Accounting Equation and 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

Introduction
Business 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 Recorded in the Balance
c) Liabilities Sheet
d) Revenues Recorded in the Trading
e) Expenses 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 - It is represents owner- - It is financial obligation
the value to the business supplied fund to the business of the business to the
- are property own by the business for the acquisitions of assets external parties
for the business
- 2 types of assets: - it is financial obligation of - 2 types of liabilities:
i) Fixed Assets/ Non Current Assets the business to the owner. i) Long term Liabilities
- assets acquired / bought not for  Owner’s Equity - it is an amount owing by
resale and it is to be used in the = Capital + Profit/ (-) the business that have
running of the business. (Losses) - drawings repayment period > 1 yr
Tangible Fixed Assets - i.e - i.e Long term loan
Land&Building,Machinery ii) Current liabilities
Intangible Fixed Assets- i .e - it is an amount owing by
Goodwill,Trademark the business that is to be
Investment – i.e Fixed deposit paid in within 1 yr
ii)Current Assets – assets that are - i.e Creditors, bank
either cash or those that can be overdraft
converted in to cash i.e debtors,stock.

(See pg14 textbook)

Accounting Equation (A = OE + L )
- 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:

Assets = Owner’s Equity + Liabilities
A = OE + L
OE = A – L

- 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.

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 Cash increase by Capital increase by -
01/01 RM50,000 RM50,000
Effect: Increase A Effect:Increase OE Effect: NO

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 Cash decrease to 5,000 Capital still = 50,000 -
02/01 Bank increase by 45,000
#Increase & Decrease A(=) #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 Bank increase by 30,000 Capital still = 50,000 Loan increase
03/01 #Increase A to 80,0000 & by 30,000
Bank to 75,000 #No effect #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 F&F increase by 10,000 Capital still = 50,000 Loan still =
04/01 Bank decrease to 65,000 30,000
#Increase & decrease A (=) #No effect #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 Stock increase by Capital still = 50,000 Creditor increase by
05/01 18,000 18,000
#Increase A to 98,000 #No effect #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 Bank decrease by Capital still = 50,000 Creditor decrease by
06/01 8,000 8,000
#Decrease A to 90,000 #No effect #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)
- 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

Revenue Expenses
- is the gross increase in owner’s - are the cost of assets consumed or
equity resulting from business services used in the process of
activities entered into for the earning revenue.
purpose of earning income

- i.e sales of goods, services, - i.e purchased of goods, salary,
commission received interest interest expense, rent expense,
received etc. discount allowed etc.

See pg 54 textbook

Effect of transactions on the expanded
accounting equation

Effect of transactions on the expanded accounting
equation
Date (A) + (E) = (OE) + (R) + (L)
Assets Expenses Owner’s Equity Revenue Liabilities
Jan F&F 10,000 Insurance 200 Capital 50,000 Loan 30,000
06 Cash 4,800 Creditor 10,000
Bank 57,000
Stock 18,000
Jan F&F 10,000 Insurance 200 Capital 50,000 Commission 350 Loan 30,000
07 Cash 4,800 Creditor 10,000
Bank 57,350
Stock 18,000
08 Cash 4,700 Electricity 100 Creditor 10,000
Bank 57,350
Stock 18,000
09 Cash 5,100 Electricity 100 Rent 400 Creditor 10,000
Bank 57,350
Stock 18,000

Movement of stock
1. Increase in Stock Effect of Accounts
transaction
Purchase- goods bought by the business for the Purchase Expense Purchases A/c
purpose of resale increase

Purchases Return (Return Inward) – goods Sales revenue Return inward
return by buyer decrease A/c

2. Decrease in Stock Effect of Accounts
transaction
Sales – sale of goods with prime intention of Sales revenue Sales A/c
resale increase
Sales Return (Return outward) – goods return Purchase Expense Return
to supplier decrease 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

Example: Purchase & Sales Return

Purchase & Sales Return
Date (A) + (E) = (OE) + (R) + (L)
Bank 57,350 Purchases 3,000
Stock 18,000
Bank 57,350 Purchases 2,900
Stock 18,000
Bank 57,350 Purchases 2,900 Sales 1,000
Stock 18,000
Debtor 1,000

Purchase & Sales Return
Date (A) + (E) = (OE) + (R) + (L)
Bank 57,350 Purchases Sales 1,000
Stock 18,000 2,700
Debtor 1,000

Bank 57,350 Purchases Sales 900
Stock 18,000 2,700
Debtor 900

Accounting Equation and Classification

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