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Asset Source TransactionsAs previously mentioned, businesses obtain assets (resources) from three sources. They acquire assets from owners (stockholders); they borrow assets from creditors; and they earn assets through profitable operations. Asset source transactions increase total assets and total claims. A more detailed discussion of the effects of asset source transactions is provided below: Event 1 Rustic Camp Sites (RCS) was formed on January 1, 2004, when it acquired $120,000 cash from issuing common stock. When RCS issued stock, it received cash and gave each investor (owner) a stock certificate as a receipt. Since this transaction provided $120,000 of assets (cash) to the business, it is an asset source transactionTransaction that increases an asset and a claim on assets; three types of asset source transactions are acquisitions from owners (equity), borrowings from creditors (liabilities), or earnings from operations (revenues).. It increases the business’s assets (cash) and its stockholders’ equity (common stock).
Notice the elements have been divided into accounts. For example, the element assets is divided into a Cash account and a Land account. Do not be concerned if some of these account titles are unfamiliar. They will be explained as new transactions are presented. Recall that the number of accounts a company uses depends on the nature of its business and the level of detail management needs to operate the business. For example, Sears would have an account called Cost of Goods Sold although GEICO Insurance would not. Why? Because Sears sells goods (merchandise) but GEICO does not. Also, notice that a stock issue transaction affects the accounting equation in two places, both under an asset (cash) and also under the source of that asset (common stock). All transactions affect the accounting equation in at least two places. It is from this practice that the double-entry bookkeepingMethod of keeping records that provides a system of checks and balances by recording transactions in a dual format. system derives its name. Event 2 RCS acquired an additional $400,000 of cash by borrowing from a creditor. This transaction is also an asset source transaction. It increases assets (cash) and liability claims (notes payable). The account title Notes Payable is used because the borrower (RCS) is required to issue a promissory note to the creditor (a bank). A promissory note describes, among other things, the amount of interest RCS will pay and for how long it will borrow the money.4 The effect of the borrowing transaction on the accounting equation is indicated below.
The beginning balances above came from the ending balances produced by the prior transaction. This practice is followed throughout the illustration. Asset Exchange TransactionsBusinesses frequently trade one asset for another asset. In such cases, the amount of one asset decreases and the amount of the other asset increases. Total assets are unaffected by asset exchange transactions. Event 3 is an asset exchange transaction. Event 3 RCS paid $500,000 cash to purchase land. This asset exchange transaction reduces the asset account Cash and increases the asset account Land. The amount of total assets is not affected. An asset exchange transaction simply reflects changes in the composition of assets. In this case, the company traded cash for land. The amount of cash decreased by $500,000 and the amount of land increased by the same amount.
Another Asset Source TransactionEvent 4 RCS obtained $85,000 cash by leasing camp sites to customers. RevenueAn economic benefit (an increase in assets or a decrease in liabilities) that is gained by providing goods and services to customers. represents an economic benefit a company obtains by providing customers with goods and services. In this example the economic benefit is an increase in the asset cash. Revenue transactions can therefore be viewed as asset source transactions. The asset increase is balanced by an increase in the retained earnings section of stockholders’ equity because producing revenue increases the amount of earnings retained in the business.
Asset Use TransactionsBusinesses use assets for a variety of purposes. For example, assets may be used to pay off liabilities or they may be transferred to owners. Assets may also be used in the process of generating earnings. All asset use transactions decrease the total amount of assets and the total amount of claims on assets (liabilities or stockholders’ equity). Event 5 RCS paid $50,000 cash for operating expenses such as salaries, rent, and interest. (RCS could establish a separate account for each type of expense. However, the management team does not currently desire this level of detail. Remember, the number of accounts a business uses depends on the level of information managers need to make decisions.) In the normal course of generating revenue, a business consumes various assets and services. The assets and services consumed to generate revenue are called expensesEconomic sacrifices (decreases in assets or increase in liabilities) that are incurred in the process of generating revenue.. Revenue results from providing goods and services to customers. In exchange, the business acquires assets from its customers. Since the owners bear the ultimate risk and reap the rewards of operating the business, revenues increase stockholders’ equity (retained earnings), and expenses decrease retained earnings. In this case, the asset account, Cash, decreased. This decrease is balanced by a decrease in the retained earnings section of stockholders’ equity because expenses decrease the amount of earnings retained in the business.
Event 6 RCS paid $4,000 in cash dividends to its owners. To this point the enterprise’s total assets and equity have increased by $35,000 ($85,000 of revenue – $50,000 of expense) as a result of its earnings activities. RCS can keep the additional assets in the business or transfer them to the owners. If a business transfers some or all of its earned assets to owners, the transfer is frequently called a dividendTransfer of wealth from a business to its owners.. Since assets distributed to stockholders are not used for the purpose of generating revenue, dividends are wealth transfers, not expenses. Furthermore, dividends are a transfer of earnings, not a return of assets acquired in exchange for common stock.
Exercises 1-8A, 1-9A, 1-10A, 1-12A, 1-13A, 1-10B, 1-12B, 1-13B Problems 1-30A, 1-31A, 1-30B, 1-31B 4 For simplicity, the effects of interest are ignored in this chapter. We discuss accounting for interest in future chapters. |
