��

200

200

100

100

1,800

1,800

800�400

400

(expense)

Accts. Rec.—

Ana

Santiago

0

0


A resume provides a statement of your education, experience, and qualifications for a prospective employer. Your resume should be accurate, honest, and perfect in every respect. It should include all work experience along with the companies and dates of employment. Education, activities, and interests are all important items that should be covered.

Instructions:

Research how to prepare an appropriate resume using the library or the Internet. Then prepare a resume that you could send to a prospective employer.

A P P L I E D C O M M U N I C A T I O N


15 CHALLENGE PROBLEMDetermining how transactions change an accounting equation

Zachary Martin owns Zachary’s Repair Shop. On February 1, Zachary’s Repair Shop’s accounting equation indicated the following account balances. Use the form in your Working Papers to complete this problem.

Transactions:

1. Took $400.00 of supplies for personal use.

2. Had equipment repaired at Kollasch Company and agreed to pay Kollasch Company at a later date, $250.00.

3. Mr. Martin had some personal property, which he sold for $500.00 cash.

4. Paid Kollasch Company $120.00 on account.

Instructions:

1. For each transaction, complete the following.






2. Answer the following questions.

a. Why can the owner of a business withdraw assets from that business for personal use?

b. Why would the owner withdraw assets other than cash?

Assets Liabilities

Accts. Pay.—

Kollasch Co.

Beg. Bal.1.

8,552

Owner’s Equity

Zachary Martin,

Capital

Trans.

No.Cash Supplies

Prepaid

Insurance

�

�

�

��

1,485 615 3,145 9,255

Accts. Rec.—

Mary Lou

Pier

1,748

Case 1

Akira Shinoda starts a new business. Mr. Shinoda uses his personal car in the business with the expectation that later the business can buy a car. All expenses for operating the car, including license plates, gasoline, oil, tune-ups, and new tires, are paid for out of business funds. Is this an acceptable procedure? Explain.

Case 2

At the end of the first day of business, Quick Clean Laundry has the assets and liabilities shown below.

The owner, Anh Vu, wants to know the amount of her equity in Quick Clean Laundry. Determine this amount and explain what this amount represents.

Assets Liabilities

Cash $3,500.00 A/P—Smith Office Supplies $ 750.00

Supplies 950.00 A/P—Super Supplies Company 1,500.00

Prepaid Insurance 1,200.00

C A S E S F O R C R I T I C A L T H I N K I N G

The assets, liabilities, and owner’s equity for three different companies are given in the graph at right.

Analyze the graph to answer the following questions.

1. Which category is largest?

2. Why will assets always be 50% of the total?

G R A P H I N G W O R K S H O P

Selected published financial information for Best Buy Co., Inc., is reproduced in Appendix B. Look at pages B-5 through B-8, where you will find Best Buy’s financial statements. Under the heading on each page, you will see the phrase “$ in millions.” This means that all dollar amounts are rounded to the nearest million. Therefore, an amount such as $174 actually means $174,000,000. Another way to think of this is that you can calculate the actual amount by multiplying the rounded amount by 1,000,000 ($174 � 1,000,000 � $174,000,000).

Not all companies round the amounts in their financial statements to the nearest million. Many companies round to the nearest thousand.

Instructions

1. List the actual amount of Accounts Payable and Revenue for Best Buy for 2007.

2. The financial statements for Barnes & Noble include the phrase “thousands of dollars.” In 2005, the financial state-ments included Accounts Payable, $828,852, and Sales, $5,103,004. List the actual amount of Accounts Payable and Sales.

A N A L Y Z I N G B E S T B U Y ’ S F I N A N C I A L S T A T E M E N T S

12000100008000600040002000

0Arrow Co. Dexter Co. Grand Co.

Assets Equity Liabilities


Accounting

SOFTWARE

As you begin your journey into the exciting world of accounting, it is important that you also experience how today’s businesses use personal computers to record their transactions and prepare financial statements. How are transactions entered onto computer screens? How does the computer keep track of the total of the Cash account? How is the information that is collected reported on financial statements? At the end of every chapter, this feature will introduce you to Peachtree, one of the most widely recognized brands of computer accounting systems. Your teacher may also have you complete selected end-of-chapter prob-lems using Peachtree. You will discover that the knowledge of accounting you learn in this textbook will enable you to understand how Peachtree operates and provides management with the information it needs to make good business decisions. The Peachtree brand was first introduced in 1976, a time when personal computers were just beginning to become available to individuals and businesses. Since then, Peachtree Software has merged with many other soft-ware companies to form Sage Software. With millions of customers in the United States and Canada, Sage Software provides a wide variety of accounting and management software to small and medium-sized businesses.

PEACHTREE ACTIVITY*

1. Access the Sage Software web site at www.sagesoftware.com.

2. Identify the most current versions of Peachtree that are available.

3. Identify what version of Peachtree is available at your school.

A C C O U N T I N G S O F T W A R E


During your study of accounting, your instructor may introduce you to an accounting software program called QuickBooks. Accounting software programs are more efficient and can be much more accurate than com-pleting tasks manually. Many companies require new employees to have some knowledge of accounting software programs. Therefore, learning how to use QuickBooks can make you more employable. QuickBooks accounting software was developed by the Intuit Company, which was founded in 1983. The soft-ware is available in many versions. The version used by a company depends on the tasks that the company wishes to complete electronically. However, all versions of QuickBooks have general items in common. During your study of accounting, you will learn how to manually complete an accounting task. You may then be asked to complete the same task using QuickBooks. It is important to understand the manual tasks before using accounting software so that you can understand what the software is doing. An understanding of accounting also allows you to review the information that is produced electronically and check it for accuracy.

QUICKBOOKS ACTIVITY*

1. Access the Intuit web site at www.quickbooks.intuit.com.

2. Identify the most current versions of QuickBooks that are available.

3. Identify what version of QuickBooks is available at your school.


Electronic spreadsheets are one of the most popular software programs used by accountants. The reason is simple—the row and column structure of an electronic spreadsheet resembles the journal paper used by accoun-tants for decades, some say even centuries. It is not surprising, then, that publications read by accountants frequently contain articles about electronic spreadsheets. The Journal of Accountancy, published by the American Institute of Certified Public Accountants, is sent to over 300,000 accountants. The Journal regularly publishes articles that provide detailed instructions for using electronic spreadsheet features. More importantly, the articles provide examples of accounting applications of the features. As you study accounting in this course, you will have the opportunity to complete several problems on an elec-tronic spreadsheet. Along the way, you will learn a variety of helpful features. In some cases, you will be able to try out these features in your exercises.

EXCEL ACTIVITY*

1. Identify what electronic spreadsheet version is available at your school.

2. Access the Journal of Accountancy online at www.aicpa.org/pubs/jofa/joahome.htm. Perform a search for the name of your electronic spreadsheet.

3. Select one of the articles in the search results. Write a short summary of the feature described in the article.


Automated Accounting was developed by Warren Allen and Dale Klooster in the late 1970s for use in their account-ing classrooms. They were pioneers in the use of computer technology in the classroom. The software includes a complete accounting system, with modules for specialized activities such as bank statement reconciliation, plant assets, inventory, and payroll. The software was so comprehensive and easy to use that some small businesses also used the software for their business needs. South-Western acquired the software in the early 1980s as a companion to its Century 21 Accounting textbooks. Automated Accounting has been revised and updated continuously since then.

AUTOMATED ACCOUNTING ACTIVITY*

1. Consider the problems you have worked in Chapter 1. If you used a computerized accounting system to work the problems, what kinds of errors would the computerized accounting system prevent?

2. For the problems in Chapter 1, what kinds of errors would not be prevented by using a computerized accounting system?


* C O M P U T E R S A F E T Y A N D H E A LT H B A S I C S

There are some basic safety and health precautions for using computer equipment. Read the safety and health tips on the Century 21 Accounting web site.


Documents

STOCKBYTE/GETTY IMAGES - Amazon S31+pages.pdfTechKnow Consulting will own items such as cash and supplies that will be used to conduct daily operations. Anything of value that is owned