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Orutt Academy Finance & Accounting
Unit 1: Basic Accounting Concepts
LESSONS:2.THE ACCOUNTING EQUATION
3. ASSETS4. LIABILITIES
5. OWNER’S EQUITY
Lesson 2THE ACCOUNTING
EQUATION
Accounting as a whole is based on a single equation:
ASSETS = EQUITY + LIABILITIES
THE ACCOUNTING EQUATION
The word equation comes from the word equal. For any equation, one side always equals another.
EQUATION
The accounting equation should remain in balance at all times because of double-entry accounting or bookkeeping.
Double-entry means that every transaction will aff ect at least two accounts in the general ledger.
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.
EXAMPLES OF DOUBLE ENTRY
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
SO WHAT DOES THE ACCOUNTING EQUATION MEAN?
Lesson 3ASSETS
Offi cial 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.
WHAT IS AN ASSET?
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.
IN OTHER WORDS…
LandComputerVehicleCash
EXAMPLES
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.
DEBTORS
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.
ARE DEBTORS AN ASSET?
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.
MEASURABLE VALUE
1. DOES YOUR BUSINESS OWN/CONTROL IT?2. WILL IT BRING YOUR BUSINESS BENEFITS IN
THE FUTURE?3. CAN YOU VALUE IT ACCURATELY?
SO THE FULL TEST OF WHETHER SOMETHING IS AN ASSET IS:
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.
HOW TO VALUE AN ASSET
Decrease Assets Increase Assets
Purchasing Supplies (The asset account Cash decreases)
Purchasing Supplies (The asset account Supplies increases)
Owner Draws Owner Contributions
Repaying bank loans Receiving bank loans
Credit purchases
CHANGES IN ASSETS
Lesson 4LIABILITIES
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.
WHAT IS A LIABILITY?
a liability is simply... a debt of the business.The debt will result in assets (usually cash) leaving
the business in the future.
IN OTHER WORDS…
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.
EXAMPLES
Decrease Liabilities Increase Liabilities
Repaying a bank loan Receiving a bank loan
Credit Payments Credit purchases
Paying Creditors Notes payable to creditors
CHANGES IN LIABILITIES
Lesson 5OWNER’S EQUITY
The residual interest in the assets of the enterprise after deducting all its liabilities.
WHAT IS OWNER’S EQUITY
The owner’s equity is simply the owner’s share of the assets of a business.
IN OTHER WORDS…
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
OWNER’S EQUITY
ASSETS = EQUITY + LIABILITIESThe accounting equation indicates how much of
the assets of a business belong to, or are owned, by whom.
Assets can only ‘belong’ to two types of people: people outside the business who are owed money
(liabilities) the owner himself (owner’s equity).
THE ACCOUNTING EQUATION
In the case of a corporation, which is publicly owned, equity is labeled shareholder’s equity
SHAREHOLDER’S EQUITY
Decrease Owner’s Equity Increase Owner’s Equity
Expenses Revenues
Losses Gains
Owner withdraws Owner investments
Beginning Capital
CHANGES IN OWNER’S EQUITY
IncomeExample: a service company earns revenue when it
provides services to its clientsRecorded as an increases in owner’s equity and an
increase in assets
REVENUES
The costs the company incurs in carrying on operations in its eff ort to create revenue
Decrease owner’s equityCan be paid for with cash (decreases assets)Or charged (increase liabilities)
EXPENSES
The diff erence between expenses and equipment is equipment can be liquidated or converted to cash.
EXAMPLE: A company car is equipment: No affect on owner’s equity. A telephone bill is an expense Decreases owner’s equity.
EXPENSES VS. EQUIPMENT
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
NET INCOME VS. NET LOSS
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. The basic accounting equation is assets = liabilities + ______________ ______________.
THE ACCOUNTING EQUATION WORKSHEET
For each of the transactions in items 2 through 9, indicate the two (or more) eff ects on the accounting equation of the business or company.
#2
IDENTIFYING CHANGES IN THE ACCOUNTING EQUATION
The owner invests personal cash in the business.
Assets: Increase Decrease No Effect
Liabilities: Increase Decrease No Effect
Owner's (or Stockholders') Equity:
Increase Decrease No Effect
#3
IDENTIFYING CHANGES IN THE ACCOUNTING EQUATION
The owner withdraws business assets for personal use.
Assets: Increase Decrease No Effect
Liabilities: Increase Decrease No Effect
Owner's (or Stockholders') Equity:
Increase Decrease No Effect
#4
IDENTIFYING CHANGES IN THE ACCOUNTING EQUATION
The company receives cash from a bank loan.
Assets: Increase Decrease No Effect
Liabilities: Increase Decrease No Effect
Owner's (or Stockholders') Equity:
Increase Decrease No Effect
#5
IDENTIFYING CHANGES IN THE ACCOUNTING EQUATION
The company repays the bank that had lent money to the company.
Assets: Increase Decrease No Effect
Liabilities: Increase Decrease No Effect
Owner's (or Stockholders') Equity:
Increase Decrease No Effect
#6
IDENTIFYING CHANGES IN THE ACCOUNTING EQUATION
The company purchases equipment with its cash.
Assets: Increase Decrease No Effect
Liabilities: Increase Decrease No Effect
Owner's (or Stockholders') Equity:
Increase Decrease No Effect
#7
IDENTIFYING CHANGES IN THE ACCOUNTING EQUATION
The owner contributes her personal truck to the business
Assets: Increase Decrease No Effect
Liabilities: Increase Decrease No Effect
Owner's (or Stockholders') Equity:
Increase Decrease No Effect
#8
IDENTIFYING CHANGES IN THE ACCOUNTING EQUATION
The company purchases a significant amount of equipment on credit.
Assets: Increase Decrease No Effect
Liabilities: Increase Decrease No Effect
Owner's (or Stockholders') Equity:
Increase Decrease No Effect
#9
IDENTIFYING CHANGES IN THE ACCOUNTING EQUATION
The company purchases land by paying half in cash and signing a note payable for the other half.
Assets: Increase Decrease No Effect
Liabilities: Increase Decrease No Effect
Owner's (or Stockholders') Equity:
Increase Decrease No Effect