Chapter 1, Problem 1APSA

To determine

Introduction:

Impact of Transactions on Financial Statements

• Financial statements are financial records of the entities transactions for a given reporting period and indicate the financial health of an entity. They comprise of:

1. Income Statements and Notes to Income Statement,
2. Balance Sheets and,
3. Cash flow statements.

• Income Statements and Notes to Income Statement record the results of the company’s operations during a particular reporting period and provide information about the sources of funds and expenses of an entity.

• Balance Sheet is a list of the closing balance of assets and liabilities of an entity as on a particular date and it is used for analysis of the financial health of the entity. Assets are resources that increase revenue directly or indirectly for the business and liabilities are monetary obligations to be fulfilled by the entity.

• Cash flow statements are an integral part of the financial statements of a company. They reflect the direction and movement of the cash inflows and outflows during a reporting period.

• The cash inflows and outflows from financial transactions are segregated into the following activities:

• Cash flows from Operating activities − The cash inflows refer to sales and income from operating activities and cash outflows include both cash and non-cash outflows from the operating activities i.e. the day to day activities of the business.

• Cash flows from investing activities − The cash inflows refer to sales and income from investing activities and cash outflows include cash outflows from the investing activities in the form of purchase of fixed assets and investments.

• Cash flows from financing activities − The cash inflows refer to income from financing activities such as raising share capital and debt and cash outflows include cash outflows from the financing activities in the form of dividends and interest paid.

To Determine:

How transactions affect the financial statements

Answer to Problem 1APSA

Solution:

		Balance Sheet			Income Statement	Cash Flow Statements
	Transaction	Total Assets	Total Liabilities	Total Equity	Net Income	Operating Activities	Financing Activities	Investing Activities
1	Owner Invests cash in a business	+		+			+
2	Receives cash for services provided	+			+	+
3	Pays cash for employee wages	-			-	-
4	Incurs legal costs on credit		+		-	-
5	Borrows cash by signing long term notes payable	+	+				+
6	Buys office equipment for cash	+ / -						-
7	Buys Land by signing long term notes payable	+	+				+	+
8	Provides services on credit	+			+	+
9	Owner withdraws cash	-		-			-
10	Collects cash from receivables	+ / -				+

Explanation of Solution

• In case of Asset and Expenses accounts, the opening balance will be Debit Balance and in case of Liabilities and Incomes accounts, the opening balance is Credit Balance.

• In order to increase balances of Asset and Expenses accounts, they are debited and in order to decrease the balances, they are credited.

• In order to increase balances of Liabilities and Incomes accounts, they are credited and in order to decrease the balances, they are debited.

• Every financial transaction has a double entry effect i.e. two or more accounts get affected however the totals of all debits and credits must be equal.

• Cash flow statements measure the cash inflows and cash outflows that are affected during a particular reporting period including the non-cash items and items that are recorded owing to the accrual principle.

• Cash inflows and outflows from both balance sheet accounts such as accounts receivable, accounts payable, inventory etc. as well as Income statement accounts such as Sales, Depreciation Expense etc. and the changes in the values from the preceding period and the effect of the same on the net income is detailed in the cash flow statement of the current year.

• Operating Activities refer to the results from operations of the business. This includes cash inflows from sale of goods and services and cash outflows to fund the expenses of the operations. The operating activities also capture change in balance sheet accounts such as change in values of inventory or change in closing balances of accounts payables etc.

• Investing activities are related to acquisition of assets and disposal of assets during the reporting period. They are concerned with the changes in non-current assets of the business. Examples of Non-current assets include fixed assets such as Plant and Machinery, Buildings, Land etc. and Investments such as Investment in Shares of other companies etc.

• Financing activities are concerned with the acquisition and disposal of funds in the forms of equity and debt during a reporting period. They are concerned with the changes in non-current liabilities of the business. Non-Current liabilities refer to long term liabilities such as notes payable and common stock.

• When Owner Invests cash in a business balances of Total assets and Total Equity increase i.e. balances of cash and capital increase. Cash is an asset and must be debited to indicate increase and credited to indicate decrease in balances. Capital is a liability and must be credited to indicate increase and debited to indicate decrease in balances. It is part of financing activities since it affects non-current liabilities such as equity.

• When owner receives cash for services provided, balances of Total Assets and Income Statement increase i.e. balances of cash and sales revenue increase. Cash is an asset and must be debited to indicate increase and credited to indicate decrease in balances. Sales revenue is an income account and must be credited to indicate increase and debited to indicate decrease in balances. It is part of operating activities since it is concerned with income from operations of the entity.

• When owner pays cash for employee wages, balances of Total Assetsand Income Statementdecrease i.e. balances of cash decrease and wages expense increase. Cash is an asset and must be debited to indicate increase and credited to indicate decrease in balances. Wages expense is an expense account and must be debited to indicate increase and credited to indicate decrease in balances. It is part of operating activities since it is concerned with income from operations of the entity

• When owner incurs legal costs on credit balances of Total Liabilities Increase and Income Statementdecrease i.e. balances oflegal costs payable increase and legal cost expenses also increase. Legal costs payable are a liability and must be credited to indicate increase and debited to indicate decrease in balances. Legal expense is an expense account and must be debited to indicate increase and credited to indicate decrease in balances. It is part of operating activities since it is concerned with income from operations of the entity

• When owner borrows cash by signing long term notes payable balances of Total Assetsand Total Liabilitiesincrease i.e. balances of cash and notes payable increase. Cash is an asset and must be debited to indicate increase and credited to indicate decrease in balances Notes payable are a liability and must be credited to indicate increase and debited to indicate decrease in balances. It is part of financing activities since it affects non-current liabilities such as long term borrowings.

• When owner buys office equipment for cash there is an increase and decrease in the balance of Total Assetsi.e. balances of cash decrease and office equipment increase. Cash is an asset and must be debited to indicate increase and credited to indicate decrease in balances Office equipment is an asset and must be debited to indicate increase and credited to indicate decrease in balances. It is part of the investing activities since it is concerned with the non-current assets such as office furniture.

• When owner buys Land by signing long term notes payable balances of Total Assetsand Total Liabilitiesincrease i.e. balances of land and notes payable increase. Land is an asset and must be debited to indicate increase and credited to indicate decrease in balances Notes payable are a liability and must be credited to indicate increase and debited to indicate decrease in balances. It is part of the investing activities since it is concerned with the non-current assets such as Land and part of financing activities since it affects noncurrent liabilities such as long term borrowings.

• When owner provides services on credit, balances of Total Assets and Income Statement increase i.e. balances of accounts receivable and sales revenue increase. Accounts receivable is an asset and must be debited to indicate increase and credited to indicate decrease in balances. Sales revenue is an income account and must be credited to indicate increase and debited to indicate decrease in balances. It is part of operating activities since it is concerned with income from operations of the entity.

• When the owner withdraws cashbusiness balances of Total Assetsand Total Equitydecrease i.e. balances of cash and capitaldecrease. Cash is an asset and must be debited to indicate increase and credited to indicate decrease in balances. Capital is a liability and must be credited to indicate increase and debited to indicate decrease in balances. It is part of financing activities since it affects noncurrent liabilities such as equity.

• Collects cash from receivablesthere is an increase and decrease in the balance of Total Assetsi.e. balances of cash increase and accounts receivable decrease. Cash is an asset and must be debited to indicate increase and credited to indicate decrease in balances. Accounts receivable is an asset and must be debited to indicate increase and credited to indicate decrease in balances.It is part of operating activities since it is concerned with income from operations of the entity.

Conclusion

Hence the impact of the financial transactions has been explained.