The Accounting Equity

Owning and Owing

Introducing Jack

Jack has just been left $100,000 by a rich aunt and he has $10,000 in the bank.

He has always dreamt of running business of his own.

Accountants advice

Jack is no fool and goes to his accountant, Frank, who suggests to Jack he open a bank account for the business and put the $110,000 in it.

This way his personal affairs will not get mixed up with his business.

Before buying the business

Before Jack visits the bank manager

Jack owns $110,000

Business owns $0

Smart Milk Bar

As soon as Jack opens the bank account in the name of Smart Milk Bar and puts the money into that account, the money belongs to the business.

So now…

The business owns the $110,000.If Jack wanted his money back, he would

have to sell the business.So the business can be said to owe

$110,000 to Jack.

The Accounting equation

The business owns the $110,000 in the bank

And it owes this $110,000 to Jack

What the business owns = what the business owes

Owning

Everything owned by the business is called an:

Asset

Assets

Any item:

– the business owns.

– that earns the business revenue e.g. stock for sale.

– the business has control over.

– that create a future economic benefit for the business.

Assets - examples

MoneyDebtor – who owe the business moneyStockDelivery TruckComputersShelving

Owing inside the business

The money the business owes to Jack is part of:

OWNER’S EQUITY

Owner’s Equity - examples

Capital – money put in the business by the owner

Drawings – money taken out of the business by the owner

Profit or Loss – made by the business

Owing outside the business

Any money owed to the Bank or suppliers is called

Liabilities

Liabilities - examples

LoansCreditors – suppliers of stock bought on

creditGST

Back to Smart Milk Bar

The left-hand side of the equation shows everything the business owns while the right-hand side shows everything the business owes.

Assets = Owner’s Equity

Bank $110,000 = Capital $110,000

What Jack does next

Jack finds a suitable shop to rent and decides to buy some goods for sale $50,000

Goods for sale are called STOCKThey are Assets because…

Stock are Assets because…

They are owned by the business.

They will be sold to earn revenue.

The Accounting Equations

Assets = Owner’s Equity

Bank $60,000 = Capital $110,000

Stock $50,000

And then…

Jack decides to buy the business a freezer from United Electric for $15,000.

United Electric agrees to wait a month for payment.

So the business owes United Electrical $15,000

The Accounting Equation

Assets = Liabilities + Owner’s Equity

Bank $60,000 = Creditor Capital $110,000

Stock $50,000 United Electric

Freezer $15,000 $15,000

What is Total Assets? What is Total Equities?

The Accounting Equation

Assets = Liabilities + Owner’s Equity

Bank $60,000 = Creditor + Capital $110,000

Stock $50,000 United Electric

Freezer $15,000 $15,000

Total Assets = $125,000 Total Equities = $125,000

The Accounting Equation

Every time Jack buys or sells some thing, the Accounting Equation changes.

If Jack sold his business, how much money could he get?

Selling up

Jack would get the value of the assets less what he owed to his Creditors.

Total Assets Less Liabilities = Capital

$125,000 - $15,000 = $110,000

Balance Sheet

This report:lists all the Assets, Liabilities & Owner’s

Equity.shows the Accounting Equation for the

business.shows the state of the business at a certain

point in time.calculated Total Assets & Total Equities.Is prepared once during the reporting period.

Balance Sheet

For the Smart Milk Bar as at 30th June 200X

Assets LiabilitiesBank 60,000 Creditor United Electric 15,000 Stock 50,000

Freezer 15,000

Owner’s Equity Capital

110,000

Total Assets 125,000 Total Equities125,000

Owner’s Equity

Assets

Bank

EquipmentDebtors (owe business money)

Stock (for sale)

Liabilities

Overdraft

Loan

GST Payable

Owner’s EquityCapital (What the owner put into

the business)

Net ProfitDrawings (What the owner takes

out of the business

The Total Assets must equal the Total Equities (Liabilities + Owner’s Equity)

Balance Sheet

Quiz – True or False

A liability is something owed

An asset is something owed

Owner’s Equity is owed to the owner

The accounting equation is Assets – Liabilities = Owner’s Equity

The owner’s private affairs must be separate from the business

Total Assets are all assets

Total Equities are all assets

What to do now

Complete “The Accounting Equation” and file it in your Home Directory to study for the test.