Post on 18-Nov-2014
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Unit 1 : The Accounting Equation1-1. Assets1-2. Liabilities1-3. Owner’s Equity 1-4. Expenses1-5. Revenue1-6. Net Income versus Net Loss1-7. Effects on the Accounting Equation1-8. Solving for a variable1-9. Financial Position1-10. Defining Accounting
The Accounting Equation
The Accounting equation
» Accounting as a whole is based on a single equation:
ASSETS = EQUITY + LIABILITIES
equation
» The word equation comes from the word equal. For any equation, one side always equals another.
Double entry
» The accounting equation should remain in balance at all times because of double-entry accounting or bookkeeping.
» Double-entry means that every transaction will affect at least two accounts in the general ledger.
Examples of Double Entry
» Examples˃ An owner's investment into the company will increase the company's
assets and will also increase owner's equity.˃ When the company borrows money from its bank, the company's
assets increase and the company's liabilities increase.
So what does the accounting equation mean?
» Well, in order to answer that question we need to look at what each of the terms in the equation mean…
1. Assets2. Liabilities
3. Owner’s Equity
1-1 Assets
What is an asset?
» Official Definition: A resource controlled by the enterprise as a result of past events and from which future economic benefits are expected to flow to the enterprise.
In other words…
» An asset is˃ A possession of a business that will bring the business benefits in the
future.˃ Anything that will add future value to your business.
Examples
» Land» Computer» Vehicle» Cash
Debtors
» Debtors are people that owe your business money and the value of these debts as a whole.
» Another name for debtors is accounts receivable. The word receivable simply means capable of being received, or will be received.
Are debtors an asset?
» Would debtors or accounts receivable be an asset for your business? ˃ Answer: Even though you cannot own a debtor, you will get benefits in
the future from having money owed to your business. ˃ The benefits are simple – you will get paid! So if you have $3,000
owed to you by Mr. Smith, you have a debtor, an asset, worth $3,000.
Measurable value
» An additional requirement for an asset is that you have to be able to accurately measure its value.
» This is usually quite simple, as the value is equal to how much you paid for it.
» Are employees considered an asset? ˃ Can you put an accurate, reliable figure on how much an employee is
worth to you, bearing in mind that he or she can resign at any point by giving notice? Tricky, right? As you can imagine, it's nearly impossible to place a value on people – consequently employees are actually never included as assets in accounting - but only because we can't value them.
So the full test of whether something is an asset is:
1. DOES YOUR BUSINESS OWN/CONTROL IT?2. WILL IT BRING YOUR BUSINESS BENEFITS IN
THE FUTURE?3. CAN YOU VALUE IT ACCURATELY?
How to value an asset
» The cost of an asset includes all costs necessary to get it to the business premises and into a condition in which it can be sold. So the cost of an asset can include the following:˃ Purchase price˃ Import duties,
- Transport costs to get it to your premises,- Installation or set-up costs.
Changes in assets
Increase Assets Decrease Assets
Purchasing Supplies (The asset account Supplies increases)
Purchasing Supplies (The asset account Cash decreases)
Owner Contributions Owner Draws
Receiving bank loans Repaying bank loans
Credit purchases
1-2 Liabilities
What is a liability?
» A present obligation of the enterprise arising from past events, the settlement of which is expected to result in an outflow from the enterprise of resources embodying economic benefits.
In other words…
» a liability is simply... a debt of the business.» The debt will result in assets (usually cash)
leaving the business in the future.
Examples
» The most common liability is a loan. » Another common liability is called creditors.
˃ A creditor, also known as a payable, is any business or person (apart from the bank) that you owe.
˃ Suppliers (who you owe for products purchased on credit) would fall under creditors.
Changes in Liabilities
Increase Liabilities Decrease Liabilities
Receiving a bank loan Repaying a bank loan
Credit purchases Credit Payments
Notes payable to creditors Paying Creditors
1-3 Owner’s Equity
What is Owner’s Equity
» The residual interest in the assets of the enterprise after deducting all its liabilities.
In other words…
» The owner’s equity is simply the owner’s share of the assets of a business.
Owner’s equity
» Represents the value of the assets that the owner can lay claim to.
» The value of all the assets after deducting the value of assets needed to pay liabilities.
» It is the value of the assets that the owner really owns.
OWNER’S EQUITY = ASSETS - LIABILITIES
ASSETS = EQUITY + LIABILITIES» Assets can only ‘belong’ to two types of people:˃ people outside the business who are owed money
(liabilities)˃ the owner himself (owner’s equity).
Shareholder’s equity
» In the case of a corporation, which is publicly owned, equity is labeled shareholder’s equity
Changes in Owner’s Equity
Increase Owner’s Equity Decrease Owner’s Equity
Revenues Expenses
Gains Losses
Owner contributions Owner withdraws
Beginning Capital
Expenses
» The costs the company incurs in carrying on operations in its effort to make money
» Decrease owner’s equity» Can be paid for with cash (decreases assets)» Or charged (increase liabilities)
Expenses vs. equipment
» The difference between expenses and equipment is equipment can be liquidated or converted to cash.
» EXAMPLE: ˃ A company car is equipment: No effect on owner’s equity.˃ A telephone bill is an expense: Decreases owner’s equity.
Revenues
» Income» Example: a service company earns revenue
when it provides services to its clients» Recorded as an increase in owner’s equity and
an increase in assets» Investopedia Explains Revenues
1-6 Net Income vs.
Net Loss
» Net Income: The company is bringing in more money than it is spending to continue operations.
Revenues > Expenses
» Net Loss: The company is bringing in less money than it is spending to continue operations
Revenues < Expenses
» Break Even: When a company’s revenues are equal to their expenses˃ Revenues = Expenses
Owner’s Equity =
Beginning CapitalPLUS
Additional Investment
Net Income*
Revenues -- Expenses
Withdraws+ -
If expenses are greater than revenues, then a net loss would result. This loss would be subtracted from capital because it would be a negative number.
1-7 Effects on the Accounting Equation
» Every transaction affects TWO or more accounts!
» This is how the accounting equation stays in balance
For each of the transactions, indicate the two (or more) effects on the accounting equation of the business or company.
The owner invests personal cash in the business.
Assets: Increase Decrease No EffectLiabilities: Increase Decrease No EffectOwner's (or Stockholders') Equity:
Increase Decrease No Effect
The owner withdraws business assets for personal use.
Assets: Increase Decrease No EffectLiabilities: Increase Decrease No EffectOwner's (or Stockholders') Equity:
Increase Decrease No Effect
The company receives cash from a bank loan.
Assets: Increase Decrease No EffectLiabilities: Increase Decrease No EffectOwner's (or Stockholders') Equity:
Increase Decrease No Effect
The company repays the bank that had lent money to the company.
Assets: Increase Decrease No EffectLiabilities: Increase Decrease No EffectOwner's (or Stockholders') Equity:
Increase Decrease No Effect
The company purchases equipment with its cash.
Assets: Increase Decrease No EffectLiabilities: Increase Decrease No EffectOwner's (or Stockholders') Equity:
Increase Decrease No Effect
The owner contributes her personal truck to the business
Assets: Increase Decrease No EffectLiabilities: Increase Decrease No EffectOwner's (or Stockholders') Equity:
Increase Decrease No Effect
The company purchases a significant amount of equipment on credit.
Assets: Increase Decrease No EffectLiabilities: Increase Decrease No EffectOwner's (or Stockholders') Equity:
Increase Decrease No Effect
The company purchases land by paying half in cash and signing a note payable for the other half.
Assets: Increase Decrease No EffectLiabilities: Increase Decrease No EffectOwner's (or Stockholders') Equity:
Increase Decrease No Effect