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ABFA1013 INTRODUCTION TO ACCOUNTING 1

Lecture 1: The Accounting Equation


Learning objectives:
Important Textbook Reading: After you have studied this chapter, you should be able to:
 Chapters 1, 2 & 4: Frank Wood & Alan Sangster “Business Accounting 1”  Explain the meaning of assets, liabilities and equity
 Additional reference per approved unit plan  Understand the accounting equation
Recommended Practice Questions:  Explain the meaning of profit, revenue and expenses
 Chapter 1: Question no. 1.11, 1.12A  Understand the profit determination equation

THE ACCOUNTING EQUATION

Assets

equals to

Liabilities

plus
Equity

Profit

equals to

Expenses

minus

Revenue
ABFA1013 INTRODUCTION TO ACCOUNTING 2

Business Owner
$$ Cash $$ increases
Other resources increase
Assets

equals to

plus Capital increases $$ Cash $$


Other resources
Equity
Capital

equals to

minus

Assets = Equity
ABFA1013 INTRODUCTION TO ACCOUNTING 3

1. Equity

Equity represents the resources that are provided by the owner into the There are 2 categories of assets:
business, for use in the business. i) Non-current assets – assets acquired for continuing use over a long
period of time (more than 1 year), e.g. building, machinery, fixture
Drawings represents withdrawals made by the owner for personal use and fittings, furniture, office equipment, motor vehicles, etc.
(equity will reduce). ii) Current assets – assets owned by the business and likely to change
in the short term (within a year), e.g. inventories (oil, spare parts,
Equity will increase when the business makes a profit. Equity will etc), receivables (trade and others), deposits, bank and cash
reduce when the business makes a loss. balances.

Example: Example:
Mr. Lee decided to start a business in repairing and servicing vehicles, The following are examples of the assets that Lee Workshop needs in
trading under the name of “Lee Workshop”. His father gave him order to run the business:
RM300,000 cash as injection of capital into the business. Mr. Lee Types of assets What are assets used for?
brought a computer (valued at RM3,000) and some furniture (valued at Cash  To purchase tools and equipment for
RM1,000) from his home to be used in his business. Due to urgent <current assets> repairing vehicles
needs, Mr. Lee withdrew RM2,000 cash for personal use.  To purchase spare parts for repairing
customers’ vehicles
Business Owner  To pay rental for the workshop
Lee Workshop Mr. Lee  To pay salaries for the workers
Computer  To keep record of all customers’
Receive cash RM300,000 Injects capital RM300,000
Receive computer RM3,000 Injects capital RM3,000 <non-current assets> information
 To issue invoices to customers
Receive furniture RM1,000 Injects capital RM1,000
 To keep record of all business transactions
Less: Pay cash RM2,000 Less: Withdraw cash RM2,000
Furniture  To be used in the office

Total assets = RM302,000 Total capital = RM302,000 <non-current assets>  To be used for entertaining customers in the
workshop
Tools and equipment  To be used for repairing vehicles
2. Assets <non-current assets>
Inventories  Spare parts, oils etc for repairing or
Assets are the resources that are inside the business, to be used for <current assets> servicing customers’ vehicles
running the business activities. The more assets a business has, the Receivables  Customers who have not yet paid (due to
bigger and stronger is the business, compared to competitors who have <current assets> credit term e.g. 15 days or 30 days)
fewer assets.
ABFA1013 INTRODUCTION TO ACCOUNTING 4

Business Bank / Suppliers


$$ Cash $$ increases
Other resources increase
Assets

equals to
Amount owing increases

Liabilities
plus $$ Cash $$
Other resources
Amount owing

equals to

minus

Assets = Liabilities
ABFA1013 INTRODUCTION TO ACCOUNTING 5

3. Liabilities

Liabilities represent the supply of resources by outsiders: Liabilities will be reduced when the business repays the loan or settles
i) Bank loan – the bank gives loan (cash) to the business. This is an the amount owing to suppliers (payables).
amount owing to the Bank.
ii) Suppliers – supply other resources for use in the business, such as, Example:
the purchases of inventories, non-current assets, etc. This is an Lee Workshop settles the following amounts owing to suppliers:
amount owing to the suppliers, also called as payables.
Business Outsiders
There are 2 categories of liabilities: Lee Workshop Payables
i) Non-current liabilities - amount payable for more than 1 year, e.g.
mortgage loan, bank loan, etc. Pay RM500 for tools Receive cash RM500
ii) Current liabilities – amount payable within one year, e.g. short-term Pay RM90,000 for equipment Receive cash RM90,000
loan, bank overdraft, payables (trade or others), etc. Pay RM5,000 for spare parts Receive cash RM5,000

Example:
The following are examples of the resources that Lee Workshop needs Assets reduce by RM95,500 Liabilities reduce by RM95,500
to obtain from outsiders in order to run the business:
It is a disadvantage if the business has a lot of liabilities because it will
Business Outsiders be burdened with the pressure to find the assets (resources) to settle
Lee Workshop Bank / Suppliers them, together with interest (cost of capital), if any.
Receive cash RM50,000 Loan RM50,000
Receive tools RM500 Supply tools RM500 4. The accounting equation
Receive equipment RM90,000 Supply equipment RM90,000
Receive spare parts RM5,000 Supply spare parts RM5,000 ASSETS = EQUITY + LIABILITIES .

All the assets (resources) available in the business are either provided by
Total assets = RM145,500 Total liabilities = RM145,500 the owner (equity) and/or supplied by outsiders (liabilities).
ABFA1013 INTRODUCTION TO ACCOUNTING 6

Illustration 1:

Elaine Tan started business on 1 May, operating a shop “Sweet Bun” selling Prepare a listing based on the Accounting Equation as at 31 May.
various types of buns, with her own cash of RM30,000 and a 2-year loan Types Amount (RM)
from RHB Bank of RM20,000. She opened a current account with RHB Assets Cash
Bank and deposited RM40,000 into it. During the month, she paid the Bank
following by cheques: Fixture and fittings
Furniture
 Fixture and fittings RM8,000 Office equipment
 Furniture RM7,000 Inventories
 Office equipment RM5,000 50,000
 Inventories RM3,000
Liabilities Loan
Calculate the cash and bank balances at the end of May.
Equity Capital
Increase Decrease Balance
50,000
(RM) (RM) (RM)
Cash:
 Capital injection by Elaine Tan
 Loan from RHB Bank
 Deposited into the bank account
Bank account:
 Deposited into the bank account
 Paid for fixture & fittings
 Paid for furniture
 Paid for office equipment
 Paid for inventories
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Business Customers
$$ Cash $$ increases
minus
Assets Inventories decrease

equals to

Profit increases equity

plus
$$ Cash $$
Equity
Payment

Revenue
Revenue minus cost of inventories sold Profit Sale of inventories

equals to

Cost of inventories sold Expenses

minus

$$ Cash $$ received Revenue

Assets (increase) = Equity (increase)

Profit = Revenue - Expenses


ABFA1013 INTRODUCTION TO ACCOUNTING 8

5. Profit 6. Revenue

Business makes a profit when the selling price charged to the customer Revenue is the income received/earned by the business from
is higher than the cost of the inventories. undertaking business activities, which results in an increase of assets,
e.g. cash/receivables. Types of revenue are:
All profits made by the business belong to the owner. Therefore, all i) Sales – income earned from selling goods and services, e.g. selling
profits made will increase equity. Conversely, when the business spare parts to customers, repairing vehicles.
makes a loss, it will reduce equity. ii) Other income – other sources of income earned that are not directly
related to the main business activities, e.g. rent received, discount
Example: received, interest received, commission received, etc.
Lee Workshop sells 10 boxes of spare parts to a walk-in customer at a
total selling price of RM500. Lee Workshop had purchased these spare 7. Expenses
parts from the supplier at a price of RM20 per box (total = RM200):
Expenses are all the resources that have been consumed in running the
Business Outsiders business. Types of expenses are:
Lee Workshop Customers i) Cost of goods sold – cost of inventories sold to customers.
ii) Expenses – other forms of resources, e.g. salaries to workers, rental,
Sell inventories costing RM200 Inventories selling price RM500
electricity, telephone, water, insurance, etc.
Receive cash RM500 Pay RM500
8. The Profit Determination Equation
Assets increase by RM300 Amount owing = Nil
PROFIT = REVENUE - EXPENSES .

Cost of inventories RM200 Profit is the net amount after adding up all the revenue and deducting all
Selling price RM500 the expenses. If expenses exceed revenue, then the business makes a
loss.
Profit increase by RM300
ABFA1013 INTRODUCTION TO ACCOUNTING 9

Illustration 2:

Continuing from Illustration 1 above, Elaine Tan’s “Sweet Bun” business Prepare a listing based on the Profit Determination Equation for the month
transactions during the month of June are as follows: ended 30 June.
Types Amount (RM)
 Purchases of inventories by cheque totalling RM5,000 Revenue Sales
 Sales totalling RM20,000, all deposited into the bank account Discount received
(inventories sold were costing RM7,000) 20,200
 Received a cheque RM200 being discount received from supplier
 Paid staff salaries by cash RM2,000 Cost of inventories sold
Expenses
 Paid shop rental by cheque RM3,000 Staff salaries
 Paid electricity by cash RM500 Shop rental
 Withdrew RM2,000 cash for personal use (drawings) Electricity
12,500
Calculate the cash, bank and inventories balances as at 30 June.
Increase Decrease Balance
(RM) (RM) (RM) Profit Revenue - Expenses 7,700
Cash:
 Balance from last month
Prepare a listing based on the Accounting Equation as at 30 June.
 Paid staff salaries Types Amount (RM)
 Paid electricity Assets Cash
 Drawings Bank
Bank: Fixture and fittings
 Balance from last month Furniture
 Purchase of inventories Office equipment
 Sales Inventories
 Discount received 55,700
 Paid shop rental
Inventories: Liabilities Loan
 Balance from last month Equity Capital
 Purchases Drawings
 Sales Profit
55,700