Chapter D, Problem 4BTN

The expanded accounting equation consists of assets, liabilities, common stock, dividends, revenues, and expenses. It can be used to reveal insights into changes in a company’s financial position.

Required
1. Form learning teams of six (or more) members. Each team member must select one of the six components, and each team must have at least one expert on each component: (a) assets, (b) liabilities, (c) common stock, (d) dividends, (e) revenues, and (/) expenses.
2.Form expert teams of individuals who selected the same component in part l. Expert teams are to draft a report that each expert will present to his or her learning team addressing the following:
a. Identify for its component the (i) increase and decrease side of the account and (ii) normal balance side of the account.
b. Describe a transaction, with amounts, that increases its component.
c. Using the transaction and amounts in (b), verify the equality of the accounting equation and then explain any effects on the income statement and statement of cash flows.
d. Describe a transaction, with amounts, that decreases its component.
e. Using the transaction and amounts in (t/), verify the equality of the accounting equation and then explain any effects on the income statement and statement of cash flows.
3.Each expert should return to his/her learning team. In rotation, each member presents his/her expert team’s report to the learning team. Team discussion is encouraged.

To determine

(a)

Accounting Equation represents the dual entry accounting system, i.e., each transaction has dual effects. It depicts the relationship between assets, liabilities and stockholders’ equity.

To form:

Teams and select one component of expanded accounting equation.

Explanation of Solution

A team is a group of individuals who work together to achieve a common goal. Various teams of six members each have been formed.

ACCOUNTING EQUATION
Assets = Liabilities + Shareholders’ Stock
Assets	Liabilities	Shareholders’ Stock

EXPANDED ACCOUNTING EQUATION
Assets = Liabilities + Shareholders’ Stock
Assets	Liabilities	Shareholders’ Stock
		Revenue	Expenses	Common Stock	Dividends

Each of the six individuals of a team took one component each. It can be stated as follows:

Individual	Team 1	Team 2	Team 3
A	Assets	Assets	Assets
B	Liabilities	Liabilities	Liabilities
C	Revenue	Revenue	Revenue
D	Expenses	Expenses	Expenses
E	Common Stock	Common Stock	Common Stock
F	Dividends	Dividends	Dividends

Now,

• Individual A of each team will report about assets.
• Individual B of each team will report about liabilities.
• Individual C of each team will report about revenue.
• Individual D of each team will report about expenses
• Individual E of each team will report about common stock.
• Individual F of each team will report dividends.

To determine

(b)

Accounting Equation represents the dual entry accounting system, i.e., each transaction has dual effects. It depicts the relationship between assets, liabilities and stockholders’ equity.

To form:

Expert team and report the following about their topic:

1. The side of account that record increase and decrease along with its normal balance.
2. Event to increase it.
3. Effect of event (b) on accounting equation, income statement and cash flow statement.
4. Event to decrease it.
5. Effect of event (d) on accounting equation, income statement and cash flow statement.

Explanation of Solution

(a) If balance of an ‘account’ increases with debit and decreases with credit then it has debit as normal balance. If balance of an account increases with credit and decreases with debit then it has normal credit balance.

Expert Team	Increase side	Decrease side	Normal Balance side
Assets	Debit	Credit	Debit
Liabilities	Credit	Debit	Credit
Revenue	Credit	Debit	Credit
Expenses	Debit	Credit	Debit
Common Stock	Credit	Debit	Credit
Dividends	Debit	Credit	Debit

(b) The following events were recorded by expert teams that increase their balance

Expert Team	Event to increase
Assets	Equipment bought on account for $10,000.
Liabilities	Took loan for $1,000.
Revenue	Sold goods of $5,000 for cash.
Expenses	$2,000 rent paid by cash.
Common Stock	Issued stock of $7,000 for cash.
Dividends	Paid dividend of $2,500 for cash

(c) Each entry has dual effect on accounting equation. The transaction may affect income statement as well as cash flow statement as follows:

Effect on ‘EXPANDED ACCOUNTING EQUATION’
Assets = Liabilities + Shareholders’ Stock
Expert Teams	Assets	Liabilities	Shareholders’ Stock
			Revenue	Expenses	Common Stock	Dividends
Assets	$10,000	$10,000	$5,000	$2,000
Liabilities	$1,000	$1,000
Revenue	$5,000
Expenses	($2,000)
Common Stock	$7,000				$7,000
Dividends	($2,500)					$2,500
Total	$18,500	$11,000	$5,000	$2,000	$7,000	$2,500

Shareholders’ Equity = Common Stock + Net Income − Dividends
Net Income = Revenue − Expenses
Net Income = $5,000 - $2,000 = $3,000
Shareholders’ Equity = $7,000 + $3,000 - $2,500
Shareholders’ Equity = $7,500
As per accounting equation,
Assets = Liabilities + Shareholders’ Stock
$18,500 = $11,000 + $7,500
$18,500 = $18,500 

Hence, accounting has been verified.

Expert Team	Effect on Income Statement
Assets	No effect
Liabilities	No effect
Revenue	Increase in revenue by $5,000
Expenses	Increase in expenses by $2,000
Common Stock	No effect
Dividends	No effect

Expert Team	Effect on Cash Flow Statement
Assets	No effect (it is a non-cash transaction)
Liabilities	Cash inflow under financing activities.
Revenue	Cash inflow under operating activities
Expenses	Cash outflow under operating activities
Common Stock	Cash inflow under financing activities.
Dividends	Cash outflow under financing activities.

(d) The following events were recorded by expert teams that decrease their balance

Expert Team	Event to decrease
Assets	Plant depreciation expense of $700.
Liabilities	Paid $1,500 outstanding loan.
Revenue	Sales return $2,000 for cash.
Expenses	Returned goods of $500 for cash
Common Stock	Repurchased stock of $5,000 for cash.
Dividends	No such entry

(e) Each entry has dual effect on accounting equation. The transaction may affect income statement as well as cash flow statement as follows:

Effect on ‘EXPANDED ACCOUNTING EQUATION’
Assets = Liabilities + Shareholders’ Stock
Expert Teams	Assets	Liabilities	Shareholders’ Stock
			Revenue	Expenses	Common Stock	Dividends
Assets	($700)			$700
Liabilities	($1,500)	($1,500)
Revenue	($2,000)		($2,000)
Expenses	$500			($500)
Common Stock	($5,000)				($5,000)
Dividends	-	-	-	-	-	-
Total	($8,700)	($1,500)	($2,000)	$200	($5,000)

Shareholders’ Equity = Common Stock + Net Income − Dividends

Net Income = Revenue − Expenses

Net Income = ($2,000) - $200 = ($2,200)

Shareholders’ Equity = ($5,000) + ($2,200) - $0

Shareholders’ Equity = ($7,700)

As per accounting equation,

Assets = Liabilities + Shareholders’ Stock

($8,700) = ($1,500) + ($7,200)

($8,700) = ($8,700)

Hence, accounting has been verified.

Expert Team	Effect on Income Statement
Assets	Increase in expenses by $700.
Liabilities	No effect
Revenue	Decrease in revenue by $2,000.
Expenses	Decrease in expenses by $500.
Common Stock	No effect
Dividends	No effect

Expert Team	Effect on Cash Flow Statement
Assets	Non-cash expense, add back to net income under operating activities.
Liabilities	Cash outflow under financing activities.
Revenue	Cash outflow under operating activities
Expenses	Cash inflow under operating activities
Common Stock	Cash outflow under financing activities.
Dividends	No effect.

To determine

(c)

Accounting Equation represents the dual entry accounting system, i.e., each transaction has dual effects. It depicts the relationship between assets, liabilities and stockholders’ equity.

To discuss:

Experts discuss the observations with original team.

Explanation of Solution

Individual	Team 1	Team 2	Team 3
A	Assets	Assets	Assets
B	Liabilities	Liabilities	Liabilities
C	Revenue	Revenue	Revenue
D	Expenses	Expenses	Expenses
E	Common Stock	Common Stock	Common Stock
F	Dividends	Dividends	Dividends

Observations:

Assets: The balance of asset account increases with a debit and decreases with a credit. It has debit balance as normal account balance and is represented on balance sheet. It is a summation of liabilities and shareholders’ equity. For cash transactions, increase in fixed asset is shown as outflow under investing activities whereas decrease in fixed asset is considered an inflow under investing activities. It doesn’t affect the income statement.

Liabilities: The balance of liability account increases with a credit and decreases with a debit. It has credit balance as normal account balance and is represented on balance sheet. It is the difference of assets and shareholders’ equity. For cash transactions, decrease in long term liabilities is shown as outflow under financing activities whereas increase in long term liabilities is considered an inflow under financing activities. It doesn’t affect the income statement.

Revenue: The balance of revenue account increases with a credit and decreases with a debit. It has credit balance as normal account balance and is represented on income statement. It is used to derive net income which is a part of shareholders’ equity. Revenue increases the net income, which further increases shareholders’ equity. For cash transactions, net income is shown under operating activities.

Expenses: The balance of expense account increases with a debit and decreases with a credit. It has debit balance as normal account balance and is represented on income statement. It is used to derive net income which is a part of shareholders’ equity. Expense decreases the net income, which further decreases shareholders’ equity. For cash transactions, net income is shown under operating activities.

Common Stock: The balance of common stock account increases with a credit and decreases with a debit. It has credit balance as normal account balance and is represented on balance sheet. It is the difference of assets and liabilities. For cash transactions, decrease in common stock are shown as outflow under financing activities whereas increase in common stock is considered an inflow under financing activities. It doesn’t affect the income statement.

Dividends: The balance of dividend account increases with a debit and decreases with a credit. It has debit balance as normal account balance and is represented on balance sheet as a part of shareholders’ equity. Dividends decrease shareholders’ equity. For cash transactions, dividends paid is shown as outflow of cash under financing activities.