Concept explainers
The
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
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.
(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.
(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:
- The side of account that record increase and decrease along with its normal balance.
- Event to increase it.
- Effect of event (b) on accounting equation, income statement and cash flow statement.
- Event to decrease it.
- 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. |
(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.
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