ACCOUNTING EQUATION
THE ENTITY CONCEPTEach 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.
EXAMPLEDIYANA(individual)DIYANA(sole trader of book store)Separate accounting entity(record of personal transaction)Separate accounting entity(record of transaction relating business transaction)
ACCOUNTING EQUATIONAccounting equation is an equality that must be prepared at any point of time in accounting period.Basic accounting equation:
ASSET = EQUITIESThe equation shows the resources owned by the business and the claims against these resources
ASSET = CAPITAL+ LIABILITIES
ELEMENTS IN THE ACCOUNTING EQUATIONAssets : resources owned by the business
AssetsFixed AssetsCurrentAssets
Assets that have a useful life > 1 yearUsed in business operations to generate profitExample : Land and building,Plant and Machinery, Vehicles
Assets that can be converted intoCash within 1 yearExample : stock, debtor, cash in hand
ELEMENTS IN THE ACCOUNTING EQUATIONLiabilities : Amount owed by the business to external parties (creditors, bank)LiabilitiesLong term liabilitiesCurrentliabilities
Debts which are not expected to be paid within a yearExample : Bank loansDebts which are expected to bePaid within a yearExample : Creditors, accrued expenses
ELEMENTS IN THE ACCOUNTING EQUATIONOwner equity : the total of resources or funds provided for by its ownerOwners equityCapitalDrawingRevenueExpenses
The amount of money Invested by the ownerIn the business
Withdrawals of Assets by the ownerInflow of cash orAssets from the salesOf goods or servicesCost of assets consumed or servicesrendered to earn revenue
THUS..
ACCOUNTING EQUATIONOwners equity = capital drawing + revenue - expenses
EXPANDED ACCOUNTING EQUATIONASSETS = EQUITIES ASSETS = LIABILITY + OWNERS EQUITYASSETS = LIABILITY + CAPITAL DRAWING + REVENUE - EXPENSESASSETS = LIABILITY + CAPITAL DRAWING + NET PROFITASSETS + EXPENSES + DRAWING = LIABILITY + CAPITAL + REVENUEAED (Debit balance in nature)LCR (Credit balance in nature)(DOUBLE ENTRY SYSTEM)OR
TRANSACTIONS THAT INCREASE OR DECREASE OWNERS EQUITYINCREASES (+)DECREASES (-)Owners investment in the business
Revenue receivedOwners withdrawalfrom the business
Expenses incurredOWNERS EQUITY
DOUBLE ENTRY SYSTEMIncreases in Assets, Drawings and Expenses : the entry will be debited
Decreases in Assets, Drawings and Expenses : the entry will be credited
THE DOUBLE ENTRY SYSTEMIncreases in Liabilities, capital and Revenue : the entry will be credited
Decreases in Liabilities, capital and Revenue : the entry will be debited
EXAMPLEDiyana 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 CASHRM 50,000 ========= The business OWES the following:Owners equityCAPITALRM 30,000Liabilities LOAN FROM BANK RM 20,000TOTALRM 50,000 =========
EXAMPLE( From previous information)Derive the fundamental accounting equation
ASSET = OWNERS EQUITY + LIABILITIESCash RM 50,000 Capital RM 30,000 Loan RM 20,000ORASSETSRM 50,000LIABILITIESRM 20,000OWNERS EQUITYRM 30,000
TRANSACTIONS ON CREDIT TERMSOwner of the business
BuyerSales goods or services toBecomes our DEBTORSellerPurchase goods or services fromBecomes our CREDITOR