Accounting: The Language of Business - Vol 2 (Intermediate: Part 25)

That's what's so satisfying about acting. You can come as prepared as you like, but there's no accounting for what's going to come at you from the other actor. That's part of the joy and the play of it. If you don't have that it's a different kind of performance.

David Oyelowo

Review of the Accounting Cycle (Part B)

by

Charles Lamson

EXAMPLE 4.1

Analysis of Transactions with the Expanded Accounting Equation

PROBLEM: Plush Service Corporation began 2018 with the following account balances.

The company engaged in the following transactions during 2018:

1. Issued an additional 10,000 shares of common stock on January 2. The stock was sold for $80,000, which equals the par value of the stock.

2. Purchased store equipment for $10,000 cash on January 3.

3. Provided services for cash of $35,000 on February 5.

4. Provided services on credit for $90,000 on February 10th.

5. Received Bill and paid utilities of $15,000 on February 15.

6. Sales employees worked and were paid sales salaries of $30,000 on March 1.

7. Incurred legal fees of $6,000 on April 10 but did not pay for the services.

8. Declared and paid dividends to stockholders of $2,000 on April 30.

9.  Collected $25,000 for services to be provided over the coming year on June 30.

10.  Paid $72,000 for a three year insurance policy on July 10 with coverage beginning on August 1.

11. Paid $1,000 for a three-week equipment rental on September 10.

12. Collected $10,000 from the February 10 transaction on October 20.

13. Paid $1,000 of the amount owed for legal fees incurred on April 10 on November 18.

Assume that Plush Service is not subject to tax. Illustrate the effect of each transaction on the expanded accounting equation.

SOLUTION: We analyze each transaction below, explaining the effect on the accounting equation by determining the increases and decreases in assets, liabilities, and components of shareholders' equity. Changes in assets must equal changes in liabilities and stockholders' equity after each transaction. Note that the first row of the table below contains balances at the beginning of the period. For simplicity, we are adding the noncash asset accounts together as well as the other liability accounts. Noncash assets include accounts receivable and store equipment. Liabilities include accounts payable, legal fees payable, and notes payable.

TRANSACTIONS ANALYSIS

1. Plush received cash in exchange for equity. As a result, it will increase its assets and increase stockholders equity through the contributed capital (common stock) account.

2. Because Plush paid cash to purchase store equipment. Store equipment increases and the asset cash decreases. This transaction changes the composition of the assets but not the total. 

3. Because plush received cash for services provided, it will increase its assets and will increase stockholders' equity through the service revenue account.

4.  Plush provided services on account. Therefore, it will increase its noncash assets (for the receivable) and will also increase stockholders' equity through the service revenue account for services provided.

5.  Because Plush used and paid for utilities, it will decrease the asset cash and decreases stockholders' equity by recognizing expenses.

6. Plush used and paid for the services of its employees, so it will decrease the asset cash and increase stockholders' equity through expenses.

7. Because Plush incurred legal fees but did not yet pay for them, it will increase a liability and decrease stockholders' equity by recognizing expenses.

8. Plush declared and paid dividends. In this case, it will decrease the asset cash and decrease stockholders' equity due to the dividends declared.

9. Because plush collected cash, it will increase the asset cash. However, plush still owes services to the customer so it will also increase liabilities.

10. Plush acquired an asset (the benefit of an insurance policy) and paid cash. Thus, it will increase an asset, prepaid insurance, and decrease the asset cash.

11. Plush paid cash for an equipment rental. It will decrease the asset cash and increase an expense, thus decreasing equity.

12.  Because Plush collected cash for amounts owed to the company, it will increase an asset, cash, and decrease another asset, accounts receivable. 

13. Plush paid cash for amounts it owed for unpaid legal fees. The company will increase the asset cash and decrease liabilities. 

*GORDON, RAEDY, SANNELLA, 2019, INTERMEDIATE ACCOUNTING, 2ND ED., PP. 95-97*

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