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
DIYANA
(individual)

DIYANA
(sole trader of book store)

Separate accounting entity

(record of personal
transaction)

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
ASSET = CAPITAL+ LIABILITIES

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, bank)

Liabilities
Long term
liabilities

Debts which are not expected to

be paid within a year
Example : Bank loans

Current
liabilities

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

The amount of money

Invested by the owner
In the business

Drawing

Withdrawals of
Assets by the owner

Revenue

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

Expenses
Cost of assets
consumed or services
rendered to earn
revenue

THUS..

ACCOUNTING
EQUATION
Owners equity = capital drawing + revenue - expenses

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)

TRANSACTIONS THAT INCREASE OR

DECREASE OWNERS EQUITY

INCREASES (+)

DECREASES (-)

Owners withdrawal
from the business

Owners investment
in the business

OWNERS EQUITY

Revenue received

Expenses incurred

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

EXAMPLE
Diyana 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
RM 50,000
=========
The business OWES the following:
Owners equity
CAPITAL
RM 30,000
Liabilities
LOAN FROM BANK
RM 20,000
TOTAL

RM 50,000
=========

EXAMPLE
( From previous information)
Derive the fundamental accounting equation
ASSET
Cash RM 50,000

OWNERS EQUITY
Capital RM 30,000

OR
ASSETS
RM 50,000

LIABILITIES
RM 20,000
OWNERS
EQUITY
RM 30,000

LIABILITIES
Loan RM 20,000

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