Transactions and the Accounting Equation

  • Explain the effect of various transactions on the accounting equation

 

Accounting is the process of analyzing, classifying, recording, summarizing, and interpreting business transactions. One of the key aspects of the process is keeping running totals of things. Examples of items a business might keep track of include the following:

  • The amount of cash the business currently has
  • What a company has paid for utilities for the month
  • The amount of money it owes
  • A company’s income for the entire year
  • The total cost of all the equipment it has purchased

It’s important that businesses keep these running totals up to date so they are readily available when the information is needed.

We will now refer to these running totals as balances and these items as accounts. Any item that a business needs to keep track of in terms of a running dollar balance is set up as an account. With these accounts, businesses can easily check in to determine “how much of X do we have right now?” or “how much of X have we sold so far?”

The first step in accounting is to do basic bookkeeping in order to capture the data that we will eventually turn into reports and statements. We do this by recording transactions. An accounting transaction is any business event that has a monetary impact on the financial statements of a business, and there is usually some kind of supporting paper or electronic documentation. For instance, a cash deposit into the bank is a transaction, and the bank statement or deposit slip is the evidence.

NeatNiks

Let’s revisit Nick Frank’s business that he started in October of this year. NeatNiks provides customized cleaning services to high-end homeowners in the Santa Fe area of New Mexico.

Photograph of a Black man wearing professional blazer, who is looking to the left

As a reminder, these are the transactions that Nick has recorded for the month of October:

  • Oct 1: The owner, Nick Frank, opened a bank account in the name of NeatNiks using $20,000 of his own money from his personal account.
  • Oct 4: Nick rented a truck for $12,000 cash for October through March (6 months).
  • Oct 7: Purchased $2,600 of supplies on account from Cleaning Supplies, Inc.
  • Oct 15: Received $1,500 cash for services performed.
  • Oct 20: Billed customers for $7,250 worth of work done in October.
  • Oct 25: Paid in cash: $1,500 for insurance & $1,100 for independent contractors’ work.
  • Oct 26: Paid $1,000 to Cleaning Supplies, Inc. on account.
  • Oct 30: Collected $1,600 from customers on account.
  • Oct 31: Withdrew $4,000 cash for personal use.
  • Oct 31: Nick owes independent contractors $1,200 for work done in October—he’ll pay it in November.
  • Oct 31: Nick had $1,000 of supplies leftover at the end of the month.

Nick has now hired you as the outsourced bookkeeper/accountant for his company, so let’s walk through some of these transactions and see what it would look like for Nick to try to keep track of them—for example, in a spreadsheet. For now, let’s just worry about the cash transactions, and we’ll look at the non-cash transactions later.

Click through the interactive activity below and we’ll help you figure this out:

What is NeatNiks’s Status?

Okay, we’ve finished our spreadsheet that lets us enter and categorize all of the cash-related October transactions. How many of these questions can we answer now?

At the end of October:

Question 1: How much money did Nick make or lose during his first month in business?

Question 2: Nick wants to buy another truck for $5,000 in order to keep up with demand—does he have enough cash in the bank to do that right now?

Question 3: How much do customers owe Nick?

Question 4: How much does Nick owe to his suppliers?

Question 5: What is Nick’s equity in his business at the end of October?

So it looks like our spreadsheet only allows us to answer one question so far!