Topic 3 - Accounting Equation

Larson, Wild, Chiapetta, Ropidah, Haslinda, Aryati, Liana © The McGraw-Hill Companies, Inc., 2007

Accounting Equation and

Financial Statement

Topic

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A = L + E!!


Learning ObjectivesLearning Objectives

Explain the concept and accounting equation

Identify effects of business transactions on the accounting equation

Prepare financial statement


Concept of Accounting EquationConcept of Accounting Equation

Accounting equation present the resources of the business and claims to those resources

Assets are the resources owned by a business Equities are the rights or claims against these

resources Equities divided into : 1) Claims of creditor (Liabilities) 2) Claims of owner (Owner Equity)


Concept of Accounting Equation (con’t)Concept of Accounting Equation (con’t)

Asset = Liabilities + Owner’s Equity

(economic resources) (claims to economic resources) Asset must equal to the sum of liabilities and owner’s equity Because creditors’ claims are paid before ownership claims

if a business is liquidated, liabilities are shown before owner’s equity

Accounting equation applies to all economic entities regardless of size, nature of business or form of business organisation

The equation provides the underlying framework for recording and summarizing the economic events of a business enterprise.


AssetsLiabilities & Equity

Accounting EquationAccounting Equation

LiabilitiesLiabilities EquityEquityAssetsAssets = +


LandLand

EquipmentEquipment

BuildingsBuildings

CashCash

VehiclesVehicles

Store Supplies

Store Supplies

Notes Receivable

Notes Receivable

Accounts Receivable

Accounts Receivable

Resources owned or controlled

by a company

Resources owned or controlled

by a company

AssetsAssets


Taxes Payable

Taxes Payable

Wages Payable

Wages Payable

Notes Payable

Notes Payable

Accounts Payable

Accounts Payable

Creditors’ claims on

assets

Creditors’ claims on

assets

LiabilitiesLiabilities


Owner’sclaims

on assets

Owner’sclaims

on assets

RevenuesRevenues

Owner Investments

Owner Investments

Owner Withdrawals

Owner Withdrawals

ExpensesExpenses

EquityEquity



Expanded Accounting EquationExpanded Accounting Equation

RevenuesRevenues ExpensesExpensesOwner CapitalOwner Capital

Owner Withdrawals

Owner Withdrawals

_ + _


The accounting equation must remain in balance after each transaction.


Transaction Analysis EquationTransaction Analysis Equation


The accounts involved are:

(1)

(2)

J. Scott, the owner, contributed $20,000 cash to start the business.

Transaction Analysis - ExampleTransaction Analysis - Example


Transaction AnalysisTransaction Analysis

1)J. Scott, the owner, contributed $20,000 cash to start the business.



(1)

(2)


2) Purchased supplies paying $1,000 cash.



2)Purchased supplies paying $1,000 cash.



(1))

(2))


3)Purchased equipment for $15,000 cash.



3)Purchased equipment for $15,000 cash.



(1)

(2)

(3)

Transaction AnalysisTransaction Analysis4)Purchased Supplies of $200 and Equipment of $1,000 on account.


Transaction AnalysisTransaction Analysis4.Purchased Supplies of $200 and Equipment of $1,000 on account.



(1)

(2)


5) Borrowed $4,000 from 1st American Bank.



5)Borrowed $4,000 from 1st American Bank.


Transaction AnalysisTransaction AnalysisThe balances so far appear below. Note that the

Balance Sheet Equation is still in balance.

Now let’s look at transactions involving revenue, expenses and withdrawals.



(1)

(2)

Transaction AnalysisTransaction Analysis6) Rendered consulting services

receiving $3,000 cash.


Transaction AnalysisTransaction AnalysisRendered consulting services

receiving $3,000 cash.



(1)

(2)


7) Paid salaries of $800 to employees.

.



Remember that expenses decrease equity.

7) Paid salaries of $800 to employees.



(1)

(2))

Transaction AnalysisTransaction Analysis8) J. Scott withdrew $500 from the

business for personal use.

.



Remember that withdrawals decrease equity.

8)J. Scott withdrew $500 from the business for personal use.


Financial StatementsFinancial StatementsLet’s prepare the Financial Statements

reflecting the transactions we have recorded.

1. Income Statement

2. Statement of Owner’s Equity

3. Balance Sheet

4. Statement of Cash Flows


Profit is the difference between

Revenues and Expenses.

The income statement describes a company’s revenues and expenses

along with the resulting profit or loss over a period of time due to earnings

activities.


The profit of $2,200

increases Scott’s capital

by $2,200.

The Statement of Owner’s Equity

explains changes in equity from profit (or loss) and from owner

investments and withdrawals for a

period of time.


The Balance Sheet

describes a company’s

financial position at a point in time.

The Balance Sheet

describes a company’s

financial position at a point in time.

Owner’s Equity in Balance Sheet


From Statement of Owner’s Equity


The Statement of Cash Flows identifies cash inflows and cash outflows over a

period of time.

Topic 3 - Accounting Equation

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