Exam (elaborations)
HBS Business CORE - HBX CORe Financial Accounting
- Course
- HBS Business CORE - HBX CORe
- Institution
- Harvard University
HBS Business CORE - HBX CORe
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Accounting EquationAssets = Liabilities + Owners’ Equity
Or
Owners’ Equity = Assets – Liabilities
Balance sheet
Fundamental financial report in which AE is present, an expanded representation of the AE
● Those two sides should always balance
● Communicates to owners, business manager, investors, employees and other
stakeholders.
1.1 Accounting Equation Components
Assets equal resources, while liabilities plus equity represents how those resources were
funded.
Assets
● Resources like cash, inventory, or equipment that are owned or controlled by a business
or organization.
● Produce benefits in the future, like selling inventory for cash, using cash for
maintenance, etc.
Liabilities
Obligations that need to be paid, like loans and AP, to a third party.
● Loan from bank, wages payable, or AP.. cash, labor, goods/services that they expect to
be paid for.
○ Cash from a loan is an asset, balanced by the liability — the cash will provide
future benefit to the business.
Equity
Contributions from the owners of the business, recorded as equity.
● Different from liabilities in two ways:
○ Owners have a say in the business, a liability holder doesn’t.
○ Payments made to the owners are discretionary, not obligatory.
● Profit generated by business belongs to business.
● Funds from the owner and profits increase owner’s equity.
Essentially, owners’ equity is the difference between what a business has and what a business
owes to others.
,Examples
Apple Inc.
● Assets: cash, inventory, buildings, computers
● Liabilities: accounts payable, salaries payable
● Shareholders' Equity: contributed capital, retained earnings
Cardullo's Gourmet Shoppe
● Assets: cash, inventory, furniture and fixtures, equipment
● Liabilities: wages payable, sales tax payable, unredeemed gift certificates
● Owners' Equity: contributed capital, retained earnings
Bikram Yoga Natick
● Assets: cash, yoga mats, prepaid expenses
● Liabilities: accounts payable, long term debt
● Owner's Equity: contributed capital, retained earnings
1.2 Basic Transactions and the Equation
2:15:48
Transactions affect the accounting equation, like a loan, purchase, selling merchandise, and
paying invoices. All transactions affect the balance sheet — an investment of cash equals equity
and assets.
Cash: can mean physical currency or money in an account — physical, ETF, writing a check,.
Non-Cash Transaction: Buying something on credit terms, so payment isn’t require
immediately.
Inventory and equipment purchase: If you buy a machine with cash, the assets “go down”
because of the cash going out, but immediately increase as well because the equipment value
,is recorded.
If bought on credit, the assets go up from the equipment value and liabilities go up to match.
Revenue and Expenses
Revenue: Is equity, value generated from a sale of goods/services yields revenue.
● Revenue is not an asset
● Cash received is an asset, while revenue is considered equity.
Expense transaction
Costs associated with providings goods/services, yield a decrease in equity (it’s no longer a
resource that provides future benefit) that’s equal to the cost you pay to acquire it.
The cost of the product purchased would have been previously recorded in the inventory
account. When it’s sold, an asset (inventory) would have decreased by the cost of the product.
The reduction in assets is an expense related to the sale of the product and expenses decrease
owners' equity.
Cash Receipt and Revenue
First, the cash receipt of a $25 sale increases assets (cash) by $25. The sale also increases
revenue by $25, which increases owners' equity.
Expense and Outflow of Inventory
The sale of a $25 product decreases assets (inventory) by $25 and because the cost of goods
sold is an expense, it decreases owners' equity by $25.
Matching Principle: Requires that a company match its expenses to the related revenues in
the accounting period to which they relate.
● When you sell something, you record the revenue and the expense (associated with the
cost of purchasing inventory) in the same period.
Buying and Selling on Credit
Accounts Payable: The obligation to pay in the future is recorded as a liability.
, Buying on credit:
● At the time of the purchase, inventory is an asset, so assets increase by $500. The
obligation to pay within 30 days is a liability, so liabilities increase by $500.
● 30 days later, at the time of the payment, cash is an asset, so the payment in cash
decreases assets by $500. The obligation to pay was a liability, so the payment in cash
decreases liabilities by $500.
Selling on credit:
● Cash Accounting: Transactions are recorded when cash changes hands, usually used
by small businesses.
● Accrual Accounting: Revenue is recognized in the period in which the merchandise is
delivered, when it is “earned and realized.”
Realization principle: If the business has performed the work/service/goods and can
reasonably expect to receive cash, it can recognize the revenue in that period.
● If you think the customer might not pay, you’ve delivered goods they didn’t agree to pay
for, etc., then don’t recognize it until it’s more certain.
Expenses should also be recognized in the same period in which the revenues they generate
are recognized.
If a good worth $250 is sold for $500 on credit, then recognize revenue at the time of sale —
$500 assets in AR, $500 equity in revenue.
The expense is also recognized, so $250 less assets (inventory value) and $250 in inventory
that is no longer available to the business as a resource.
The matching principle dictates that expenses should be recognized when the revenue is
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