Edelweiss Provides Services to a Costumer on Account
What would happen if Edelweiss Corporation did some work for a customer in exchange for the customer's promise to pay $5,000? This requires further explanation; try to follow this logic closely! You already know that retained earnings is the income of the business that has not been distributed to the owners of the business. When Edelweiss Corporation earned $5,000 (which they will collect later) by providing a service to a customer, it can be said that they generated revenue of $5,000. Revenue is the enhancement to assets resulting from providing goods or services to customers. Revenue will bring about an increase to income, and income is added to retained earnings. Can you follow that?
As you examine the balance sheet on the top of the next page, notice that accounts receivable and retained earnings went up by $5,000 each, indicating that the business has more assets and more retained earnings. And, guess what: assets still equal liabilities plus equity.
Edelweiss Pays Expenses With Cash
It would be nice if you could run a business without incurring any expenses. However, such is not the case. Expenses are the outflows and obligations that arise from producing goods and services. Imagine that Edelweiss paid $3,000 for expenses. The lower set of balance sheets on the following page shows this impact.
Generalizing About the Impact of Transactions
There are countless types of transactions that can occur, and each and every transaction can be described in terms of its impact on assets, liabilities, and equity. What is important to know is that no transaction will upset the fundamental accounting equation of assets = liabilities + owners' equity.
Services to a customer on account:
|
EDELWEISS CORPORATION Balance Sheet December 31, 20X3 (before indicated transaction) |
EDELWEISS CORPORATION Balance Sheet December 31, 20X3 (after indicated transaction) |
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|
Assets Cash |
$ 35,000 |
Assets Cash |
$ 35,000 |
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|
Accounts receivable |
40,000 |
+ $5,000 |
Accounts receivable |
45,000 |
||
|
Inventories Land Building Equipment Other assets |
35,000 125,000 400,000 280,000 10,000 |
Inventories Land Building Equipment Other assets |
35,000 125,000 400,000 280,000 10,000 |
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|
Total assets |
$925 000 |
+ $5,000 |
Total assets |
$930 000 |
||
|
Liabilities Accounts payable Loans payable |
$ 50,000 155,000 |
Liabilities Accounts payable Loans payable |
$ 50,000 155,000 |
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|
Total liabilities |
$205,000 |
+ $0 |
Total liabilities |
$205,000 |
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|
Stockholders' equity Capital stock |
$120,000 |
Stockholders' equity Capital stock |
$120,000 |
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|
Retained earnings Total stockholders' equity |
600,000 |
720,000 |
+ $5,000 + $5,000 |
Retained earnings Total stockholders' equity |
605,000 |
725,000 |
|
Total liabilities and equity |
$925,000 |
Total liabilities and equity |
$930,000 |
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Pays expenses:
|
EDELWEISS CORPORATION Balance Sheet December 31, 20X3 (before indicated transaction) |
EDELWEISS CORPORATION Balance Sheet December 31, 20X3 (after indicated transaction) |
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|
Assets |
Assets |
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|
Cash |
$ 35,000 |
- $3,000 |
Cash |
$ 32,000 |
||
|
Accounts receivable Inventories Land Building Equipment Other assets |
45,000 35,000 125,000 400,000 280,000 10,000 |
Accounts receivable Inventories Land Building Equipment Other assets |
45,000 35,000 125,000 400,000 280,000 10,000 |
|||
|
Total assets |
$930,000 |
- $3,000 |
Total assets |
$927 000 |
||
|
Liabilities Accounts payable Loans payable |
$ 50,000 155,000 |
Liabilities Accounts payable Loans payable |
$ 50,000 155,000 |
|||
|
Total liabilities |
$205,000 |
+ $0 |
Total liabilities |
$205,000 |
||
|
Stockholders' equity Capital stock |
$120,000 |
Stockholders' equity Capital stock |
$120,000 |
|||
|
Retained earnings |
605,000 |
- $3,000 |
Retained earnings |
602,000 |
||
|
Total stockholders' equity |
725,000 |
- $3,000 |
Total stockholders' equity |
722,000 |
||
|
Total liabilities and equity |
$930 000 |
Total liabilities and equity |
$927 000 |
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Distinguishing Between Revenue and Income
In day-to-day conversation, some terms can often be used casually and without a great deal of precision. Words may be treated as synonymous, when in fact they are not. Such is the case for the words "income" and "revenue." Each term has a very precise meaning, and you should accustom yourself to the correct usage. It has already been pointed out that revenues are enhancements resulting from providing goods and services to customers. Conversely, expenses can generally be regarded as costs of doing business. This gives rise to another "accounting equation":
Revenues - Expenses = Income
Revenue is the "top line" amount corresponding to the total benefits generated from business activity. Income is the "bottom line" amount that results after deducting the expenses from revenue. In some countries, revenue is also referred to as "turnover."
