BACHELOR OF BUSINESS

MANAGEMNET
FIN2254
WEEK 3
ACCOUNTING EQUATION
 Accounting Equation

• If a firm is to be set up and start trading, then

it needs resources.
• Let us assume that the owner of the business
who has supplied all of the resources.
• This can be shown as:
• Resources in the business =
Resources supplied by the owner.
 Accounting Equation

• The amount of the resources supplied by the

owner is called CAPITAL.
• The actual resources that are then in the
business are called ASSETS.
• This means that the accounting equation can
be shown as:
• Assets = Capital
 Accounting Equation

• At a point, people other than the owner have

supplied some of the assets. i.e.: liabilities
• The equation has now changed to:
• Assets = Capital + Liabilities

• It can be seen that the two sides of the

equation will have the same totals.
 Accounting Equation

• This is because we are dealing with the

same thing from two different points of view.
It is:
• Resources: what they are =
Resources: who supplied them
• (Assets) = (Capital + Liabilities)
 Accounting Equation

• The totals of each side will always equal one

another, and that this will always be true no
matter how many transactions there may be.
• The components changes in amount but the
equation remains the same.
 Accounting Equation

• Assets consist of property of all kinds, such

as buildings and machinery, benefits such as
debtors and cash.
• Liabilities consist of money owing for goods
supplied to the firm and for expenses as well
loans made to the firm are included.
• Capital is often called the owner's equity or
net worth.
 Expanded Accounting Equation

• It breaks out the Owner’s Equity section into

2 components:  Revenues and Expenses.
• Revenues = what the business earns for
providing goods or services.
• Expenses = the cost of assets the business
uses to generate revenues (payroll,
depreciation, rent, utilities, taxes)
 Expanded Accounting Equation

• Profit or Loss = Revenues - Expenses.

• Revenues > Expenses = Profit.
• Expenses > Revenues = Loss.
• The owner of the company also has the
option to withdraw equity from the company
in the form of drawings (proprietorships and
partnerships) or dividends (corporations).
 Expanded Accounting Equation

• Looking at these relationships to Owner’s

Equity in terms of the accounting equation
you see that:
• Revenues increase Owner's Equity
• Expenses decrease Owner's Equity
• Drawings or Dividends decrease Owner’s
Equity
 Expanded Accounting Equation

• The expanded Accounting Equation looks

like this:
• Assets = Liabilities + Owner's Equity +
Revenues – Expenses - Drawings
Assets, Liabilities and
Owners’ Equity
 Asset

• Assets are resources owned or controlled by

a company and that have expected future
benefits and categorized into two. i.e. current
and non-current assets.
• Current assets - current liabilities to calculate
working capital as to know the business
organization’s capability to meet its short-
term obligations.
 Current Asset

• An asset should be classified as a current asset

when it:
• is expected to be realised in, or is held for sale or
consumption in, the normal course of the enterprise’s
operating cycle; or
• is held primarily for trading purposes or for the short
term and expected to be realised within twelve months
of the balance sheet date; or
• is cash or a cash equivalent asset which is not
restricted in its use.
 Current Asset

• The operating cycle of an enterprise is the

time between the acquisition of materials
entering into a process and its realisation in
cash or an instrument that is readily
convertible into cash.
Current Asset
 Non- Current Asset

• All other assets should be classified as non-

current assets.
• Some examples of non-current or fixed
assets are equipment, buildings, land.
 Liabilities

• Liabilities are claims (by creditors) against

assets, which means they are obligation to
transfer assets or provide products or
services to other entities.
• A liability = current liability when it:
• is expected to be settled in the normal
course of the enterprise’s operating cycle;
or
• is due to be settled within twelve months of
the balance sheet date.
 Liabilities

• All other liabilities should be classified as

non-current liabilities.
• Current liabilities = trade payables and
accruals for employees and other operating
costs, form part of the working capital used in
the normal operating cycle of the business.
• Such operating items are classified as
current liabilities even if they are due to be
settled after > 12 months from the BS date.
 Liabilities

• Other current liabilities are not settled as part of

the current operating cycle but are due for
settlement within twelve months of the balance
sheet date.
• Examples are the current portion of interest-
bearing liabilities, bank overdrafts, dividends
payable, income taxes and other non-trade
payables. Interest-bearing liabilities that provide
the finance for working capital on a long-term
basis, and are not due for settlement within
twelve months, are non-current liabilities.
 Liabilities

• Some examples of current and non-current

liabilities are creditors, accounts (Trade)
payable, note payable, unearned revenue,
accrued liabilities (wages payable, taxes
payables and interest payable)
 Owners’ Equity

• The owner's claim on a company's assets is

called equity or owner's equity.
• Equity is the owners’ residual interest in the
assets of a business after deducting liabilities.
• When the owner withdraws assets for
personal use, the withdrawal decreases both
the company's assets and its total equity.
(Owners of proprietorships cannot receive
salaries because they are not legally separate
from their entities)
 Owners’ Equity

• Withdrawals are not expenses of the

business. They are simply the opposite of
owner investments.
• Revenues and expenses are the final two
categories of equity. Examples of revenue
accounts are Sales, Commissions Earned,
Professional Fees Earned, Rent Earned, and
Interest Revenue. Revenues increase equity
and from products or services provided to
customers.
 Owners’ Equity

• Examples of expense accounts are

Advertising Expense, Store Supplies
Expense, Office Salaries Expense, Office
Supplies Expense, Rent Expense, Utilities
Expense, and Insurance Expense. Expenses
decrease equity and result from assets or
services used in a company's operations.
 References
• 1. F. Wood (2015). Business Accounting.
Pitman Publishing 13th Edition.
ISBN9781292084664

• F3 FINANCIAL ACCOUNTING (FA) Apr 16,

2018 by Kaplan Publishing.
ISBN9781787400801

• F7 FINANCIAL REPORTING (FR) Apr 16,

2018by KaplanPublishing.ISBN9781787400856

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