MAT 200 Module 2 The Accounting Equation and Transactions Example

Every Transaction Has Two Sides: Applying the Accounting Equation to a Bike Shop's First Ten Events

Student Name

Business Administration Program, Aspen University

MAT 200: Principles of Accounting I

Instructor Name

Month Day, Year

Every Transaction Has Two Sides: Applying the Accounting Equation to a Bike Shop's First Ten Events

Module 1 identified who will use Prairie Spoke Cycles' accounting information. This module records what actually happened in the shop's first month, using the accounting equation. The equation is simple: the total of assets matches liabilities and owner's equity added together. Assets are what the business owns, liabilities are what it owes to others and owner's equity is the owner's claim on what remains. Every transaction changes at least two parts of the equation, and the equation always balances. This paper explains why and applies it to ten transactions.

Where Double Entry Came From

Sangster (2016) examined how double entry bookkeeping began. He argued that it emerged in the thirteenth century in the banks of Florence and other Italian cities, where bankers needed a reliable record of amounts owed by and to each customer, often across many transactions and transfers. Recording each transaction twice, once as a debit and once as a credit, gave bankers a check on their records and a clear statement of each customer's position. The method spread to merchants and was later described in print by Luca Pacioli in 1494.

Why People Keep Records at All

Basu and Waymire (2006) took a longer view. They argued that recordkeeping, including accounting, grew out of the human need to track reciprocal exchange: who gave what to whom and what is owed in return. As trade extended beyond small groups of people who knew one another, records allowed people to cooperate with those they could not monitor directly. Accounting, on this view, is a tool that makes trust between strangers possible. That is exactly what Prairie Spoke needs with its bank and supplier.

The Mathematics Behind the Balance

Ellerman (1985) showed that double entry bookkeeping can be understood as an application of a simple algebraic structure. Each transaction is recorded as a pair of equal and opposite entries, so the total of debits always equals the total of credits. Because of this structure, if the equation balances before a transaction, it must balance after. The accounting equation is not a coincidence; it is built into the method.

The First Ten Transactions

1. Sam invests $85,000 cash in the business. 2. The shop borrows $60,000 from the bank. 3. It buys twelve e-bikes and tools for $48,000 cash. 4. It buys inventory of bikes and parts for $42,000, paying $22,000 cash and owing $20,000 to the supplier. 5. It pays $6,000 for three months' rent in advance. 6. It sells bikes and repairs for $9,500 cash, with inventory costing $5,800 leaving the shop. 7. It performs a $1,200 repair job for a cycling club on account. 8. It pays $3,100 in wages. 9. The club pays $700 of what it owes. 10. Sam withdraws $2,000 for personal use.

Three Transactions Students Often Get Wrong

Three of the ten deserve a closer look. In transaction 5, the shop pays $6,000 for three months of rent in advance. This is not yet an expense; it is an asset, prepaid rent, because the shop has paid for something it has not used. Each month, a third of it will become rent expense, which Module 4 covers. In transaction 7, the shop earns $1,200 for a repair but receives no cash. Revenue increases equity, and the club's promise to pay is an asset, accounts receivable. In transaction 10, Sam's $2,000 withdrawal reduces equity but is not an expense of running the shop. Treating it as an expense would understate the shop's profit and mislead the bank.

What the Equation Does Not Show

The equation records events in dollars at the amounts actually paid or owed. It does not show what the e-bikes would sell for today, the value of Sam's reputation among local riders or the skill of the mechanics. Those matter to the shop's future, but they are not recorded because they cannot be measured reliably from transactions. Users reading the statements should understand that the balance sheet is a record of transactions, not an appraisal of the business.

From the Equation to Debits and Credits

The table above uses plus and minus signs. In practice, accountants record the same effects as debits and credits in journals and ledgers, which Module 3 covers. Increases in assets are debits; increases in liabilities and equity are credits. Because each transaction's debits equal its credits, the equation stays in balance, just as Ellerman's treatment shows.

Reading the Result

After ten transactions, the shop has $164,800 in assets, financed by $80,000 owed to the supplier and the bank and $84,800 of owner's equity. Equity started at $85,000; it rose by the $3,700 gross margin on sales and $1,200 of repair revenue on account, fell by $3,100 of wages and fell by Sam's $2,000 withdrawal. Two lessons stand out for Sam. First, cash fell from $145,000 after the investment and loan to $74,100, mostly because money became equipment and inventory, not because the shop lost money. Second, the $1,200 repair job raised equity before any cash arrived, which is why profit and cash are not the same. Third, the shop owes $80,000, and the supplier's $20,000 is due within thirty days. Sam's $74,100 in cash covers it comfortably today, but the bank will watch that relationship closely each quarter, because a shop that runs short of cash can fail even while it earns a profit. Watching the equation month by month lets Sam see that pressure coming.

Conclusion

Sangster shows that double entry was invented to keep reliable track of obligations, Basu and Waymire show that recordkeeping makes trust possible and Ellerman shows why the equation always balances. Applied to Prairie Spoke's first month, the equation gives Sam a clear picture of what the shop owns, owes and has earned.

References

Basu, S., & Waymire, G. B. (2006). Recordkeeping and human evolution. Accounting Horizons, 20(3), 201-229. https://doi.org/10.2308/acch.2006.20.3.201

Ellerman, D. P. (1985). The mathematics of double entry bookkeeping. Mathematics Magazine, 58(4), 226-233. https://doi.org/10.1080/0025570X.1985.11977191

Sangster, A. (2016). The genesis of double entry bookkeeping. The Accounting Review, 91(1), 299-315. https://doi.org/10.2308/accr-51115