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4. How Transactions Impact the Accounting Equation

The preceding balance sheet for Edelweiss was static. This means that it represented the financial condition at the noted date. But, each passing transaction or event brings about a change in the overall financial condition. Business activity will impact various asset, liability, and/or equity accounts; but, they will not disturb the equality of the accounting equation. So, how does this happen? To reveal the answer to this question, let's look at four specific transactions for Edelweiss Corporation. You will see how each transaction impacts the individual asset, liability, and equity accounts, without upsetting the basic equality of the overall balance sheet.

4.1. Edelweiss Collects an Account Receivable

If Edelweiss Corporation collected $10,000 from a customer on an existing account receivable (i.e., not a new sale, just the collection of an amount that is due from some previous transaction), then the balance sheet would be revised as follows:

EDELWEISS CORPORATION Balance Sheet December 31, 20X3 (before indicated transaction)

EDELWEISS CORPORATION Balance Sheet December 31, 20X3 (after indicated transaction)

Assets

Assets

Cash

$ 25,000

+ $10,000

Cash

$ 35,000

Accounts receivable

50,000

- $10,000

Accounts receivable

40,000

Inventories Land Building Equipment Other assets

35,000

125,000

400,000

250,000

10,000

Inventories Land Building Equipment Other assets

35,000 125,000

400,000 250,000

10,000

Total assets

$895,000

+ $0

Total assets

$895,000

Liabilities

Accounts payable Loans pay able

$ 50,000 125,000

Liabilities

Accounts payable Loans pay able

$ 50,000

125,000

Total liabilities

$175,000

+ $0

Total liabilities

$175,000

Stockholders' equity

Capital stock Retained earnings

$120,000 600,000

Stockholders' equity

Capital stock Retained earnings

$120,000

600,000

Total stockholders' equity

720,000

+ $0

Total stockholders' equity

720,000

Total liabilities and equity

$895 000

Total liabilities and equity

$895 000

The illustration plainly shows that cash (an asset) increased from $25,000 to $35,000, and accounts receivable (an asset) decreased from $50,000 to $40,000. As a result total assets did not change, and liabilities and equity accounts were unaffected. Thus, assets still equal liabilities plus equity.

4.2. Edelweiss Buys Equipment With Loan Proceeds

If Edelweiss Corporation purchased $30,000 of equipment, agreeing to pay for it later (i.e. taking out a loan), then the balance sheet would be further revised as follows.

EDELWEISS CORPORATION Balance Sheet December 31, 20X3 (before indicated transaction)

EDELWEISS CORPORATION Balance Sheet December 31, 20X3 (after indicated transaction)

Assets

Cash

Accounts receivable

Inventories

Land

Building

$ 35,000 40,000 35,000

125,000

400,000

Assets

Cash

Accounts receivable

Inventories

Land

Building

$ 35,000 40,000 35,000

125,000 400,000

Equipment

250,000

+ $30,000

Equipment

280,000

Other assets

10,000

Other assets

10,000

Total assets

$895 000

+ $30,000

Total assets

$925 000

Liabilities

Accounts payable

$ 50,000

Liabilities

Accounts payable

$ 50,000

Loans payable

125,000

+ $30,000

Loans payable

155,000

Total liabilities Stockholders' equity

Capital stock Retained earnings

$120,000 600,000

$175,000

Total liabilities Stockholders' equity

Capital stock Retained earnings

$120,000

600,000

$205,000

Total stockholders' equity

720,000

+ $0

Total stockholders' equity

720,000

Total liabilities and equity

$895 000

+ $30,000

Total liabilities and equity

$925 000

This illustration shows that equipment (an asset) increased from $250,000 to $280,000, and loans payable (a liability) increased from $125,000 to $155,000. As a result, both total assets and total liabilities increased by $30,000, but assets still equal liabilities plus equity.

 
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