# Accounting Equation

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## Accounting Equation for a Corporation: Transactions C5–C6

Corporation Transaction C5.

On December 5, 2011 Accounting Software, Inc. pays \$600 for ads that were run in recent days. The effect of the advertising transaction on the corporation’s accounting equation is:

 Assets = Liabilities + Stockholders’ Equity –\$600 = No Effect + –\$600

Since ASI is paying \$600, its assets decrease. The second effect is a \$600 decrease in stockholders’ equity, because the transaction involves an expense. (An expense is a cost that is used up or its future economic value cannot be measured.)

Although stockholders’ equity decreases because of an expense, the transaction is not recorded directly into the retained earnings account. Instead, the amount is initially recorded in the expense account Advertising Expense and in the asset account Cash. The journal entry for this transaction is:

 Date Account Titles Debit Credit Dec. 5, 2011 Advertising Expense 600 Cash 600

The combined effect of the first five transactions is:

 Transaction Assets = Liabilities + Stockholders’ Equity C1 +\$10,000 = No Effect + +\$10,000 C2 –\$100 = No Effect + –\$100 C3 +\$5,000 = No Effect + No Effect –\$5,000 C4 +\$7,000 = +\$7,000 + No Effect C5 –\$600 = No Effect + –\$600 Totals \$16,300 = \$7,000 + \$9,300

The totals now indicate that Accounting Software, Inc. has assets of \$16,300. The creditors provided \$7,000 and the stockholders provided \$9,300. Viewed another way, the corporation has assets of \$16,300 with the creditors having a claim of \$7,000 and the stockholders having a claim of \$9,300.

The balance sheet as of the end of December 5, 2011 is presented here:

 Accounting Software, Inc. Balance Sheet December 5, 2011 ASSETS LIABILITIES Cash \$ 11,300 Notes Payable \$ 7,000 Equipment 5,000 STOCKHOLDERS’ EQUITY Common Stock 10,000 Retained Earnings (600)* Less: Treasury Stock (100) . Total Stockholders' Equity 9,300 Total Assets \$ 16,300 Total Liabilities & Stkrs' Equity \$ 16,300 .
 . Beginning Retained Earnings \$ 0 + Net Income** + (600) Subtotal \$ 0 – Dividends – 0 Ending Retained Earnings, Dec. 5 \$ (600)* .

**The income statement (which reports the company’s revenues, expenses, gains, and losses for
a specified time period) is a link between balance sheets. It provides the results of operations—
an important part of the change in retained earnings and stockholders’ equity.

Since this transaction involves an expense, it will affect ASI’s income statement. The corporation’s income statement for the first five days of December is presented here:

 Accounting Software, Inc. Income Statement For the Five Days Ended December 5, 2011 REVENUES \$ 0 EXPENSES Advertising Expense 600 NET INCOME \$ (600)
Because we assume that Accounting Services, Inc. is a Subchapter
S corporation, income tax expense is not reported on the corporation’s
income statement.

Corporation Transaction C6.

On December 6, 2011 ASI performs consulting services for its clients. The clients are billed for the agreed upon amount of \$900. The amounts are due in 30 days. The effect on the accounting equation is:

 Assets = Liabilities + Stockholders’ Equity +\$900 = No Effect + +900

Since ASI has performed the services, it has earned revenues and it has the right to receive \$900 from its clients. This right means that assets increased. The earning of revenues also causes stockholders’ equity to increase.

Although revenues cause stockholders’ equity to increase, the revenue transaction is not recorded directly into a stockholders’ equity account at this time. Rather, the amount earned is recorded in the revenues account Service Revenues . This will allow the corporation to report the revenues account on its income statement at any time. (After the year ends, the amount in the revenues accounts will be transferred to the retained earnings account.) The general journal entry for providing services on credit is:

 Date Account Titles Debit Credit Dec. 6, 2011 Accounts Receivable 900 Service Revenues 900

The effect on the accounting equation from the first six transactions can be viewed here:

 Transaction Assets = Liabilities + Stockholders’ Equity C1 +\$10,000 = No Effect + +\$10,000 C2 –\$100 = No Effect + –\$100 C3 +\$5,000 = No Effect + No Effect –\$5,000 C4 +\$7,000 = +\$7,000 + No Effect C5 –\$600 = No Effect + –\$600 C6 +\$900 = No Effect + +900 Totals \$17,200 = \$7,000 + \$10,200

The totals tell us that at the end of December 6, the corporation has assets of \$17,200. It also shows that \$7,000 of the assets came from creditors and that \$10,200 came from stockholders. The totals can also be viewed another way: ASI has assets of \$17,200 with its creditors having a claim of \$7,000 and the stockholders having a claim for the remainder or residual of \$10,200.

The balance sheet as of midnight on December 6, 2011 is presented here:

 Accounting Software, Inc. Balance Sheet December 6, 2011 ASSETS LIABILITIES Cash \$ 11,300 Notes Payable \$ 7,000 Accounts Receivable 900 STOCKHOLDERS’ EQUITY Equipment 5,000 Common Stock 10,000 Retained Earnings 300* Less: Treasury Stock (100) . Total Stockholders' Equity 10,200 Total Assets \$ 17,200 Total Liabilities & Stkrs' Equity \$ 17,200 .
 . Beginning Retained Earnings \$ 0 + Net Income** + 300 Subtotal \$ 300 – Dividends – 0 Ending Retained Earnings, Dec. 6 \$ 300* .

**The income statement (which reports the company’s revenues, expenses, gains, and losses for
a specified time period) is a link between balance sheets. It provides the results of operations—
an important part of the change in retained earnings and stockholders’ equity.

The income statement for Accounting Software, Inc. for the period of December 1 through December 6 is shown here:

 Accounting Software, Inc. Income Statement For the Six Days Ended December 6, 2011 REVENUES Service Revenues 900 EXPENSES Advertising Expense 600 NET INCOME \$ 300

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