Ch 3 accounting equation & classification

ACC 106

Chapter 3

Accounting Equation and Classification

Learning Objectives:After going through this chapter, you should be able to: Define & explain the balance sheet, assets, liabilities and owner’s equity.

Define & understand the use of the accounting equation in analyzing transactions

Define revenue & expenses

Identify the relationship of profit to the to the accounting equation

Show the effect of the transaction on the accounting equation

Identify the movement of stock

IntroductionBusiness transaction- is an event or happening that affects the financial position of a business, &

requires recording- Usually involves:

2 @ more parties, such as a seller & a buyer. Some exchange of goods @ services between the 2 parties Some kind of payment which may be in the form of cash or things in value,

immediately @ at some future date

- It can be classified into 5 categories as follows:a) Assets

b) Owner’s equity

c) Liabilities

d) Revenues

e) Expenses

Recorded in the Balance Sheet

Recorded in the Trading Profit & Loss

The Balance Sheet Presentation Sole Proprietorship

Dr. Balance Sheet as at 31 December 20xx Cr.

Assets: RM Owner’s equity: RM

Fixed Assets: Opening Capital xxx

Land & Building xxx Add: Net Profit xxx

Machinery xxx Less: Drawings (xxx)

xxx xxx

Current Asset: Liabilities:

Stock xxx Long Term Liabilities xxx

Debtors xxx Current Liabilities:

Cash xxx Creditors xxx

TOTAL LIABILITIES

TOTAL ASSETS XXX & OWNER’S EQUITY XXX

BS (Assets = Owner’s Equity+Liabilities)Assets Owner’s Equity Liabilities

- Economic resources which are of the value to the business

- are property own by the business

- It is represents owner-supplied fund to the business for the acquisitions of assets for the business

- It is financial obligation of the business to the external parties

- 2 types of assets:

i) Fixed Assets/ Non Current Assets

- assets acquired / bought not for resale and it is to be used in the running of the business.Tangible Fixed Assets - i.e Land&Building,MachineryIntangible Fixed Assets- i .e Goodwill,TrademarkInvestment – i.e Fixed deposit

ii)Current Assets – assets that are either cash or those that can be converted in to cash i.e debtors,stock.

- it is financial obligation of the business to the owner.

Owner’s Equity

= Capital + Profit/ (-) (Losses) - drawings

- 2 types of liabilities:

i) Long term Liabilities- it is an amount owing by

the business that have repayment period > 1 yr

- i.e Long term loan

ii) Current liabilities- it is an amount owing by

the business that is to be paid in within 1 yr

- i.e Creditors, bank overdraft

(See pg14 textbook)

- All assets that a business owns have to be supplied by the owner and the external parties

- Therefore, the relationship between The assets and the equities ( that of the owner and the external parties) of the business can be expressed in the following equation:

- The above equation is known as basic accounting equation or the balance sheet equation.

-The accounting equation A = OE + L is expressed in a financial statement known as the Balance Sheet.

- Balance Sheet is an accounting report that shows all the assets, liabilities & owner’s equity of an organization at a particular time.

Accounting Equation (A = OE + L )

Assets = Owner’s Equity + Liabilities

A = OE + L

OE = A – L

The Balance Sheet & The Effects of Business Transaction

2.5.1 The Introduction of Capital

On 1st January 20XX, Beckham started business & invested RM50,000 cash to the business. i)The Balance sheet would appear as follows:

Beckham Enterprise

Dr. Balance Sheet as at 01 January 20XX Cr.


Cash 50,000 Opening Capital 50,000

ii)The effect on the accounting equation

Date Assets(A) = Owner’s Equity(OE) + Liabilities(L)

2006

01/01

Cash increase by RM50,000

Effect: Increase A

Capital increase by RM50,000

Effect:Increase OE

-

Effect: NO

The Balance Sheet & The Effects of Business Transaction (Cont’d)

2.5.2 The Transfer of Cash to a Bank Account

On 2nd January 20XX, the business opens bank account & deposit RM45,000 of the cash into the account. i)The Balance sheet would appear as follows:

Beckham Enterprise



Cash 5,000 Capital 50,000

Bank 45,000 50,000 50,000



2006

02/01

Cash decrease to 5,000

Bank increase by 45,000

Increase & Decrease A(=)

Capital still = 50,000

OE still equal with A

-

NO effect


2.5.3 The Borrowing from Bank

On 3rd January 200XX, the business borrows from bank amount RM30,000 and deposited the loan into bank. i)The Balance sheet would appear as follows:

Beckham Enterprise



Cash 5,000 Capital 50,000

Bank 75,000 Long Term Liability:Loan30,000 80,000 80,000



2006

03/01

Bank increase by 30,000

Increase A to 80,0000 & Bank to 75,000


No effect

Loan increase by 30,000

Increase L


2.5.4 Purchase of Fixtures & Fittings by cheque

On 4th January 20XX, the business purchase Fixtures & Fittings by cheque amount RM10,000. i)The Balance sheet would appear as follows:

Beckham Enterprise



Fixtures&Fittings 10,000 Capital 50,000

Cash 5,000 Long Term Liabilities:

Bank 65,000 Long Term Loan 30,000 80,000 80,000


2006

04/01

F&F increase by 10,000

Bank decrease to 65,000

Increase & decrease A (=)


No effect

Loan still = 30,000

No effect



2.5.5 Purchase of Stock of Goods on Credit

On 5th January 20XX, the business purchase Stock of Goods on credit amount RM18,000.

i)The Balance sheet would appear as follows:

Beckham Enterprise



Fixtures&Fittings 10,000 Capital 50,000

Cash 5,000 Long Term Liabilities:

Bank 65,000 Long Term Loan 30,000

Stock 18,000 Creditors 18,000

98,000 98,000



20XX

05/01

Stock increase by 18,000

Increase A to 98,000


No effect

Creditor increase by 18,000

Increase L to 48,000


2.5.6 Payment to suppliers by cheque

On 6th January 20XX, the business paid a cheque amount RM8,000 to its supplier.

The effect on the accounting equation


20XX

06/01

Bank decrease by 8,000

Decrease A to 90,000


No effect

Creditor decrease by 8,000

Decrease L to 40,000


2.5.6 Payment to suppliers by cheque

The Balance sheet would appear as follows:

Beckham Enterprise



Fixed Assets: Capital 50,000

Fixtures&Fittings 10,000

Liabilities:

Current Assets: Long Term Liabilities:

Cash 5,000 Long Term Loan 30,000

Bank 57,000 Current Liabilities:

Stock 18,000 Creditors 10,000

90,000 90,000

Trading Profit & Loss Presentation

Beckham Enterprise

Trading and Profit and Loss Accounts for the year ended 31st December 20xx

Opening Stock RM 14,000 Sales RM100,000

Purchases 60,000

74,000

Less: Closing Stock (14,000)

Cost of Goods Sold 60,000

Gross Profit c/d 40,000

100,000 100,000

Telephone & Electricity 200 Gross Profit b/d 40,000

Salary 5,000 Rent received 800

Stationery 100 Commission Received 500

Net Profit 36,000

41,300 41,300

TPL(P) = Revenue(R) – Expenses(E)

Revenue Expenses

- is the gross increase in owner’s equity resulting from business activities entered into for the purpose of earning income

- are the cost of assets consumed or services used in the process of earning revenue.

- i.e sales of goods, services, commission received interest received etc.

- i.e purchased of goods, salary, interest expense, rent expense, discount allowed etc.

- Profit is the differences between revenue & expenses

- the relationship of profit to the accounting equation is that profit belongs to owner of the business, so it should be added to the capital of the business.

A = OE + P + L , A = OE + R – E + L, A + E = OE + R + L

See pg 54 textbook

Effect of transactions on the expanded accounting equation

Date (A) + (E) = (OE) + (R) + (L)

Assets Expenses Owner’s Equity Revenue Liabilities

Jan 06

F&F 10,000

Cash 4,800

Bank 57,000

Stock 18,000

Insurance 200 Capital 50,000 Loan 30,000

Creditor 10,000

Jan 07

F&F 10,000

Cash 4,800

Bank 57,350

Stock 18,000

Insurance 200 Capital 50,000 Commission 350 Loan 30,000

Creditor 10,000

Jan 08

F&F 10,000

Cash 4,700

Bank 57,350

Stock 18,000

Insurance 200

Electricity 100

Capital 50,000 Commission 350 Loan 30,000

Creditor 10,000

Jan 09

F&F 10,000

Cash 5,100

Bank 57,350

Stock 18,000

Insurance 200

Electricity 100

Capital 50,000 Commission 350

Rent 400

Loan 30,000

Creditor 10,000

Effect of transactions on the expanded accounting equation

Accounting for stock

Movement of stock

1. Increase in Stock Effect of transaction

Accounts

Purchase- goods bought by the business for the purpose of resale

Purchase Expense increase

Purchases A/c

Purchases Return (Return Inward) – goods return by buyer

Sales revenue decrease

Return inward A/c

2. Decrease in Stock Effect of transaction

Accounts

Sales – sale of goods with prime intention of resale

Sales revenue increase

Sales A/c

Sales Return (Return outward) – goods return to supplier

Purchase Expense decrease

Return outward A/c

Purchase & Sales of Goods

Purchase and sales of goods can be divided into 2 categories:

Transactions Accounts Involved

a. Cash Purchase Cash Account & Purchase Account

b. Credit Purchase Creditors Account & Purchases Account

c. Cash Sales Cash Account & Sales Account

d. Credit Sales Debtors Account & Sales Account

Purchase & Sales of Goods

Example: Purchase & Sales Return

Purchase & Sales Return

Date (A) + (E) = (OE) + (R) + (L)


Jan 10

F&F 10,000

Cash 5,100

Bank 57,350

Stock 18,000

Insurance 200

Electricity 100

Purchases 3,000


Rent 400

Loan 30,000

Creditor 13,000

Jan 11

F&F 10,000

Cash 5,100

Bank 57,350

Stock 18,000

Insurance 200

Electricity 100

Purchases 2,900


Rent 400

Loan 30,000

Creditor 13,000

Jan 12

F&F 10,000

Cash 5,100

Bank 57,350

Stock 18,000

Debtor 1,000

Insurance 200

Electricity 100

Purchases 2,900


Rent 400

Sales 1,000

Loan 30,000

Creditor 13,000

Jan 13

F&F 10,000

Cash 5,100

Bank 57,350

Stock 18,000

Debtor 1,000

Insurance 200

Electricity 100

Purchases 2,700


Rent 400

Sales 1,000

Loan 30,000

Creditor 12,800

Jan 14

F&F 10,000

Cash 5,100

Bank 57,350

Stock 18,000

Debtor 900

Insurance 200

Electricity 100

Purchases 2,700


Rent 400

Sales 900

Loan 30,000

Creditor 12,800

Date (A) + (E) = (OE) + (R) + (L)


Purchase & Sales Return

Ch 3 accounting equation & classification

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