2.1. Capital acquisition transaction analysis

1) Capital acquisition of $3,500 is an asset source transaction. The transaction acts to increase assets (Cash) and equity (Contributed Capital).

Note: While looking at the scheme below ignore account titles that are unfamiliar at this time; they will be explained later when introduced:

Illustration 2: Effect of capital acquisition

2.2. Recording revenue on account transaction analysis

2) According to the accrual accounting rules, the $2,800 of revenue should be recognized in 20X6, although only $2,000 of this amount is collected in that period. As you can see, revenue recognition ($2,800) and cash collection ($2,000) do not go side by side (they are separated in time). In our case, Mr. Candely's productive activity has resulted in an asset increase of $2,800. This asset is called an account receivable.

Accounts receivable refer to amounts of future cash receipts that are due from customers (i.e., amounts to be collected in the future). Accounts receivable are shown on the asset side of the balance sheet.

The transaction of revenue recognition is an asset source transaction:

Illustration 3: Effect of recognizing accounts receivable and revenue

Note that the contracts for $1,600 of consulting services to be performed in 20X7 are not recognized in 20X6. The reason is that revenue can be recorded only when services have been provided. Thus we will leave this $1,600 without recording until Mr. Candely provides services in 20X7.

2.3. Cash collection transaction analysis

3) Now we will record the collection of $2,000 in cash. Because we have already recorded that amount as an account receivable (Event No. 2), we just need to transfer the amount from the account receivable to cash $2,000. The Cash account will increase and the Account Receivable account will decrease. This is an asset exchange transaction.

Asset exchange transactions occur when only asset accounts are engaged in a transaction. For example, collection of cash on accounts receivable is an asset exchange transaction. Total assets remain unchanged after such transactions.

Illustration 4: Effect of cash collection

Also make certain to note that in this transaction revenue is not affected. The revenue recognition of $2,800 already happened when we recorded the increase in the account receivable (Event No. 2). If we had recorded revenue again when we received cash, then the revenue would have been recorded twice. This would not be in accordance with generally accepted accounting principles.

Not a member?

See why people join our
online accounting course: