Accounting Equation

Corporation Transaction C5.

On December 5, 2006 Accounting Software, Inc. pays $600 for ads that were run in recent days. The effect of the advertising transaction on the corporation’s accounting equation is:

Since ASI is paying $600, its assets decrease. The second effect is a $600 decrease in stockholders’ equity, because the transaction involves an expense. (An expense is a cost that is used up or its future economic value cannot be measured.)

Although stockholders’ equity decreases because of an expense, the transaction is not recorded directly into the retained earnings account. Instead, the amount is initially recorded in the expense account Advertising Expense and in the asset account Cash. The journal entry for this transaction is:

The combined effect of the first five transactions is:

The totals now indicate that Accounting Software, Inc. has assets of $16,300. The creditors provided $7,000 and the stockholders provided $9,300. Viewed another way, the corporation has assets of $16,300 with the creditors having a claim of $7,000 and the stockholders having a claim of $9,300.

The balance sheet as of the end of December 5, 2006 is presented here:

Since this transaction involves an expense, it will affect ASI’s income statement. The corporation’s income statement for the first five days of December is presented here:

Corporation Transaction C6.

On December 6, 2006 ASI performs consulting services for its clients. The clients are billed for the agreed upon amount of $900. The amounts are due in 30 days. The effect on the accounting equation is:

Since ASI has performed the services, it has earned revenues and it has the right to receive $900 from its clients. This right means that assets increased. The earning of revenues also causes stockholders’ equity to increase.

Although revenues cause stockholders’ equity to increase, the revenue transaction is not recorded directly into a stockholders’ equity account at this time. Rather, the amount earned is recorded in the revenue account Service Revenues . This will allow the corporation to report the revenues account on its income statement at any time. (After the year ends, the amount in the revenue accounts will be transferred to the retained earnings account.) The general journal entry for providing services on credit is:

The effect on the accounting equation from the first six transactions can be viewed here:

The totals tell us that at the end of December 6, the corporation has assets of $17,200. It also shows that $7,000 of the assets came from creditors and that $10,200 came from stockholders. The totals can also be viewed another way: ASI has assets of $17,200 with its creditors having a claim of $7,000 and the stockholders having a claim for the remainder or residual of $10,200.

The balance sheet as of midnight on December 6, 2006 is presented here:

The income statement for Accounting Software, Inc. for the period of December 1 through December 6 is shown here:

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