QUESTION:

Cash is the only asset that appears in the cash-basis accounting equation.

o True

o False

1. Consider the following two cash-basis equations: = 1 2 Assets/Resources Cash Shareholders' Equity (SHE) Contributed Capital Earned Capital = + a. The second equation simply portrays assets (or resources) from the first equation as containing one component, Cash, and Shareholders' Equity from the first equation as containing two components: 1) contributed capital, and 2) earned capital. b. Owners contribute capital to the business, with the expectation that managers will generate profits. Think of this as external capital (i.e., capital from the outside). c. In contrast, the firm generates earned capital from transactions with customers and vendors, which create revenues and expenses, respectively. So, earned capital is non-owner capital generated by using the firm's internal resources. Revenues minus expenses equal profit or loss. If the firm is profitable, then earned capital grows, and if the firm is unprofitable, then earned capital shrinks. Note that profits represent potential dividend payments to shareholders (i.e., a return on their investments). i. Key is that earned capital requires transactions with non-owner parties (i.e., arms-length transactions). ii. For now, think of earned capital as the cumulative, life-to-date profit or loss for the business. And profit or loss is simply the difference between revenues and expenses