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