Untitled Lesson

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 Dissolving

a Proprietorship

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

PHOTO: PHOTODISC/GETTY IMAGES

PHOTODISC/GETTY IMAGES

The Accounting Equation

Lesson 1-1

7

Assets

Left side amount

$0

Liabilities � Owner’s Equity

�

Right side amounts
$0

$0

�

�

TH E ACCO U NTI N G E Q UATI 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.

Instructions
Obtain 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.

Accounting Scandals Rock

the Financial World

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

PHOTO: BLEND IMAGES/GETTY IMAGES

8

Chapter 1

Starting a Proprietorship: Changes That Affect the Accounting Equation

E n d o f L e s s o n
REVIEW

T 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.
Assets

�Liabilities

�Owner’s Equity

?

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.
Assets

�Liabilities

�Owner’s Equity

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 EC E IVI 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-
talis $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 Balances
Received cash from owner
as an investment

New Balances

$0

�5,000

$5,000

10

Chapter 1

Starting a Proprietorship: Changes That Affect the Accounting Equation

PAY I N G C A S H

TechKnow Consulting pays cash for supplies and insurance.

Paid Cash for Supplies
TechKnow 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 Insurance
Insurance 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.

Assets

Liabilities

Owner’s Equity

�

�

Kim Park,

Capital

$0

$0

Supplies

�

Cash

�

Balances
Paid cash for insurance

New Balances

$4,725
�1,200

$3,525

$275

$275

$5,000

$5,000

Prepaid
Insurance

$0

�1,200

$1,200

�

$0

Balances
Paid cash for supplies

$5,000
�275

$0

�275

$5,000

$0

How Business Activities Change the Accounting Equation

Lesson 1-2

11

TR AN SAC TI O N S O N ACCO U NT

Bought Supplies on Account
TechKnow 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 Depotis
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 Account
Since 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 Cash

is $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.

Assets

Liabilities

Owner’s Equity

�

�

Kim Park,

Capital

Supplies

�

Cash

�

Balances
Bought supplies on account

New Balances

$3,525

$3,525

$275
�500

$775

$5,000

$5,000

Prepaid
Insurance

$1,200

$1,200

�

Accts. Pay.—

Supply
Depot

$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).

12

Chapter 1

Starting a Proprietorship: Changes That Affect the Accounting Equation

E n d o f L e s s o n
REVIEW

1. 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?

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  2

transaction

account

account title

account balance

capital

Determining how transactions change an 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 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 Equity

Assets

1.

Liabilities
Trans.

No.

�

�

O N Y O U R O W N 1  2

Determining how transactions change an accounting equation

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

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 Equity

Assets

1.

Liabilities
Trans.

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 VE N U E TR AN SAC TI O N S

Sold Services on Account
A 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.

Assets

Liabilities

Owner’s Equity

�

�

Kim Park,

Capital

Supplies

�

Cash �

Balances
Received cash from sales

New Balances
Sold 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

Prepaid
Insurance

$1,200

$1,200

$1,200

�

Accts. Pay.—

Supply
Depot

$200

$200

$200

�

(revenue)

Accts. Rec.—

Oakdale

School

�

$0

$0

�350

$350

(revenue)

14

Chapter 1

Starting a Proprietorship: Changes That Affect the Accounting Equation

E XPE N S E TR AN SAC TI 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.

Assets

Liabilities

Owner’s Equity

�

�

Kim Park,

Capital

Supplies

�

Cash �

Balances
Paid cash for rent

New Balances
Paid cash for telephone bill

New Balances

Total of right side:

$200 � $5,305 � $5,505

Total of left side:

$3,180 � $350 � $775 � $1,200 � $5,505

$3,520
�300

$3,220

�40

$3,180

$775

$775

$775

$5,645
�300

$5,345

�40

$5,305

Prepaid
Insurance

$1,200

$1,200

$1,200

�

Accts. Pay.—

Supply
Depot

$200

$200

$200

�

(expense)

Accts. Rec.—

Oakdale
School

�

$350

$350

$350

(expense)

P

HOTO

DISC/

GETTY

IMA

GES

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

Assets

Liabilities

Owner’s Equity

�

�

Kim Park,

Capital

Supplies

�

Cash �

Balances
Received cash on account

New Balances
Paid cash to owner
for personal use

New Balances

Total of right side:

$200 � $5,180 � $5,380

Total of left side:

$3,255 � $150 � $775 � $1,200 � $5,380

$3,180
�200

$3,380

�125

$3,255

$775

$775

$775

$5,305

$5,305

�125

$5,180

Prepaid
Insurance

$1,200

$1,200

$1,200

�

Accts. Pay.—

Supply
Depot

$200

$200

$200

�

Accts. Rec.—

Oakdale

School

�

$350
�200

$150

$150

(withdrawal)

OTH E R C A S H TR AN SAC TI O N S

Received Cash on Account
When 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 Use
Assets 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 Equity
Immediately 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

16

Chapter 1

Starting a Proprietorship: Changes That Affect the Accounting Equation

E n d o f L e s s o n
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

W O R K T O G E T H E R 1  3

O N Y O U R O W N 1  3

Determining how transactions change an accounting equation

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

Determining how transactions change an accounting equation

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

Capital

Trans.

No.
Cash

Supplies
Prepaid

Insurance

�

�

�

�

�

�
Accts. Rec.—
Bowman Co.�

Assets

Liabilities

Accts. Pay.—

Barrett Co.

1.

Owner’s Equity

Vincent Orr,

Capital

Trans.

No.
Cash

Supplies
Prepaid

Insurance

�

�

�

�

�

�
Accts. Rec.—
Navarro Co.�

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

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

PHOTO: PHOTOGRAPHER’S CHOICE/GETTY IMAGES

What Is GA AP?

18

Chapter 1

Starting a Proprietorship: Changes That Affect the Accounting Equation

Go Beyond the Book
(

)

For more information go to
www.C21accounting.com

11

APPLICATION PROBLEM

Completing 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

?

2,500

138,000

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

?

36,000

125,000

69,000

?

11,000

?

6,000

?

2,000

3,300

12

APPLICATION PROBLEM

Determining 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

Supplies
Prepaid

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.

20

Chapter 1

Starting a Proprietorship: Changes That Affect the Accounting Equation

13

APPLICATION PROBLEM

Determining 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

Supplies
Prepaid
Insurance

�

�

�

�

�

�

�

375

375

300

300

200

200

1,100
�300

800

(expense)

Accts. Rec.—

Lisa Lee

0

0

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. 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.

14

MASTERY PROBLEM

Determining 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.

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. 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.

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

Starting a Proprietorship: Changes That Affect the Accounting Equation

Chapter 1

21

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

22

Chapter 1

Starting a Proprietorship: Changes That Affect the Accounting Equation

15

CHALLENGE PROBLEM

Determining 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.
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. 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.

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

12000
10000
8000
6000
4000
2000

0

Arrow Co.

Dexter Co.

Grand Co.

Assets

Equity

Liabilities

Starting a Proprietorship: Changes That Affect the Accounting Equation

Chapter 1

23

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 WA R E

A C C O U N T I N G S O F T WA 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.

24

Chapter 1

Starting a Proprietorship: Changes That Affect the Accounting Equation

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.

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

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?

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

*COM PUTE R SAFET Y AN D H E ALTH BA S I CS

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.

Starting a Proprietorship: Changes That Affect the Accounting Equation

Chapter 1

25

26

BLEND IMAGES/GETTY IMAGES

4. Analyze how transactions to set up a business

affect accounts.

5. Analyze how transactions affect owner’s equity

accounts.

After studying Chapter 2, you will be able to:

1. Define accounting terms related to analyzing

transactions into debit and credit parts.

2. Identify accounting practices related to analyz-

ing transactions into debit and credit parts.

3. Use T accounts to analyze transactions showing

which accounts are debited or credited for each
transaction.

C H A P T E R 2

Analyzing Transactions
into Debit and
Credit Parts

O B J E C T I V E S

K E Y T E R M S

•T account
•debit

•credit
•normal balance

•chart of accounts

www.C21accounting.com

Point Your Browser
(

)

26

Company Headquarters
Go to the homepage of a com-
pany of your choice.

Instructions
Search the site to find when
the company was started and
where its headquarters (or
home office) is located. This
information is typically found
under one of the following
headings: “About Us,” “Investor
Relations,” “History,” or “Con-
tact Us.”

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

27

©AAA, WWW.AAANEWSROOM.NET, ABOUT AAA, 2004

American Automobile Association (AAA)

Traveling with the American Automobile Association (AAA)
Picture yourself driving on a dark, deserted road. Suddenly your car stalls.
You pull over to the side of the road. What do you do next? If you are a mem-
ber of the American Automobile Association (AAA), you can pick up your cell
phone and call for emergency roadside assistance.

Many people realize the benefits of a membership with the AAA. How-

ever, not many people know that the AAA was instrumental in starting the
nationwide School Safety Patrol program back in 1920. In 1930, the AAA pio-
neered the driver education program still in existence in many high schools.

As early as 1916, the AAA was fighting for federal

dollars to be used to construct a national

highway system.

The AAA sells memberships
to individuals and families. In

exchange for the membership

fee, the AAA provides an

array of benefits including

emergency roadside as-
sistance, travel services,
insurance services, driv-
er protection services,
and even emergency
check cashing services.

Critical Thinking

1. What asset and liability accounts might the AAA use to record its

transactions?

2. List at least two transactions that the AAA might record.

Source: www.aaa.com

DIGITAL VISION/GETTY IMAGES

27

L E S S O N

2-1

Using T Accounts

Even though the effects of transactions can be recorded
in an accounting equation, the procedure is not practical
in an actual accounting system. The number of accounts
used by most businesses would make the accounting

ANALY Z I N G TH E ACCO U NTI N G E Q UATI O N

equation cumbersome to use as a major financial record.
Therefore, a separate record is commonly used for each
account. The accounting equation can be represented as a
T, as shown below.