ACCOUNTING PRINCIPLES

DOAN THUY DUONG

SAA
1-1
 Chapter 2: Accounting equation

Learning Content
1 Assets, liabilities and the business entity concept

2 The accounting equation

3 The statement of financial position

4 The statement of profit or loss

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1.Assets, liabilities and the business entity concept

Assets
Assets are classified into two types:
 NON-CURRENT ASSETS
Assets acquired for on-going, long-term use in the business.
e.g. Land and buildings, motor vehicles, plant and machinery.
 CURRENT ASSETS
Assets acquired for resale or expected to be realised within the
normal course of trading.
e.g. Inventory (stock), receivables (money owed by credit
customers) and cash.

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1.Assets, liabilities and the business entity concept

Liabilities
Liabilities are classified into two types:
NON-CURRENT LIABILITIES
Long-term liabilities payable more than 12 months
after the statement of financial position date
e.g. Loan
CURRENT LIABILITIES
Liabilities which are payable within 12 months of the
statement of financial position date
e.g. Trade payables (money owed to credit
suppliers), overdraft
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1.Assets, liabilities and the business entity concept

Capital – Sole trader

This is how much the business owes back to the owner. The
calculation of year end capital shown on the face of the
statement of financial position for a sole trader is:
Balance at start of year: X
Add: net profit for year
X Profit ‘belongs’ to the owner of the business
(deduct a loss)
Amounts invested in the business in accounting period
Add: capital injections X
by the owner

Amounts taken out of the business in the accounting

Less: drawings for year (X)
period by the owner

Balance at the end of year X

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1.Assets, liabilities and the business entity concept

Equity – Companies
The capital within a company is shown in a slightly
different way as there are often many different owners
and when they invest in the company, they do so by
purchasing shares. We therefore need to show their
investment in these shares separate to the profits earned
and retained by the business => study in chapter 9

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2. Accounting Equation

Owner's
Assets = Liabilities +
Equity

Basic Accounting Equation

 Provides the underlying framework for recording and
summarizing economic events.
 Assets are claimed by either creditors or owners.
 If a business is liquidated, claims of creditors must be paid
before ownership claims.

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 Basic Accounting Equation

Owner's
Assets = Liabilities +
Equity

Assets
 Resources a business owns.
 Provide future services or benefits.
 Cash, Supplies, Equipment, etc.

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 Basic Accounting Equation

Owner's
Assets = Liabilities +
Equity

Liabilities
 Claims against assets (debts and obligations).
 Creditors (party to whom money is owed).
 Trade payable, other Payable, Salaries and Wages
Payable, etc.

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 Basic Accounting Equation

Owner’s
Assets = Liabilities +
Equity

Owner’s equity
 Ownership claim on total assets.
 Referred to as residual equity.
 Investment by owners and revenues (+)
 Drawings and expenses (-).

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 Owner’s Equity Illustration 1-6
Expanded accounting
equation

Increases in Owner’s Equity

 Investments by owner are the assets the owner puts into the
business.
 Revenues result from business activities entered into for the
purpose of earning income.
► Common sources of revenue are: sales, fees, services,
commissions, interest, dividends, royalties, and rent.

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 Owner’s Equity Illustration 1-6
Expanded accounting
equation

Decreases in Owner’s Equity

 Drawings An owner may withdraw cash or other assets for
personal use.
 Expenses are the cost of assets consumed or services used in
the process of earning revenue.
► Common expenses are: salaries expense, rent expense,
utilities expense, tax expense, etc.

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 DO IT! Owner's Equity Effects

Classify the following items as investment by owner, owner’s

drawings, revenue, or expenses. Then indicate whether each
item increases or decreases owner’s equity.

Classification Effect on Equity

1. Rent Expense Expense Decrease

2. Service Revenue Revenue Increase

3. Drawings Drawings Decrease

4. Salaries and Wages
Expense Expense Decrease

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 The main financial statement

Companies prepare four financial statements :

Statement Statement Statement Statement

of profit of change of Financial of Cash
and loss in Equity Position Flows

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 ASSETS –
STATEMENT OF FINANCIAL POSITION

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 CAPITAL – EQUITY
STATEMENT OF FINANCIAL POSITION
Capital (sole trader):

Equity (company)

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 Liabilities-
STATEMENT OF FINANCIAL POSITION

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 Income/Expense
STATEMENT OF PROFIT AND LOSS

 Revenue
 Cost of Sales: the purchase or production cost
of the goods sold
 Gross Profit = Revenue – Cost of Sales
 Profit for the year = Gross profit – expenses +
non-trading income

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 Question 1
• Which one of the following can the accounting
equation can be rewritten as?
a) Assets + profit – drawings – liabilities = closing
capital
b) Assets – liabilities – drawings = opening capital +
profit
c) Assets – liabilities – opening capital + drawings =
profit
d) Assets – profit – drawings = closing capital –
liabilities
 Question 2
The profit earned by a business in 20X7 was
$72,500. The proprietor injected new capital of
$8,000 during the year and withdrew goods for
his private use which had cost $2,200. If net
assets at the beginning of 20X7 were $101,700,
what were the closing net assets?
a) $35,000
b) $39,400
c) $168,400
d) $180,000
 Question 3
• A sole trade borows $10,000 from a bank.
Which elements of the accounting equation
will change due to this transaction?
a) Assets and liabilities
b) Assets and capital
c) Capital and liabilities
d) Assets only