Topic 2: Assets, Liabilities, Owner'S Equity and Accounting Equation

TOPIC 2
ASSETS, LIABILITIES, OWNER’S

EQUITY AND ACCOUNTING
EQUATION
1
Learning Outcomes
At the end of the lesson, students must be able to understand and explain:
o The components of financial statements and its main elements.
o The accounting equation and the computation.
o The relationships between its components.
o The effect of accounting equation on Statement of Financial Position.
o The effect of expanded accounting equation on Statement of Financial

Position.
2
The Components of Financial Statements
1. Statement of
Comprehensive
Income
5. Accounting
Policies and 2. Statement of
Explanatory Financial Position
Notes
Five
Components
3. Statement of
4. Statement of
of Changes in
Cash Flows
Equity
3
Statement of Comprehensive Income
A statement that measures company's financial performance over a specific

accounting period. Financial performance is assessed by giving a summary of
how the business incurs its revenues and expenses through operating
activities.
Statement of Financial Position
A statement showing the financial position of a business as at a specific date,

which normally is the date at end of a certain accounting period. It shows the
relationship between assets, liabilities and owner’s equity in accounting
equation form.
4
Main Elements of Financial Statement
Statement of Comprehensive Income Statement of Financial Position
Revenues Assets
Liabilities
Expenses
Owner’s
Equity
5
o Actual resources owned by a business because
they bring future benefits to the business entity.
Assets o Acquired for a business to carry out its day-to-
day activities.
Classification of Assets
Tangible
Assets
Non-
Intangible
current
Assets
Assets Assets
Current Long-term
Assets Investment
6
Assets Non-current Assets / Fixed Assets
Goodwill Patents
Copyrights Trademarks
o It is permanent in nature and expected to be used

for more than one accounting year.
o They include tangible assets, intangible assets
and long-term investment.
o It acquired to help in the running of the business.
o Not for resale.
o Examples: premises, machinery, motor vehicles,
office equipment, fittings and fixtures and
furniture.
7
Assets Current Assets
o It can be converted into cash easily or will be

consumed within an accounting year from the
current date.
o Examples: cash in hand, cash at bank, debtors,
inventory, prepaid expenses and accrued revenues.
o To determine whether an item is a fixed asset or

current asset, one should not just look at the item but
How to also the nature of the business.
determine? o For example, a computer is a fixed asset to an
accounting firm but a current asset, inventory, to a
company that selling computers.
8
o Amounts owed by the business to outside parties.
o Business obligations that represent the claims by the

Liabilities external parties against the business assets.
o In the event of non-payment, creditors can force the

business to liquidate and be paid the amounts due to
them before any claims by the owners.
Classification of Liabilities
Non-current
Liabilities
Liabilities
Current
Liabilities
9
Liabilities
Non-current Liabilities
o The amounts owed and which the business has

more than one accounting year to settle.
o Examples: bank loans, mortgages and debentures.
Current Liabilities
o The amounts owed by the business that have to be
settled within an accounting year from the current
date.
o Examples: bank overdraft, creditors, accrued
expenses and prepaid revenues.
10
o Capital is the investment made by the owner.
Owner’s
o It represents the owner’s interest in the business.
Equity
o It is what the business owes to the owner.
Owner’s Equity = Assets - Liabilities
o Drawings refer to the withdrawal of money or

goods for personal use.
o Drawings will reduced the owner’s equity.
o For a sole proprietorship, capital comes from

Where
the owner himself.
business capital
o For a partnership business, capital comes from
comes from? the partners.
o For public companies, capital can be collected
through the issue of shares to the public.
11
Accounting Equation
How much How much Owner’s
biz owns biz owes interest
Owner’s
Assets Liabilities
Equity
Relationship between assets, liabilities and owner’s equity
Accounting equation shows the financial position of a business entity at a particular date
(i.e. how much the business owns and owes, and the owner’s interest in the business).
From the equation:

o Asset of a company have been financed by liability and owner’s equity.
o In the event of liquidation, asset can only belong to two types of people:
o People outside the business that business owe them money (liability)
o Owner himself (owner’s equity)
12
Example
Transaction 1:
Mr Zack commences his business with cash of RM50,000 as capital.
Since the Accounting Entity Convention regards the business and the owner as two
separate entities, the effects of the above transaction can be stated as follows:
Effects:
(a) The business received cash, an asset, RM50,000 Asset (Cash)
(b) The business owed to the owner RM50,000 Owner’s equity (Capital)
If expressed in terms of an equation, the above transaction can be shown as follows:
Cash = Capital
RM50,000 = RM50,000
13
Example
Transaction 2:
The business obtained a bank loan of RM10,000.
Effects:
(a) Cash, an asset, is increased by RM10,000 Asset (Cash)
(b) Loan of RM10,000, a liability, is created Liability (Loan)
After Transaction 2, the relationship between asset, liability and owner’s equity can be
shown as follows:
Asset = Liability + Owner’s Equity
Cash = Loan + Capital
Transaction 1 RM50,000 = - + RM50,000
Transaction 2 RM10,000 = RM10,000 + -
Total remain balance RM60,000 = RM10,000 + RM50,000
The above shows that the business assets are always equal to the total of
the external liabilities and the owner’s equity. The assets of the business
are financed by the liabilities (loans and credits) and the owner.
14
Accounting Equation
(summary)
A positive relationship exists between assets & owner’s
equity and assets & liabilities
Statement of Financial Position Statement of Financial Position
Assets Owner’s Equity Assets Liabilities
A negative relationship exists between liabilities & owner’s

equity and assets & assets
Statement of Financial Position Statement of Financial Position
Liabilities Assets
Owner’s Equity Assets
15
Effects of Transactions on the
Accounting Equation
o A business transaction involves an exchange in which
the parties involved receive and give value as in the case
of purchases or sales of goods and services.
o Each transaction must have at least two effects on the

accounting equation.
o Regardless of the types of transactions, the equality of

the accounting equation is always maintained.
16
Effects of Transactions on the Accounting Equation
Asset Asset
Transaction 1: An increase in an asset with a corresponding decrease in another asset

Example: The business bought a delivery van for RM15,000 paid by cash.
Assets Liabilities + Owner’s Equity

Cash Vehicles Total Loan Capital Total
RM RM RM RM RM RM
Balance (old) 60,000 - 60,000 10,000 50,000 60,000
Effects - 15,000 + 15,000 0 - - 0
Balance (new) 45,000 15,000 60,000 10,000 50,000 60,000
Negative relationship
Note:
1. An increase in vehicles (asset) of RM15,000.
2. A decrease in cash (asset) of the same amount.
3. There is no change in the total value of the assets (RM60,000), only the composition of the
assets is changed (cash RM45,000 and vehicles RM15,000).
4. The capital remains intact (RM50,000).
5. The accounting equation remains balanced at RM60,000.
17
Asset Liability
Transaction 2: An increase in an asset with a corresponding increase in liability

Example: The business bought furniture for RM4,000 on credit.

Cash Vehicles Furniture Total Creditors Loan Capital Total
RM RM RM RM RM RM RM RM
Balance (old) 45,000 15,000 - 60,000 - 10,000 50,000 60,000
Effects - - + 4,000 + 4,000 + 4,000 - - + 4,000
Balance (new) 45,000 15,000 4,000 64,000 4,000 10,000 50,000 64,000
Positive relationship
Note:
1. An increase in furniture (asset) of RM4,000.
2. An increase in creditor (liability) of the same amount.
3. The total value of the assets is increased by RM4,000 to RM64,000 but the capital remains
unchanged (RM50,000).
4. The increase in asset is financed by the creditor (RM4,000).
18
Asset Liability
Transaction 3: A decrease in an asset with a corresponding decrease in liability

Example: The business paid the creditor RM2,000 in cash.

Balance (old) 45,000 15,000 4,000 64,000 4,000 10,000 50,000 64,000
Effects - 2,000 - - - 2,000 - 2,000 - - - 2,000
Balance (new) 43,000 15,000 4,000 62,000 2,000 10,000 50,000 62,000
Note:
1. A decrease in cash (asset) of RM2,000.
2. A decrease in creditor (liability) of the same amount.
3. The total value of the assets is decreased by RM2,000 to RM62,000 but the capital remains
unchanged (RM50,000).
19
Liability Liability
Transaction 4: An increase in one liability with a corresponding decrease in another liability

Example: The business borrowed RM1,000 to pay the creditor.

Balance (old) 43,000 15,000 4,000 62,000 2,000 10,000 50,000 62,000
Effects - - - 0 - 1,000 + 1,000 - 0
Balance (new) 43,000 15,000 4,000 62,000 1,000 11,000 50,000 62,000
Note:
1. A decrease in creditor (liability) of RM1,000.
2. An increase in loan (liability) of the same amount.
3. The value of total liabilities remains unchanged (RM12,000); only the composition changes
(creditors RM1,000 and loan RM11,000).
4. The capital remains intact (RM50,000).
20
Asset Owner’s equity
Transaction 5: An increase in asset with a corresponding increase in owner’s equity

Example: The owner brought in furniture worth RM1,000 for office use.

Balance (old) 43,000 15,000 4,000 62,000 1,000 11,000 50,000 62,000
Effects - - + 1,000 + 1,000 - - + 1,000 + 1,000
Balance (new) 43,000 15,000 5,000 63,000 1,000 11,000 51,000 63,000
Note:
1. An increase in furniture (asset) of RM1,000.
2. An increase in capital (owner’s equity) of the same amount.
3. The increase in asset is financed by the owner’s additional investment.
21
Asset Owner’s equity
Transaction 6: A decrease in asset with a corresponding decrease in owner’s equity

Example: The owner withdrew cash of RM500 for personal use.

Balance (old) 43,000 15,000 5,000 63,000 1,000 11,000 51,000 63,000
Effects - 500 - - - 500 - - - 500 - 500
Balance (new) 42,500 15,000 5,000 62,500 1,000 11,000 50,500 62,500
Positive relationship Drawing (expense) increase,

Capital (owner’s equity) decrease
Note:
1. A decrease in cash (asset) of RM500.
2. A decrease in capital (owner’s equity) of the same amount.
3. Drawings, as opposed to owner’s investment, reduce the value of assets and capital by the
same amount.
22
For example:
Given below are the accounting records of assets, liabilities and owner’s equity of a retailer as at 1 April
2021:
Assets = Liabilities + Owner’s Equity
Cash Debtors Office Furniture Van Loan Creditors Capital
RM RM RM RM RM RM RM
12,000 8,000 10,000 25,000 = 15,000 5,000 + 35,000
During the month of April 2021, the following transactions took place:
a) Purchased a new office table for RM400 paid in cash.
b) Received cash RM2,000 from debtors.
c) Paid creditors RM1,200 in cash.
d) Repaid loans of RM3,000.
e) Bought a used van for RM10,000, partly paid in cash RM4,000 and the balance to be paid in July.
f) The owner brought in cash of RM5,000 as additional capital.
g) Sold old office furniture (at cost) for RM500 cash.
h) The owner withdrew RM300 for personal use.
You are required to record the above transactions by completing the table given above and prepare a
Statement of Financial Position as at 30 April 2021.
23
e) Bought a used van for RM10,000, partly paid
in cash RM4,000 and the balance to be paid in
July.
a) Purchase a new office table for RM400 • Van (Asset) increases
paid in Cash • Cash (Asset) decreases
• Office furniture (Asset) increases • Creditor (Liability) increases
• Cash (Asset) decreases • Dr. Van RM10,000; Cr. Cash RM4,000; Cr.
• Dr. Office Furniture; Cr. Cash Creditor RM6,000
b) Received cash RM2,000 from debtors f) The owner brought in cash of RM5,000 as
• Cash (Asset) increases additional capital
• Debtors (Asset) decreases • Cash (Asset) increases
• Dr. Cash; Cr. Debtors • Capital (OE) increases
c) Paid creditors RM1,200 in cash • Dr. Cash; Cr. Capital
• Creditors (Liability) decreases g) Sold old office furniture (at cost) for RM500
• Cash (Asset) decreases cash
• Dr. Creditors; Cr. Cash • Office furniture (Asset) deceases
• Cash (Asset) increases
d) Repaid loans of RM3,000
• Dr. Cash; Cr. Office Furniture
• Loans (Liability) decreases
• Cash (Asset) decreases h) The owner withdrew RM300 for personal use
• Dr. Loan; Cr. Cash • Capital (OE) decreases due to Drawings
• Cash (Asset) decreases
• Dr. Drawings; Cr. Cash
24
Suggested Solution:
Cash Debtors Office Furniture Van Loan Creditors Capital
RM RM RM RM RM RM RM
12,000 8,000 10,000 25,000 = 15,000 5,000 + 35,000
a) -400 400
b) 2,000 -2,000
c) -1,200 -1,200
d) -3,000 -3,000
e) -4,000 10,000 6,000
f) 5,000 5,000
g) 500 -500
h) -300 -300
10,600 6,000 9,900 35,000 = 12,000 9,800 + 39,700
25
Suggested Solution:
Statement of Financial Position as at 30 April 2021
RM RM
Non-current Assets
Office furniture 9,900
Van 35,000 44,900
Current Assets
Debtors 6,000
Cash 10,600 16,600
61,500
(-) Current Liability
Creditors 9,800
Non-current Liability
Loan 12,000
Owner’s Equity
Capital 39,700
61,500
26
The Expanded Accounting Equation
o Revenue is the money received or will be received in future by

the business arising from the goods sold and services rendered.
o It DOES NOT include capital contribution of the owner or loans
made to the entity.
o Revenues increase assets (cash / bank) and decrease liability
Revenues (unearned revenue).
o Examples: [main income: sale of goods, services rendered]; [other
income: rent received, commission received, interest received].
o Expenses are money or other assets that a business uses up as a

result of its activities.
o Expenses are incurred when a business purchases goods, to avail
the services and to run its business.
Expenses o Expenses decrease assets (cash / bank) and increase liabilities
(accrued expenses).
o Examples: [main expense: purchase of goods for resale, cost
related to purchase]; [operating expenses: insurance, salaries and
wages, carriage outwards, rent paid, interest paid].
27
Relationship between Revenues and Expenses
The relationship between revenues and expenses can

be measured in terms of profits and losses.
Revenues Expenses Profit
Revenues Expenses Loss

28
Assets Liabilities Owner’s Equity Revenues Expenses
The Expanded Accounting Equation Rewritten
Assets Liabilities Owner’s Equity Profit
Assets Liabilities Owner’s Equity Loss
29
Statement of Comprehensive Income (SOCI)
o The SOCI is a financial report that shows the income earned and the expenses incurred
by a business for an accounting period.
o It shows the relationship between revenues and expenses.
o This statement reflects the business performance for a particular period.
Relationship between Revenues, Expenses and Owner’s Equity

o A positive relationship exists between revenues and owner’s equity as revenue
increases the value of the assets of a business entity. (Revenue , OE )
o A negative relationship exists between expenses and owner’s equity as expenses use
up the assets of a business entity. (Expenses , OE )
o Profits increase owner’s equity.
o Losses decrease owner’s equity.
Statement of Financial Position SOFP SOFP
Capital Capital Assets OE Assets OE
(+) Profit (-) Loss
Increase in OE Decrease in OE
30
Effects of Transactions on the Expanded Accounting Equation
 Transactions that increase revenues will increase assets, hence increasing owner’s equity.
E.g.: Receive income in cash
 Revenues => Assets => Owner’s equity (+ve relationship)
 Transactions that increase expenses will decrease assets, hence decreasing owner’s equity.
E.g. pay expenses in cash
 Expenses => Assets => Owner’s equity (-ve relationship)
 Transactions that increase expenses will increase liabilities, hence decreasing owner’s
equity. E.g. accrued expenses
 Expenses => Liabilities => Owner’s equity (-ve relationship)
 Transactions that decrease revenue will increase liabilities, hence decreasing owner’s
equity. E.g. prepaid income
 Revenues => Liabilities => Owner’s equity (+ve relationship)

31
Effects of Transactions on the Expanded
Accounting Equation
o Transactions involving revenues and / or expenses

affect at least two items in the accounting equation.
o Regardless of the effects of revenues or expenses on

the accounting equation, the equality of the
accounting equation is always maintained.
32
Owner’s equity Revenue Asset
Transaction 1: The business earns revenue and receives cash

Example: The business received cash of RM500 as commission revenue.

Cash Vehicles Debtors Total Creditors Loan Capital Total
Balance (old) 5,000 15,000 8,000 28,000 1,000 10,000 17,000 28,000
Effects + 500 - - + 500 - - + 500 + 500
Balance (new) 5,500 15,000 8,000 28,500 1,000 10,000 17,500 28,500
Note:
1. When the business receives commission, it increase the asset, cash by the same amount.
2. An increase in assets results in a similar increase in capital (commission received is a
revenue, hence revenue increase capital).
33
Owner’s equity Expense Asset
Transaction 2: The business incurs expenses and pays cash

Example: The business paid wages of RM300 in cash.

Cash Vehicles Debtors Total Creditors Loan Capital Total
Balance (old) 5,500 15,000 8,000 28,500 1,000 10,000 17,500 28,500
Effects - 300 - - - 300 - - - 300 - 300
Balance (new) 5,200 15,000 8,000 28,200 1,000 10,000 17,200 28,200
Note:
1. When the business pays wages, it decrease the asset, cash by the same amount.
2. The decrease in assets results in a similar decrease in capital.
34
Example:
Alvin is a public accountant. His business’s financial position is shown below. Using the equation
given below, show how the various transactions in the month of March 2021 affect his financial
position.
Bank Debtors Equipment Creditors Capital
RM RM RM RM RM
8,650 5,350 12,000 = 4,000 + 22,000
March 2021
4 Paid rent RM400.
7 Purchased a computer for RM3,000. RM1,000 was paid by cheque and the balance
will be paid next month.
10 Received RM1,000 from clients for service rendered.
15 Paid general expenses of RM300.
17 Prepared final accounts for clients and bills sent to them amounted to RM1,200.
20 Paid creditors RM1,500.
24 Received RM2,250 from debtors.
26 Paid insurance RM500.
30 Paid electricity RM100.
35
Suggested Solution:
March
4 Paid rent RM400. Expense (rent) increased

Owner’s equity decreased
Asset (bank) decreased
7 Purchased a computer for RM3,000. RM1,000 was Asset (equipment) increased
paid by cheque and the balance will be paid next Asset (bank) decreased
month. Liability (creditor) increased
10 Received RM1,000 from clients for service Asset (bank) increased
rendered. Revenue (service) increased
Owner’s equity increased
15 Paid general expenses of RM300. Expense (general) increased
36
Suggested Solution:
March
17 Prepared final accounts for clients and bills sent Asset (debtor) increased
to them amounted to RM1,200. Revenue (sales) increased
Owner’s equity increased
20 Paid creditors RM1,500. Asset (bank) decreased
Liability (creditor) decreased
24 Received RM2,250 from debtors. Asset (bank) increased
Asset (debtor) decreased
26 Paid insurance RM500. Expense (insurance) increased
30 Paid electricity RM100. Expense (insurance) increased
37
Suggested Solution:
Assets = Liability + Owner’s Equity

Bank Debtors Equipment Creditors Capital
March RM RM RM RM RM
1 8,650 5,350 12,000 = 4,000 + 22,000
4 -400 -400
7 -1,000 +3,000 2,000
10 +1,000 +1,000
15 -300 -300
17 +1,200 +1,200
20 -1,500 -1,500
24 +2,250 -2,250
26 -500 -500
30 -100 -100
31 8,100 4,300 15,000 = 4,500 + 22,900
38
Suggested Solution:
Statement of Financial Position as at 31 March 2021

RM RM
Non-current Assets
Equipment 15,000
Current Assets
Debtors 4,300
Bank 8,100 12,400
27,400
(-) Current Liability
Creditors 4,500
Owner’s Equity
Capital 22,000
Net profit 900 22,900
27,400
39
… End of Topic 2 …
Topic 3
40

Topic 2: Assets, Liabilities, Owner'S Equity and Accounting Equation

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TOPIC 2

ASSETS, LIABILITIES, OWNER’S

o The components of financial statements and its main elements.

o The accounting equation and the computation.

o The relationships between its components.

o The effect of accounting equation on Statement of Financial Position.

o The effect of expanded accounting equation on Statement of Financial

A statement that measures company's financial performance over a specific

Statement of Financial Position

A statement showing the financial position of a business as at a specific date,

Statement of Comprehensive Income Statement of Financial Position

o It is permanent in nature and expected to be used

o It can be converted into cash easily or will be

o To determine whether an item is a fixed asset or

o Business obligations that represent the claims by the

o In the event of non-payment, creditors can force the

o The amounts owed and which the business has

Owner’s Equity = Assets - Liabilities

o Drawings refer to the withdrawal of money or

o Drawings will reduced the owner’s equity.

o For a sole proprietorship, capital comes from

From the equation:

If expressed in terms of an equation, the above transaction can be shown as follows:

Assets Owner’s Equity Assets Liabilities

A negative relationship exists between liabilities & owner’s

Owner’s Equity Assets

o Each transaction must have at least two effects on the

o Regardless of the types of transactions, the equality of

Transaction 1: An increase in an asset with a corresponding decrease in another asset

Assets Liabilities + Owner’s Equity

Transaction 2: An increase in an asset with a corresponding increase in liability

Assets Liabilities + Owner’s Equity

Transaction 3: A decrease in an asset with a corresponding decrease in liability

Assets Liabilities + Owner’s Equity

Transaction 4: An increase in one liability with a corresponding decrease in another liability

Assets Liabilities + Owner’s Equity

Transaction 5: An increase in asset with a corresponding increase in owner’s equity

Assets Liabilities + Owner’s Equity

Transaction 6: A decrease in asset with a corresponding decrease in owner’s equity

Assets Liabilities + Owner’s Equity

Positive relationship Drawing (expense) increase,

Cash Debtors Office Furniture Van Loan Creditors Capital

12,000 8,000 10,000 25,000 = 15,000 5,000 + 35,000

Assets = Liabilities + Owner’s Equity

Cash Debtors Office Furniture Van Loan Creditors Capital

12,000 8,000 10,000 25,000 = 15,000 5,000 + 35,000

e) -4,000 10,000 6,000

10,600 6,000 9,900 35,000 = 12,000 9,800 + 39,700

o Revenue is the money received or will be received in future by

o Expenses are money or other assets that a business uses up as a

Relationship between Revenues and Expenses

The relationship between revenues and expenses can

Revenues Expenses Profit

Revenues Expenses Loss

Assets Liabilities Owner’s Equity Revenues Expenses

The Expanded Accounting Equation Rewritten

Assets Liabilities Owner’s Equity Profit

Assets Liabilities Owner’s Equity Loss

Relationship between Revenues, Expenses and Owner’s Equity

 Revenues => Assets => Owner’s equity (+ve relationship)

 Expenses => Assets => Owner’s equity (-ve relationship)

 Expenses => Liabilities => Owner’s equity (-ve relationship)

 Revenues => Liabilities => Owner’s equity (+ve relationship)