Topic 2 Accounting Equation

ABAB113
Business Accounting
Semester 1 2014/2015
1
Course Outcome 2
2
Illustrate the effect of various transactions on the
accounting equation, Assets = Liabilities + Equity,
prepare the accounting journals, ledgers, debtors
and creditors control accounts and record business
transactions in a complete accounting cycle, and
prepare the financial statements.

Basic Accounting Equation
3
The resources
owned by a
business
Assets = Liabilities + Equity/Capital
Basic Accounting Equation
4
The rights of the
creditors are the
debts of the
business.
Assets = Liabilities + Equity
Basic Accounting Equation
5
The rights of the
owners
Assets = Liabilities + Equity
Basic Accounting Equation
6
An asset is a tangible or intangible resource that is
owned or controlled by an accounting entity, and
which is expected to generate future economic
benefits (e.g. plant & machinery, office equipment,
inventories, trade receivables, cash).

A liability is a legal obligation to transfer assets or
provide services to another entity which arises
from some past transaction or event (e.g. loans,
trade payables).

Capital is the proprietors ownership interest in the
business or net resources of the business.

Example 1
A. Brown commenced business on the 1 January 20X2
with RM10,000 in cash:

A. Brown
Balance sheet at 1 J anuary 20X2
RM
Assets:
Cash 10,000
Less: liabilities 0
Capital 10,000
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On 2 January he bought goods for resale costing RM3,000
on credit:
A. Brown
Balance sheet at 2 J anuary 20X2
RM
Assets:
Cash 10,000
Inventories 3,000
13,000
Less: liabilities
Trade payables 3,000
Capital 10,000
8
Example 2
On 3 January he sold the goods on credit for RM4,000:
A. Brown
Balance sheet at 3 J anuary 20X2
RM
Assets:
Cash 10,000
Trade receivables 4,000
14,000
Less: liabilities
Trade payables 3,000
Capital 11,000
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Example 3
Analysis of transactions using accounting
equation
10
A business transaction is an economic event or
condition that directly changes an entitys financial
condition or its results of operations.
Refer to p.16




Expanded Accounting Equation
11
The Expanded Accounting Equation breaks out the
Owners Equity section into two components;
Revenues and Expenses.
Revenues from the sale of goods and services increase
equity, while expenses and drawings incurred in the
course of business decrease equity.
Drawings occur when the owner of the business take
whatever assets for his/her personal use such as cash,
goods etc.

Expanded Accounting Equation
12
Therefore, the accounting equation can be expanded
to assets equal liabilities plus equity plus revenues
minus expenses minus drawings.
If the business makes profit:
A = L + (Capital + Profit)
A = L + Capital + Revenue Expenses
A = L + Capital + Revenues Expenses Drawings
OR;
A + E = L + C + R

Revenue expenditure v capital expenditure
13
Capital - items that appear in the balance sheet
Revenue - items that appear in the income
statement.
Expenditure of the type which is to be matched against
the periods revenue and is used up in the period is
identified as revenue expenditure.
have no value at the end of the period to which it
relates.
for example, heat and light, rent, rates, etc.
Capital expenditure - amounts which it is appropriate to
carry forward as part of the next years opening
statement of financial position.
because it will be used over a number of periods and
contributes to several periods revenues.
Premises, motor vehicles, fixtures and fittings, etc.


Rules of debit and credit
14
Double-entry bookkeeping is a systematic method of
recording an enterprises transactions in a book
called the general ledger. Each page of the ledger is
split into two halves:
Left half debit side
Right half credit side
There is usually an account for every class of
expenditure, income, asset, and liability.
Rules of debit and credit
15
T-account
Account name
Date Description RM Date Description RM
1 Jan Bank 900
Rules of debit and credit
16
Debit and credit balances, and types/classes of
accounts
When the total amount of money on the debit side of an
account is greater than that on the credit side, the
account is said to have a debit balance. When the
reverse is the case, the account is said to have a credit
balance.
An account with a debit balance represents either
drawings, an asset (e.g. cash), an expense (including
purchases) or a loss.
An account with a credit balance represents either
capital, a liability, income (e.g. sales) or a gain.




Rules of debit and credit
17
Posting updating the accounting records with
transactions
3 steps
1. Determine the 2 accounts affected.
2. Consider the flow of value (when the value leaves an
account it is credited, when the value enters an
account it is debited).
3. Identify the money value that is transferring.

Which accounts do you debit and credit?
a) Bought office machinery in cash
b) Bought lorry for cash
c) A loan of RM200 is received by cheque from Earls
d) Paid stationery by cheque
e) Paid rates by cash
f) Sale of goods for RM100 cash on 3 Feb.
The value enters cash a/c (DEBIT) and leaves sales a/c (flow of
inventory out) (CREDIT).



Rules of debit and credit
18
Introduction to Financial Statements
19
After transactions have been recorded and
summarized, reports are prepared for users. The
accounting reports providing this information are
called financial statements.
Income statement/Statement of comprehensive income
Balance sheet/Statement of financial position
Cash flow statement

Introduction to Financial Statements
20
The income statement provides a summary of the results
of a business's trading activities during a given
accounting year. It shows the profit or loss for the year.
to enable users, such as the owner(s), to evaluate the
financial performance of a business.


21
The structure of income statement
ABC
Income statement for the year ended..
RM RM
Revenue X
Less: cost of sales/goods sold X
Gross profit X

Add: Other Income
Discount received X
X
Less: other costs and expenses -
Selling and distribution costs X
Administrative expenses X
Interest payable on loans X
X
Profit/(Loss) for the period X

Introduction to Financial Statements
22
Balance sheet is a list of the assets, liabilities
and capital of a business at the end of a given
accounting year.
It provides information about the resources and
debts of the reporting entity. This enables users
to evaluate its financial position, in particular
whether the business is likely to be unable to pay
its debts.
The contents of balance sheet
1. Non-current assets
Items not specifically bought for resale
Items to be used in the production or distribution of
those goods normally sold by the business.
Durable goods that usually last for several years
There must be an intention to keep them for more than
one accounting year

Examples
Land and buildings; plant and machinery; motor vehicles;
office equipment; furniture, fixtures and fittings.
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The contents of balance sheet
2. Current assets:
Items that are normally kept by a business for less than
one accounting year.
The composition of each type of current asset is
usually continually changing.

Examples
Inventories, trade receivables, short term
investments, money in a bank cheque account and
in cash.
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The contents of balance sheet
3. Current liabilities
Debts owed by a business that are payable
within one year (often considerably less) of the
reporting period date; e.g. trade payables and
bank overdrafts.
4. Non-current liabilities
These are debts owed by a business that are not
due until after one year (often much longer) of
the reporting period date; e.g. loans and
mortgages.
5. Capital (Equity)
This refers to the amount of money invested in
the business by the owner(s).
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The structure of balance sheet
ABC Sdn Bhd
Balance sheet as at ...

Non-current assets
+
Current assets
=
Total assets

=

Equity and Reserves
+
Non-current liabilities
+
Current liabilities
=
Total equity and liabilities


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Introduction to Financial Statements
27
Cash flow statement
discloses net cash flow for a particular period.
lists out the various sources from which the business
receives cash and how the cash is spent i.e. the
liquidity of the business.
contains information about operating, investing and
financing activities.
further details to be revisited in Topic 5