Transactions affecting only the balance sheet

Since each transaction affecting a business entity must be recorded in the accounting records, analyzing a transaction before actually recording it is an important part of financial accounting. An error in transaction analysis results in incorrect financial statements.

To illustrate the analysis of transactions and their effects on the basic accounting equation, the activities of Metro Courier, Inc., that led to the statements in Exhibit 2 follow. The first set of transactions (for June), 1a, 2a, and so on, are repeated in the summary of transactions, Exhibit 3 (Part A). The second set of transactions (for July) (1b–6b) are repeated in Exhibit 4 (Part A).


1a. Owners invested cash

When Metro Courier, Inc., was organized as a corporation on 2010 June 1, the company issued shares of capital stock for USD 30,000 cash to Ron Chaney, his wife, and their son. This transaction increased assets (cash) of Metro by USD 30,000 and increased equities (the capital stock element of stockholders' equity) by USD 30,000. Consequently, the transaction yields the following basic accounting equation:

Assets -Liabilities+ Stockholders' Equity
Transaction Explanation Cash Accounts Receivable Trucks Office Equipment Accounts Payable Notes Payable + Capital Stock
1a Beginning balances Stockholders Invested Cash
 $ -0-
30,000 		$ -0- $ -0- $ -0- $ -0- $ -0- $ -0-
30,000

Balance after transaction
 $30,000 $30,000
Increased by $30,000       Increased by $30,000

2a. Borrowed money

The company borrowed USD 6,000 from Chaney's father. Chaney signed the note for the company. The note bore no interest and the company promised to repay (recorded as a note payable) the amount borrowed within one year. After including the effects of this transaction, the basic accounting equation is:

Assets -Liabilities+ Stockholders' Equity
Transaction Explanation Cash Accounts Receivable Trucks Office Equipment Accounts Payable Notes Payable + Capital Stock

Balances before transaction
 $30,000 $ -0- $ -0- $ -0- = $ -0- $ -0- $30,000
2a
 Borrowed money
 6,000 6,000  
Balance after transaction
 $36,000      $6,000 + $30,000
     Increased by $6,000       Increased by $6,000    

3a. Purchased trucks and office equipment for cash

Metro paid USD 20,000 cash for two used delivery trucks and USD 1,500 for office equipment. Trucks and office equipment are assets because the company uses them to earn revenues in the future. Note that this transaction does not change the total amount of assets in the basic equation but only changes the composition of the assets. This transaction decreased cash and increased trucks and office equipment (assets) by the total amount of the cash decrease. Metro received two assets and gave up one asset of equal value. Total assets are still USD 36,000. The accounting equation now is:

Assets -Liabilities+ Stockholders' Equity
 Cash Accounts Receivable Trucks Office Equipment Accounts Payable Notes Payable + + Capital Stock
$36,000
 $ -0-
 $ -0- $ -0 - =
  $ -0-  $6,000 + $30,000
(21,500)
20,000 1,500
 
$14,500
$20,000 $1,500 =
 $6,000 + $30,000
Decreased by $21,500   Increased by $20,000
  Increased by $1,500
   

4a. Purchased office equipment on account (for credit)

Metro purchased an additional USD 1,000 of office equipment on account, agreeing to pay within 10 days after receiving the bill. (To purchase an item on account means to buy it on credit.) This transaction increased assets (office equipment) and liabilities (accounts payable) by USD 1,000. As stated earlier, accounts payable are amounts owed to suppliers for items purchased on credit. Now you can see the USD 1,000 increase in the assets and liabilities as follows:

Assets -Liabilities+ Stockholders' Equity
 Cash Accounts Receivable Trucks Office Equipment Accounts Payable Notes Payable + Capital Stock
$14,500
$20,000 $1,500 =
    $6,000  $30,000



1,000
 1,000
 
$14,500
$20,000 $2,500 =
$1,000  $6,000 +
  $30,000

 
Increased by $1,000 Increased by $1,000
    

5a. Paid an account payable 

Eight days after receiving the bill, Metro paid USD 1,000 for the office equipment purchased on account (transaction 4a). This transaction reduced cash by USD 1,000 and reduced accounts payable by USD 1,000. Thus, the assets and liabilities both are reduced by USD 1,000, and the equation again balances as follows:

Assets -Liabilities+ Stockholders' Equity
Transaction Explanation Cash Accounts Receivable Trucks Office Equipment Accounts Payable Notes Payable + Capital Stock

Balances before transaction
 $14,500 $ -0- $20,000 $2,500 =
 $1,000 $6,000 +$30,000
5a
 Paid an account payable
 1,000 (1,000)
 
Balance after transaction
 $13,500 $ -0-  $20,000  $2,500 $ -0-  $6,000 + $30,000
    Decreased by $1,000       Decreased by $1,000    

A. Summary of Transactions
METRO COURIER, INC.
Summary of Transactions
Month of June 2010
Assets -Liabilities+ Stockholders' Equity
Transaction Explanation Cash Accounts Receivable Trucks Office Equipment Accounts Payable Notes Payable
+ Capital Stock
Beginning balances 
$ -0- $ -0- $ -0- $ -0- = $ -0- $ -0- $ -0-
1a Stockholders invested cash 30,000 30,000
$30,000    
+$30,000
2a Borrowed money 6,000 =  6,000
$36,000       = $6,000 +$30,000
3a
Purchased trucks and office equipment for cash (21,500)   20,000 1,500
$14,500   $20,000 $1,500 = $6,000 +$30,000
4a Purchased office equipment on account   1,000 1,000 $6,000 +$30,000
$14,500   $20,000 $2,500
 = $1,000 $6,000 +$30,000
5a Paid an account payable (1,000) 1,000
+$30,000
End-of-month balances $13,500 (A)
 $ -0- $20,000 (B) $2,500 (C)
  = $ -0- $6,000 (D) $30,000 (E)

B. Balance Sheet
METRO COURIER , INC.
Balance Sheet
2010 June 31
Assets  Liabilities and Stockholder's Equity
Cash (A) $13,500  Liabilities:
  
Trucks (B) 20,000  Notes payable  
Office equipment
(C) 2,500  Total liabilities                            (D) $6,000
 $6,600
 
 Stockholders equity:  
     Capital stock (E) 30,000
Total assets
 $36,000
 Total liabilities and stockholders' equity  $36,000

Exhibit 3: Balance Sheet

Exhibit 3, Part A, is a summary of transactions prepared in accounting equation form for June. A summary of transactions is a teaching tool used to show the effects of transactions on the accounting equation. Note that the stockholders' equity has remained at USD 30,000. This amount changes as the business begins to earn revenues or incur expenses. You can see how the totals at the bottom of Part A of Exhibit 3 tie into the balance sheet shown in Part B. The date on the balance sheet is 2010 June 30. These totals become the beginning balances for July 2010.

Thus far, all transactions have consisted of exchanges or acquisitions of assets either by borrowing or by owner investment. We used this procedure to help you focus on the accounting equation as it relates to the balance sheet. However, people do not form a business only to hold existing assets. They form businesses so their assets can generate greater amounts of assets. Thus, a business increases its assets by providing goods or services to customers. The results of these activities appear in the income statement. The section that follows shows more of Metro's transactions as it began earning revenues and incurring expenses.