THE ACCOUNTING EQUATION

All businesses require resources in order to operate. These resources are usually provided by the owner of the business
and sometimes by using funds provided from other people or organisations outside the business.
From the business entity concept, a business is considered to be a separate entity from the owner. Hence transactions
related to the business should be separate from that of the owner.
Hence, Financial Statements are prepared for the business, NOT for the owner.

From this is derived the following:

Resources of the business = Resources obtained by the business

ASSETS

From the owner

from third parties

CAPITAL/

LIABILITIES

OWNERS EQUITY
Therefore,
Assets = Capital/Owners equity + Liabilities
NOTE: The left side of the equation is always equal to the right side of the equation
The above can be rewritten as follows:

ASSETS LIABILITIES = CAPITAL

THE ACCOUNTING EQUATION

What are Assets?

These are resources owned by the business which have a monetary value
and provide a benefit to the business. They help in generating revenue and
profits for the business.
Businesses acquire assets to ensure that they can trade or provide a service effectively.
Examples of business assets:

Land and buildings

Machinery
Equipment
Fittings
Inventories (stocks)
Trade receivables
Cash

The rule in accounting is that assets should always be valued at their cost (i.e whatever was paid for the asset). This is an
application of the COST/HISTORICAL COST concept.
This concept states that all assets of a business are shown and recorded at historical/original cost. Hence, assets that are
purchased have to be recorded at the cost of acquisition and not future market value.

TRADE RECEIVABLES (DEBTORS)

Some businesses provide goods or services to their customers on credit. This means that the customers agree to pay for
the goods or services some time after they have been sold. The amount due from credit customers is referred to as
receivables or trade receivables.

CASH
Cash is an important asset for all businesses and is essential for the survival of businesses. Usually this asset is separated
into two categories as follows:
Cash in hand: money in the form of notes and coins which is at the business premises (probably locked in a safe
or till).
Cash at bank: all money that has been transferred into a businesss bank account.

What are Liabilities?

These are amounts owed by the business to other businesses or organisations and which will eventually have to be repaid.
Liabilities could be incurred when:

Goods or services have been acquired on credit

Funds have been obtained from external parties

Examples of liabilities:
Loans from banks and from other providers
Bank overdrafts
Trade payables
TRADE PAYABLES (CREDITORS)
These are amounts owed by the business to businesses or organisations for goods supplied to the business on credit.
Payment for these goods or services are made at some later date.

What is capital?
Businesses only exist because their owners have invested their private funds in the business. These funds are called
capital or owners equity. The capital does not belong to the business and will eventually have to be repaid when the
business closes down.
The purpose of carrying out business by the owner is to make profits. Hence, profit is the reward for capital invested in a
business. Profit earned during a period should be added to capital/equity.
Drawings are amounts of money or goods taken from the business by the proprietor for his personal use. Drawings have
the effect of reducing the capital available to the business. So, drawings should be deducted from equity.
Owners equity = Equity at start + Profit for the period Drawings during the period.