THE ACCOUNTING EQUATION

THE ACCOUNTING EQUATION

•The whole of financial accounting is based on this simple idea

• It is the foundation of accounting

THE ACCOUNTING EQUATION

ASSETS CAPITAL LIABILITIES

ASSETS = CAPITAL + LIABILITIES

Assets can be thought of as the resources or the “stuff” required in order to set up and run the business

Assets can consist of:

ASSETS

BUILDINGS MACHINERY STOCK AMOUNTS OWING FROM CUSTOMERS

ASSETS = CAPITAL + LIABILITIES

• Capital can be thought of as the amount of those resources or assets supplied by the owner of the business

• Capital may also be referred to as OWNERS EQUITY

CAPITAL

• If the owner of the business has supplied all the resources initially to start up the business then the equation will be;

CAPITAL

ASSETS LIABILITIES

ASSETS = CAPITAL + LIABILITIES

• IF RESOURCES OF THE BUSINESS HAVE BEEN SUPPLIED BY SOMEONE OTHER THAN THE OWNER, THEN AMOUNTS OWING TO THESE OTHER PEOPLE IN

RESPECT OF THOSE RESOURCES SUPPLIED ARE REFERRED TO AS LIABILITIES• Liabilities can include:

LIABILITIES

LOANSAMOUNTS OWING TO

SUPLIERS

AMOUNTS OWING FOR

EXPENSES

ASSETS CAPITAL LIABILITIES

ACTUAL RESOURCES/STUFF IN THE

BUSINESS

WHO HAS CLAIMS TO THOSE ASSETS OR RESOURCES IN THE BUSINESS

– WHO SUPPLIED THEM? THIS WILL INCLUDE BOTH THE OWNERS CLAIMS AND OTHER PEOPLES CLAIMS

ASSETS = CAPITAL + LIABILITIES

• The accounting equation should always balance.

• This is because we are looking at the same thing but from two different places or points of view.

• Therefore, no matter how many transactions occur, both sides of the equation should always balance.

ACCOUNTING EQUATION EXAMPLE

• If on the 1/1/2012 Adam started a business. He deposited $10,000 into a bank account he opened specifically for his business.

ASSETS$10,000

CAPITAL$10,000

LIABILITIES$0

CASH IN BANK+ $10,000

MONEY INVESTED BY OWNER+ $10,000

ACCOUNTING EQUATION EXAMPLE

• If on the 5/1/2012 Adam bought a computer for $3,000 and he paid for this by cheque.

ASSETS$10,000

CAPITAL$10,000

LIABILITIES$0

COMPUTER = $3,000BANK = ($10,000-$3,000)

=$7,000

TOTAL=$3,000+$7,000=$10,000

UNCHANGED

BALANCE SHEET(STATEMENT OF FINANCIAL POSITION)

• ASSETS• COMPUTER $3,000• CASH AT BANK ($10,000 - $3,000) $7,000• TOTAL ASSETS $10,000

• CAPITAL $10,000

ACCOUNTING EQUATION EXAMPLE

• If Adam purchased some stock for $500 from a supplier on credit

ASSETS$10,500

CAPITAL$10,000

LIABILITIES$500

COMPUTER $3,000BANK $7,000STOCK $500TOTAL $10,500

UNCHANGEDTRADE PAYABLES $500

ADAM OWES HIS SUPPLIER $500

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