How Transactions Impact the Accounting Equation
The foregoing balance sheet for Edelweiss was the static. This means that it represented the financial state at the noted date. But, every passing transaction or event brings the change in the overall financial condition. Business action will impact various asset, responsibility, and/or equity accounts; but, they will not concern the equality of the accounting equation. Then, how can this happen? To reveal the solution to this question, let's look at four particular transactions for Edelweiss Corporation. You will see that how each transaction affects the individual liability, asset and equity accounts, without upsetting the basic equality of the entire balance sheet.
Edelweiss Collects an Account Receivable
If Edelweiss Corporation has collected $10,000 from the customer on the present account receivable (i.e., not a new sale, just the gathering of an amount that is due from some earlier transaction), then the balance sheet would be revised as shown below:
The illustration clearly shows that cash (an asset) improved from $25,000 to $35,000, and accounts receivable (an asset) reduced from $50,000 to $40,000. As a result entire assets did not change, and liabilities and equity accounts were unaltered. Thus assets are still equal to the liabilities plus equity.
The illustration clearly shows that cash (an asset) rose from $25,000 to $35,000, and accounts receivable (an asset) reduced from $50,000 to $40,000. As a result of which entire assets did not change, and liabilities and equity accounts remained unaffected. Thus assets are still equal to the liabilities plus equity.
Edelweiss Buys Equipment with Loan Proceeds
If Edelweiss Corporation buy $30,000 of equipment, agreeing to pay for it afterwards (i.e. taking out a loan), then the balance sheet should be further revised as shown below.
This design shows that equipment (an asset) rose from $250,000 to $280,000, and loans payable (a liability) rose from $125,000 to $155,000. As a result, both the total assets and the total liabilities raised by $30,000, but assets are still equal to the liabilities plus equity.
Edelweiss Provides Services to a Costumer on Account
What would occur if Edelweiss Corporation did some particular work for a customer in exchange for the customer's assure to pay $5,000? This needs further explanation; try to follow this logic directly! You previously know that engaged earnings are the income of the business that has not been spread to the owners of the business. When Edelweiss Corporation earned $5,000 (which they will collect afterwards) by providing a service to the customer, it can be said that they obtained revenue of $5,000. Revenue is the development to assets resulting from providing goods or services to customers. Revenue will bring an increment to income, and income is added to engage earnings. Can you go after that?
As you check the balance sheet on the peak of the next page, notice that accounts received and retained earnings rose by $5,000 each, indicating that the business has more resources and more retained earnings. After this resources still are equal to the liabilities plus equity.
Edelweiss Pays Expenses with Cash
It would be good if you could run a business with no incurring any expenses. However hear such is not the case. Expenditure is the outflows and obligations that arise from producing the goods and the services.
Suppose that Edelweiss waged $3,000 for expenses. The lower set of balance sheets on the next page shows this impact.
Generalizing About the Impact of Transactions
There are number of types of transactions that can happen, and each and every transaction can be explained in terms of its impact on assets, liabilities, and equity. What is important to know is that no transaction will upset the primary accounting equation of assets = liabilities + owners' equity.
Services to a customer on account:
Distinguishing Between Revenue and Income
In day-to-day discussion, some terms can often be used carelessly and without a great deal of precision. Words can be treated as identical, when actually they are not. Identical is the case for the words "income" and "revenue." Each term has a very definite meaning, and you should always accustom yourself to the accurate usage. It has already pointed that the revenues are enhancements resulting from providing products and services to the customers. Conversely, expenses can commonly be regarded as costs of doing the business. This gives rise to a further "accounting equation":
Revenues - Expenses = Income
Revenue is the "top line" quantity corresponding to the entire benefits generated from business action. Income is the "bottom line" sum that results after deducting the charge from revenue. In some of the countries, revenue in addition referred to as "turnover."
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