HTM407/20244/FPHPCS

TOPIC 3
ACCOUNTING CLASSIFICATION AND EQUATION

Learning Outcome:
LO1: Identify the elements of financial statements
LO2: Describe the basic accounting equation
LO3: Describe the expanded accounting equation
LO4: Relate the components in the statement of financial position and statement in profit or lost to
the accounting equation

1.0 ACCOUNTING TERMINOLOGY

NO TERMS DEFINITION
1. BALANCE SHEET/STATEMENT OF It is the statement of financial position of the business
FINANCIAL POSITION (SOFP) entity on a particular date.
It lists all assets, liabilities and capital. It is important to
note that this statement exhibits the state of affairs of
the business as on a particular date only. It describes
what the business owns and what the business owes to
outsiders (this denotes liabilities) and to the owners (this
denotes capital). It is prepared after incorporating the
resulting profit/losses of Income statement.
2. INCOME This account shows the revenue earned by the business
STATEMENT/STATEMENT OF and the
PROFIT AND LOST (SOPL) expenses incurred by the business to earn that revenue.
This is prepared usually for a particular accounting
period, which could be a month, quarter, a half year or a
year. The net result of the Profit and Loss Account
will show profit earned or loss suffered by the business
entity.
3. ACCURUAL BASIS OF Accrual Basis of Accounting is a method of recording
ACCOUNTING transactions by which revenue, costs, assets and
liabilities are reflected in the accounts for the period in
which they accrue. This basis includes consideration
relating to deferrals, allocations, depreciation and
amortization. This basis is also referred to as mercantile
basis of accounting.
4. CASH BASIS OF ACCOUNTING Cash Basis of Accounting is a method of recording
transactions by which revenues, costs, assets and
liabilities are reflected in the accounts for the period in
which actual receipts or actual payments are made.
5. PROFIT The excess of Revenue Income over expense is called
profit. It could be calculated for each transaction
or for business as a whole.
6. LOSS The excess of expense over income is called loss. It could
be calculated for each transaction or for
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business as a whole.
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7. ASSET Asset is a resource owned by the business with the

purpose of using it for generating future profits. Assets
can be Tangible and Intangible. Tangible Assets are the
Capital assets which have some physical existence.
They can, therefore, be seen, touched and felt, e.g. Plant
and Machinery, Furniture and Fittings, Land and
Buildings, Books, Computers, Vehicles, etc. The capital
assets which have no physical existence and whose
value is limited by the rights and anticipated benefits
that possession confers upon the owner are known as
lntangible Assets. They cannot be seen or felt although
they help to generate revenue in future, e.g. Goodwill,
Patents, Trade-marks, Copyrights, Brand Equity, Designs,
Intellectual Property, etc.
Assets can also be classified into Current Assets and Non-
Current Assets.
• Current Assets
An asset shall be classified as Current when it
satisfies any of the following:
(a) It is expected to be realised in, or is intended
for sale or consumption in the Company’s
normal Operating Cycle,
(b) It is held primarily for the purpose of being
traded,
(c) It is due to be realised within 12 months after
the Reporting Date, or
(d) It is Cash or Cash Equivalent unless it is
restricted from being exchanged or used to settle
a Liability for at least 12 months after the
Reporting Date.
• Non Current Assets
All other Assets shall be classified as Non-
Current Assets. e.g. Machinery held for long
term etc.

8. LIABILITY It is an obligation of financial nature to be settled at a

future date. It represents amount of money
that the business owes to the other parties. E.g. when
goods are bought on credit, the firm will create an
obligation to pay to the supplier the price of goods on an
agreed future date or when a loan is taken from
bank, an obligation to pay interest and principal amount
is created.
Depending upon the period of holding, these obligations
could be further classified into Long Term on noncurrent
liabilities and Short Term or current liabilities.
• Current Liabilities
A liability shall be classified as Current when it
satisfies any of the following:
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(a) It is expected to be settled in the Company’

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s normal Operating Cycle,

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(b) It is held primarily for the purpose of being

traded,
(c) It is due to be settled within 12 months after
the Reporting Date, or
(d) The Company does not have an
unconditional right to defer settlement of the
liability for at least 12 months after the reporting
date (Terms of a Liability that could, at the
option of the counterparty, result in its
settlement by the issue of Equity Instruments do
not affect its classification)

• Non-Current Liabilities
All other Liabilities shall be classified as Non-
Current Liabilities. E.g. Loan taken for 5
years, Debentures issued etc.

9. CAPITAL It is amount invested in the business by its owners. It

may be in the form of cash, goods, or any other
asset which the proprietor or partners of business
invest in the business activity. From business point of
view,
capital of owners is a liability which is to be settled only
in the event of closure or transfer of the business.
Hence, it is not classified as a normal liability. For
corporate bodies, capital is normally represented as
share
capital.
10. WORKING CAPITAL Working capital is the excess of current assets over
current liabilities. That is the amount of current assets
that remain in a firm if all its current liabilities are paid.
This concept of working capital is known as Net Working
Capital which is a more realistic concept.
Working Capital (Net) = Current Assets – Currents
Liabilities.
11. DRAWINGS It represents an amount of cash, goods or any other
assets which the owner withdraws from business
for his or her personal use. e.g. if the life insurance
premium of proprietor or a partner of business is paid
from the business cash, it is called drawings. Drawings
will result in reduction in the owners’ capital. The
concept of drawing is not applicable to the corporate
bodies like limited companies.
12. DEBTOR The sum total or aggregate of the amounts which the
customer owed to the business for purchasing
goods on credit or services rendered or in respect of
other contractual obligations. Debtors are those
persons from whom a business has to recover money on
account of goods sold or service rendered on credit.
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These debtors may again be classified as under:

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(a) Good debts: The debts which are sure to be realized

are called good debts.
(b) Doubtful Debts: The debts which may or may not be
realized are called doubtful debts.
(c) Bad debts: The debts which cannot be realized at all
are called bad debts.
It must be remembered that while ascertaining the
debtors balance at the end of the period certain
adjustments may have to be made e.g. Bad Debts,
Discount Allowed, Returns Inwards, etc
13. CREDITORS Creditor is a person to whom the business owes money
h. e.g. money payable
to supplier of goods or provider of service. Creditors are
generally classified as Current Liabilities.
14. CAPITAL EXPENDITURE This represents expenditure incurred for the purpose of
acquiring a fixed asset which is intended to be used
over long term for earning profits there from. e. g.
amount paid to buy a computer for office use is a capital
expenditure. At times expenditure may be incurred for
enhancing the production capacity of the machine. This
also will be a capital expenditure. Capital expenditure
forms part of the Balance Sheet.
15. REVENUE EXPENDITURE This represents expenditure incurred to earn revenue of
the current period.
The benefits of revenue expenses get exhausted in the
year of the incurrence. e.g. repairs, insurance, salary &
wages to employees, travel etc. The revenue expenditure
results in reduction in profit or surplus. It forms part
of the Income statement.
16. DISCOUNTS ALLOWED Discounts allowed are cash discounts granted to the
business’s customers for the prompt settlement of any
debts due to the business. The amount of cash received
from debtors who claim a cash discount will then be less
than the total amount for which they have been invoiced.
The entry for "Discount Allowed" in accounting is
typically made when a business allows a reduction in the
amount due from a customer as an incentive for early
payment or for other promotional reasons. "Discount
Allowed" is recorded as an expense because it reduces
the business's revenue.
17. DISCOUNT RECEIVES Discounts received relate to cash discounts given by the
business’s suppliers for the prompt payment of any
amounts due to them. So the amount paid to the
business creditors will be less than the invoiced amount.
The entry for "Discount Received" is recorded when a
business receives a discount from its suppliers, usually
for early payment. This discount is treated as income
because it reduces the cost of purchases.
18. TRADE DISCOUNT Trade discounts are a form of special discount. They
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may be given for placing a large

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order, for example, or for being a loyal customer. Trade

discounts are deducted from the
normal purchase or selling price. They are not recorded
in the books of account and
they will not appear on any invoice.
19. SALES The Sales Account records the value of goods sold to
customers during a particular accounting period. The
account includes both cash and credit sales. It does not
include receipts from (say) the sale of a motor car
originally purchased for use within the business.
20. DEPOSIT (CUSTOMER DEPOSIT When a business receives a deposit as an initial
OR UNEARNED REVENUE) payment from a customer, it is recorded as a liability
because the business has an obligation to provide
goods or services in the future. This deposit is generally
recorded in an "Unearned Revenue" or "Customer
Deposit" account until the service or goods are delivered.
This entry recognizes the cash received and records the
liability, as the service has not yet been provided. Once
the service is completed, the "Customer Deposits"
account is debited, and revenue is credited.
21. CREDIT NOTES A credit note is issued by a business to a customer when
goods are returned, or if there has been an overcharge
or an error in the original invoice. It reduces the amount
the customer owes to the business.
The journal entry for a credit note depends on whether
it’s related to sales returns or a price adjustment. This
entry reduces the revenue and adjusts the amount owed
by the customer OR the entries reduce both revenue and
the customer’s outstanding balance.

22. DEBIT NOTE A debit note is issued by a business to a supplier when

it returns goods or needs to reduce an amount owed
(for example, due to defective or excess goods). This
note essentially serves as a request to decrease the
balance due on the supplier’s account.
This entry reduces the liability owed to the supplier and
adjusts the cost of purchases OR
The entries reflect the reduction in the payable balance
and the cost associated with the returned or
overcharged goods.

2.0 THE FINANCIAL STATEMENTS

❑ It is a structured report of a business financial activities throughout a period of time.

❑ It is a report that is prepared on a regularly basis – monthly, quarterly, half yearly / yearly.
❑ It provides overall picture of a business ‘health’ and ‘wealth’

There are 5 elements of complete set of financial statements:

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a) Statement Of Financial Position (SOFP)

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b) Statement Of Profit or Loss (SOPL)

c) Statement Of Changes in Equity
d) Statement Of Cash Flows
e) Notes to the Accounts

3.0 STATEMENT OF FINANCIAL POSITIONING (SOFP) @ BALANCE SHEET

It shows the financial position of a business at a particular point in time. Financial position means
disclosing or showing the total amount of ASSETS that are owned by the business and the amount
of contributions from the OWNERS (CAPITAL) and borrowings (LIABILITIES).

a) ASSETS
Assets are resources or items of value that the business owns and expected to generate
economic benefit in the future.

ASSETS

NON-CURRENT/FIXED ASSETS CURRENT ASSETS

- Kept and used on long term basis or - Cash and other assets which are short-
useful life of > 12 months term in nature.
- Fixed assets are not for sale - Normally can be converted into was <
- They are used in the running of the 12 months
business - Examples:
➢ Tangible, e.g.: physical assets ➢ Inventories (stocks)
such as building, land, ➢ Accounts receivables (debtors)
equipment, machinery, ➢ Cash, and cash in bank
furniture and fixtures, motor ➢ Pre-payments (expenses paid in
vehicles. advance)
➢ Intangible, e.g: non physical ➢ Short term investment
assets such as good will, ➢ Preliminary expenses (expenses
franchise, pattern, copyright, related to the formation of the
trademarks. business)
➢ Long term investment, bought
for the purpose to earn interest
or dividend e.g.: fixed deposit

b) LIABILITIES
- The obligations of an entity to other entities
- External parties claim to business assets
- Amounts owed by business to outside parties

LIABILITES

NON-CURRENT LIABILITIES CURRENT LIABILITIES

- Debt repayable for more than a - Debt that are repayable in within
year > months the year < months
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➢ Long term loan ➢ Account payable (creditors)

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➢ Mortgage ➢ Short term loan

➢ Debentures ➢ Bank over draft
➢ Accrued expenses
(expenses incurred but not
yet paid)

c) OWNER’S EQUITY

Owner’s claim on the business assets.

I. Capital: amounts contributed by the owner to the business (in the form of cash or
other assets).
II. Accumulated Profits: profits earned (or minus the loss incurred) and retained in the
business.
III. Drawings are the cash or goods taken by the owner for personal use.
Owner’s equity = Capital + Accumulated Profits - Drawings equity

4.0 STATEMENT OF PROFIT AND LOST @ INCOME STATEMENT

It shows the financial performance of a business during a period of time. Financial performance
is measured by the profit earned or loss incurred during that period.

a) Revenue Category

REVENUE
(INCOME GENERATED BY THE BUSINESS EITHER BY TRADING OR NORMAL OPERATING
ACTIVITIES)
SALES OF GOODS RENDERING OF SERVICES FROM THE USE OF THE
e.g.: KFC – Sales of fried e.g.: Visa fee, commission BUSINESS ASSETS BY OTHER
chicken • Rental Income
• Interest Income (cash
deposit in a bank)
• Royalties (copyright)
• Dividend income
(investment in share

b) Expenses Category
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5.0 ACCOUNTING EQUATION

Basic accounting equation:

Asset = Owner’s Equity + Liabilities

The equation tells us in clear and simple terms that what the entity owns (or possesses)
was obtained using a combination of contributions from the entity’s owners and borrowings
from other people.

Expanded accounting equation:

Assets + Drawings + Expenses = Liabilities + Revenue + Capital

6.0 THE EFFECT OF BUSINESS TRANSACTION TO THE ACCOUNTING EQUATION

Basic double entry begins with recognizing the effect of the transaction on the accounting equation.
The effect of the business activities on the basic accounting equation,

Assets = Liability + Owner’s Equity

Example 1
EFFECT: EFFECT:
TRANSACTIONS ACCOUNTS AFFECTED
INCREASE DECREASE
Ali started a business with
RM10,000 cash in hand
The business deposited
RM8,000 of the cash into the
bank account
Received loan by cheque
RM5,000
Purchase furniture worth
RM1,000 by cheque
The owner took cash RM100
for his own use
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The effect of the business activities on the extended accounting equation:

Assets + Drawings + Expenses = Liability + Owner’s Equity + Revenue
EXAMPLE 2
EFFECT: EFFECT:
TRANSACTIONS ACCOUNTS AFFECTED
INCREASE DECREASE
Mala started a business with
RM10,000 cash in hand and
furniture amounted to
RM50,000
Purchase goods from ABC
Trading RM555 in cash
Received loan by cheque
RM5,000
The business deposited
RM8,000 of the cash into the
bank account
Paid RM500 to account
payable
Purchase furniture worth
RM1,000 and payment made
via online transfer
Sold goods worth RM1,000
to Hassan for cash
The owner took cash RM100
for his own use

EXAMPLE 3
EFFECT: EFFECT:
TRANSACTIONS ACCOUNTS AFFECTED
INCREASE DECREASE
Purchase of goods
Sales of Goods
Purchase returns/Return
Outwards (purchase return
to supplier)
Sales Return/Return Inwards
(customer return our
product)
Discount Allowed
Withdrawal of goods
Discount Received
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EXERCISE 3.0

Exercise 3.1: Chapter 3 – OCTOBER 2024

Rasa Sayang Enterprise is a grocery shop business was set up on 1 November 2022. Below are the
business transactions during the month of November 2022.

Date
November Transactions
2022
Owner brought in RM90,000 cash and furniture valued at RM22,000 into the
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business.
7 Purchased goods worth RM7,000 on credit from Pacific Store.
9 Sold goods worth RM5,500 on credit to Sally.
Purchased a display cabinet on credit from Ali Furniture worth RM4,200.
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The payment will be paid in four equal instalments starting next month.
12 Returned damaged goods to Pacific Store worth RM300.
14 A credit note of RM300 was issued to Sally for the return of damaged goods.
15 Cash sales to Marina worth RM1,300.
Received full settlement from Sally for the amount due after deducting a cash
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discount of RM50. The sum was received by electronic funds transfer.
Owner withdrew goods worth RM500 from the business for personal
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consumption.

Required:

Using the format below, answer the following questions:

a) Identify the effects (increase or decrease) on assets, liabilities, revenues, expenses or capital
for the above transactions.

SOLUTION

Date EFFECT
TRANSACTION
Nov 2022 Increase Decrease
2/11
7/11
9/11
10/11
12/11
14/11
15/11
18/11
10

20/11
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Exercise 3.2: Chapter 3 – APRIL 2024

Kawan-Kawan Nature Cruise started its business on 1 November 2022. The following
business transactions occurred in the first month of its operation.

November Details
2022
1 The owner Mr. Kaw An invested cash of RM100,000 and his personal van
worth RM75,000 into the business.
2 The business opened up a current account and banked in RM50,000 cash.

6 Purchased office furniture costing RM10,000 on credit from Recca Home

Deco Sdn.Bhd. accrue
8 Purchased goods amounting RM15,000 on credit from Othman Enterprise.

10 Sold good to Dhahab Trading on credit RM5,500.

12 Issued a credit note of RM180 to Dhahab Trading due to goods returned.

15 Issued cheque to Ismail Trading for purchased of computer printer RM1,850.

19 The owner entertained a FAM Trip worth RM650 and cash RM1,100 for his
own personal use.
22 Sold Nature Cruise Tour Package to Mr. Yamamoto in cash worth RM1,500.

24 Issued cheque RM6,000 to Othman Enterprise for goods bought on 8th

November.
26 Cash sales earned worth RM2,100.

28 Purchased goods RM4,500 paid by cheque.

29 Banked in employee’s salaries of RM15,000.

30 Paid utilities of RM250 by cash.

Required:

a. Identify the effects (increase or decrease) on assets, liabilities, revenues, expenses orowner’s
equity for the above transactions.

SOLUTION:
DATE ACCOUNTS EFFECTED EFFECT: INCREASE EFFECT: DECREASE
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Exercise 3.3: Chapter 3 – OCTOBER 2024

Gula Manis Trading, a pastry shop business was set up on 1 Oktober 2023. Below are the business
transactions during the month of December 2023

2023 TRANSACTION
DECEMBER
2 Made cash sales to Biana worth RM7,300
7 Purchase goods worth RM7,000 on credit from KY Bakery
9 Sold goods worth RM5,500 on credit to Adi Enterprise
10 Purchase shelves from Ali Baba Furniture for business use worth RM4,200. The
payment will be made in four equal installments starting next month.
12 Return faulty goods to KY Bakery worth RM300
14 A credit note of RM400 was issued to Adi Enterprise for the return of damaged
goods.
15 The owner brought in an additional RM80,000 cash into the business.
16 A rental income of RM4,200 was received from the tenant.
18 Paid in cash to KY Bakery for the amount due and received a cash discount of
RM40.
22 The owner took RM400 worth of goods for his personal use.

Required:

a) Identify the effects (increase or decrease) on assets, liabilities, revenues, expenses orowner’s
equity for the above transactions.

SOLUTION:
DATE ACCOUNTS EFFECTED EFFECT: INCREASE EFFECT: DECREASE
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REFERENCE

Sole Proprietorship in Malaysia: A Simple Guide

https://www.cleartax.com/my/en/sole-proprietorship-malaysia

Open a Partnership in Malaysia

https://companyincorporationmalaysia.com/open-a-partnership-in-malaysia/

What is private limited company (SDN BHD)

https://malaysia.acclime.com/formation/private-limited-company/
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