3.4 Analyze Business Transactions Using the Accounting Equation and Show the Impact of Business Transactions on Financial Statements
Transaction Analysis Framework
To properly analyze transactions, follow this systematic approach:
- Identify the transaction and source document
- Determine accounts affected (at least two)
- Classify each account (asset, liability, equity, revenue, expense)
- Determine increase or decrease for each account
- Apply debit/credit rules
- Verify the equation balances
- Identify PCN accounts
Comprehensive Transaction Examples
Let's analyze a series of transactions for Marie's restaurant, showing the impact on the accounting equation and financial statements.
Starting Position
Balance Sheet, November 1, 2024:
Assets = Liabilities + Equity
€10,000 = €0 + €10,000
(Cash) (Share Capital)
Transaction 1: Purchase Equipment
Transaction: Restaurant purchases €15,000 kitchen equipment, paying €5,000 cash and signing a note for €10,000.
Analysis:
- Equipment (Asset) increases: +€15,000
- Cash (Asset) decreases: -€5,000
- Notes Payable (Liability) increases: +€10,000
Equation Impact:
Before: €10,000 = €0 + €10,000
After: €20,000 = €10,000 + €10,000
(€15,000 equipment + €5,000 cash)
PCN Accounts:
- Debit: 223000 Equipment (Class 2) €15,000
- Credit: 510000 Cash (Class 5) €5,000
- Credit: 120000 Notes Payable (Class 1) €10,000
Financial Statement Impact:
- Balance Sheet: Assets increase (equipment), Cash decreases, Liabilities increase
- Income Statement: No impact (no revenue or expense)
Transaction 2: Purchase Inventory on Credit
Transaction: Restaurant purchases €2,000 of food inventory on credit from supplier.
Analysis:
- Inventory (Asset) increases: +€2,000
- Accounts Payable (Liability) increases: +€2,000
Equation Impact:
Before: €20,000 = €10,000 + €10,000
After: €22,000 = €12,000 + €10,000
PCN Accounts:
- Debit: 321000 Inventory (Class 3) €2,000
- Credit: 400000 Accounts Payable (Class 4) €2,000
Financial Statement Impact:
- Balance Sheet: Assets increase, Liabilities increase
- Income Statement: No impact (inventory is asset, not expense until sold)
Transaction 3: Provide Services for Cash (with VAT)
Transaction: Restaurant provides catering services for €1,000, receiving cash. VAT rate is 17%.
Analysis:
- Cash (Asset) increases: +€1,170 (€1,000 + €170 VAT)
- Service Revenue (Revenue, increases Equity) increases: +€1,000
- VAT Payable (Liability) increases: +€170
Equation Impact:
Before: €22,000 = €12,000 + €10,000
After: €23,170 = €12,170 + €11,000
(Revenue increases equity)
PCN Accounts:
- Debit: 510000 Cash (Class 5) €1,170
- Credit: 701000 Service Revenue (Class 7) €1,000
- Credit: 430000 VAT Payable (Class 4) €170
Financial Statement Impact:
- Balance Sheet: Assets increase, Liabilities (VAT) increase, Equity increases
- Income Statement: Revenue increases (affects net income)
Transaction 4: Pay Salaries
Transaction: Restaurant pays €3,000 salaries to employees.
Analysis:
- Cash (Asset) decreases: -€3,000
- Salaries Expense (Expense, decreases Equity) increases: +€3,000
Equation Impact:
Before: €23,170 = €12,170 + €11,000
After: €20,170 = €12,170 + €8,000
(Expense decreases equity)
PCN Accounts:
- Debit: 620000 Salaries Expense (Class 6) €3,000
- Credit: 510000 Cash (Class 5) €3,000
Financial Statement Impact:
- Balance Sheet: Assets decrease, Equity decreases
- Income Statement: Expense increases (decreases net income)
Transaction 5: Pay Accounts Payable
Transaction: Restaurant pays €1,500 to supplier for previous inventory purchase.
Analysis:
- Cash (Asset) decreases: -€1,500
- Accounts Payable (Liability) decreases: -€1,500
Equation Impact:
Before: €20,170 = €12,170 + €8,000
After: €18,670 = €10,670 + €8,000
PCN Accounts:
- Debit: 400000 Accounts Payable (Class 4) €1,500
- Credit: 510000 Cash (Class 5) €1,500
Financial Statement Impact:
- Balance Sheet: Assets decrease, Liabilities decrease
- Income Statement: No impact (payment of liability, not expense)
Summary of Transaction Impacts
| Transaction | Assets | Liabilities | Equity | Revenue | Expenses |
|---|---|---|---|---|---|
| 1. Purchase Equipment | +€10,000 | +€10,000 | - | - | - |
| 2. Purchase Inventory | +€2,000 | +€2,000 | - | - | - |
| 3. Provide Services | +€1,170 | +€170 | +€1,000 | +€1,000 | - |
| 4. Pay Salaries | -€3,000 | - | -€3,000 | - | +€3,000 |
| 5. Pay Payable | -€1,500 | -€1,500 | - | - | - |
| Net Change | +€8,670 | +€670 | -€2,000 | +€1,000 | +€3,000 |
Final Equation:
€18,670 = €10,670 + €8,000
Assets = Liabilities + Equity ✓
Luxembourg VAT Considerations
When analyzing transactions in Luxembourg, always consider VAT:
Sales Transactions:
- Record revenue (net of VAT)
- Record VAT Payable (430000)
- Total cash/receivable includes VAT
Purchase Transactions:
- Record expense/asset (net of VAT if recoverable)
- Record VAT Recoverable (431000) if business can recover VAT
- Total cash/payable includes VAT
Think It Through
A Luxembourg business sells goods for €5,000 (excluding VAT) on credit. VAT rate is 17%. Analyze this transaction showing: a) Accounts affected b) Debit/credit entries c) Impact on accounting equation d) PCN account numbers