CHAPTER 2

ACCOUNTING EQUATION

The Entity Concept

Each business is a separate entity from its owner
For accounting purposes, the business is regarded as an entity or a unit by itself. It exists separately from its owners. Thus means that all financial information relating to the business is recorded and reported separately from the owners personal financial information.

Example
Hamidah (individual) Separate accounting entity (record of personal transaction)

Hamidah (sole trader of book store)

Separate accounting entity (record of transaction relating business transaction)

Accounting equation
Accounting equation is an equality that must be prepared at any point of time in accounting period. Basic accounting equation:
ASSET = EQUITIES The equation shows the resources owned by the business And the claims against these resources.

Elements in the accounting equation

Assets resources owned by the business
Assets Fixed Assets
Assets that have a useful life > 1 year Used in business operations to generate profit Example : Land and building, Plant and Machinery, Vehicles

Current Assets

Assets that can be converted into Cash within 1 year Example : stock, debtor, cash in hand

Elements in the accounting equation

Liabilities Amount owed by the business to external parties (creditors)
Liabilities

Long term liabilities

Current liabilities

Debts which are not expected to be paid within a year Example : Bank loans

Debts which are expected to be Paid within a year Example : Creditors, accrued expenses

Elements in the accounting equation

Owner equity the total of resources or funds provided for by its owner
Owners equity

Capital

Drawing

Revenue

Expenses

The amount of money Invested by the owner In the business

Withdrawals of Assets by the owner

Inflow of cash or Assets from the sales Of goods or services

Cost of assets consumed or services rendered to earn revenue

THUS..

ACCOUNTING EQUATION
Owners equity = capital drawing + revenue - expenses

The expanded accounting equation

ASSETS = EQUITIES

ASSETS = LIABILITY + OWNERS EQUITY

ASSETS = LIABILITY + CAPITAL DRAWING + REVENUE - EXPENSES

ASSETS = LIABILITY + CAPITAL DRAWING + NET PROFIT

OR
ASSETS + EXPENSES + DRAWING = LIABILITY + CAPITAL + REVENUE

LCR (Credit balance in nature) AED (Debit balance in nature) (DOUBLE ENTRY SYSTEM)

 INCREASES (+)

TRANSACTIONS THAT INCREASE OR DECREASE OWNERS EQUITY

DECREASES (-)
Owners investment in the business

Owners withdrawal from the business

OWNERS EQUITY

Revenue received

Expenses incurred

The Double Entry System

Increases in Assets, Drawings and Expenses the entry will be debited
Decreases in Assets, Drawings and Expenses the entry will be credited

The Double Entry System

Increases in Liabilities, capital and Revenue the entry will be credited
Decreases in Liabilities, capital and Revenue the entry will be debited

 Fatin starts business with RM 30,000 cash from personal savings and RM 20,000 cash from a bank loan The business OWNS the following: Asset CASH The business OWES the following: Owners equity CAPITAL Liabilities LOAN FROM BANK TOTAL

EXAMPLE

RM 50,000

RM 30,000

RM 20,000 RM 50,000

EXAMPLE ( From previous information)

Derive the fundamental accounting equation
ASSET Cash RM 50,000 = OWNERS EQUITY Capital RM 30,000 + LIABILITIES Loan RM 20,000

OR
ASSETS RM 50,000 LIABILITIES RM 20,000 OWNERS EQUITY RM 30,000

Transactions-on credit terms

Owner of the business
Sales goods or services to Buyer Becomes our DEBTOR

Purchase goods or services from

Seller

Becomes our CREDITOR