Session: 3-4

Accounting Equation
Basic Terminology

• Entity: An entity means an economic unit that performs economic activity.

• Transaction: A transaction is an exchange in which each participants
receive or scarifies value.
• Voucher: Voucher is a document which serves as an evidence of a
transaction.
• Entry: Entry is the record made in the books of accounts in respect of a
transaction.
Basic Terminology

• Assets: Assets refers to tangible objects and intangible rights which carry
probable future benefits.
• It is an resource controlled by the enterprise which carry from which
future economic benefits are expected to flow.
• Current assets: current assets are those assets which are held
• in the form of cash
• For their conversion in to cash
• For their consumption in the production process
Basic Terminology
• Fixed Assets: These assets are held for the purpose of providing or
producing goods and services and those that are not held for resale in the
normal course of business.
• Tangible fixed assets
• Intangible fixed assets
• Liabilities: it refers to a financial obligation of an enterprise other than
owner’s fund.
• Current liabilities: current liabilities are those which fall due for payment
in a relatively short period (normally a period not more than 12 months)
• Long term liabilities:
Basic Terminology
• Capital/Owners Equity: it is the amount invested by the proprietor in the
business.
• Drawings: Any amount of cash, goods or other assets the proprietor
withdraws for their personal use.
• Stock (Inventory): The term stock refers to tangible property held for sales
in normal business or consumption in producing goods and services for
sales.
Basic Terminology
• Trade debtors/ Trade Receivables: A person from whom the amount is due
for goods sold and services rendered.
• Trade creditors/Trade Payables: A person to whom the amount is due for
goods sold and services rendered.
• Revenue: it is the economic benefit during an accounting period.
• Expenses: Cost incurred and expired to earn revenues.
Accounting Equation

The accounting equation is the statement of equality between the resources

and the sources which finance the resources.
Resources=Claim
Resources means the assets which refer to tangible objects or intangible
rights. Sources of finance means equity and liabilities.
Assets = Liabilities+ Equity
The equation, Assets = Liabilities + Equity can be rewritten as
Assets = Liabilities + Equity + (Revenues – Expenses)
Apply the accounting equation to business
organizations
• The financial statements are based on the accounting equation. This
equation presents the resources of a company and the claims to those
resources.
• Assets are economic resources that are expected to produce a benefit
in the future.
• Liabilities are “outsider claims.” They are debts owed to people and
organizations outside of the business (creditors).
• Equity (also called capital, owners’ equity, or stockholders’ equity for a
corporation) represents the “insider claims” of a business. Equity means
ownership
Apply the accounting equation to business
organizations
• The financial statements are based on the accounting equation. This
equation presents the resources of a company and the claims to those
resources.
• Assets are economic resources that are expected to produce a benefit
in the future.
• Liabilities are “outsider claims.” They are debts owed to people and
organizations outside of the business (creditors).
• Equity (also called capital, owners’ equity, or stockholders’ equity for a
corporation) represents the “insider claims” of a business. Equity means
ownership
Process for Developing Accounting
Equation

• Step 1- Ascertain the variables of an equation affected by a transaction.

• Step 2- Find out effect (in terms of increase and decrease) of a transaction
on the variables of an equation

• Step 3- Show the effect on the appropriate side of an equation

Accounting equation-based classification
of Accounts
• Assets accounts: These accounts are related to tangible and intangible
assets.
• Liabilities accounts: These accounts are related with the financial
obligations of an business towards outsiders.
• Capital accounts: These accounts are related to the owners of an
enterprise
• Revenue accounts: These accounts are related with income and profits.
• Expenses accounts: These accounts are related with expenses and losses
Thank you