Chapter

ACCOUNTING
2 EQUATION AND
FINANCIAL
STATEMENTS
 • Definition of assets, • Statement of Profit or
Learning liabilities, owner’s Loss and Other
Comprehensive
Objectives • Equity, revenue and Income
expenses. • Statement of
• Accounting equation Changes in Equity
• Effect of business • Statement of
transaction on Financial Position
accounting equation • Statement of Cash
Flows
 Define and Define and interpret the accounting
interpret equation and each of its components

Specific
Learning Analyze
Analyze business transactions using the
accounting equation

Objectives
Identify Identify and prepare basic financial
and statements and explain how they
prepare interrelate
ECONOMIC ENTITY
 Accounting Equation

Assets = Liabilities + Equity

Liabilities
Assets & Equity
 LIABILITIES

ASSETS = +
EQUITY
 A=L+E

A L E

ALE! ALE!! ALE!!!

The Elements of Financial Statements

A present economic resource

controlled by the entity as a result
of past events. An economic
resource is a right that has the
potential to produce economic
benefits.
The Elements of Financial Statements

A present obligation of the entity

to transfer an economic resource
as a result of past events. An
obligation is a duty of
responsibility that the entity has
no practical ability to avoid
The Elements of Financial Statements

The residual interest in the

assets of the entity after
deducting all its liabilities.

A=L+E
A-L=E
The Elements of Financial Statements

Increases in assets, or decreases

in liabilities, that result in
increases in equity, other than
those relating to contributions
from holders of equity claims.
The Elements of Financial Statements

Decreases in assets, or increases in

liabilities, that result in decreases
in equity, other than those relating
to distributions to holders of
equity claims.
 Assets
Cash
Accounts Notes
Receivable Receivable

Vehicles Inventories
Land

Buildings
Supplies
Equipment
 Liabilities

Accounts Notes
Payable Payable

Taxes Wages
Payable Payable
 + Equity -
Owner Owner
Investments Withdrawals

Owner’s
claims
on
assets
Revenues Expenses
 Expanded Accounting Equation
Assets = Liabilities + Equity

Owner Capital + Revenues _ Owner _ Expenses

Withdrawals
 Asset
Expense Capital
6 major
accounting
components
Withdrawal Revenue
Liability
 Transaction Analysis Equation
The accounting equation must remain in balance after
each transaction.

Assets = Liabilities + Equity

 Transaction Analysis
Jokawa, the owner, contributed $20,000
cash to start the business.

The accounts involved are:

(1) Cash (asset)
(2) Jokawa, Capital (equity)
 Transaction Analysis
Jokawa, the owner, contributed $20,000
cash to start the business.
 Transaction Analysis
Purchased supplies paying $1,000
cash.

The accounts involved are:

(1) Cash (asset)
(2) Supplies (asset)
 Transaction Analysis
Purchased supplies paying $1,000
cash.
 Transaction Analysis
Purchased equipment for $15,000
cash.

The accounts involved are:

(1) Cash (asset)
(2) Equipment (asset)
 Transaction Analysis
Purchased equipment for $15,000
cash.
 Transaction Analysis
Purchased Supplies of $200 and
Equipment of $1,000 on account.

The accounts involved are:

(1) Supplies (asset)
(2) Equipment (asset)
(3) Accounts Payable (liability)
 Transaction Analysis
Purchased Supplies of $200 and
Equipment of $1,000 on account.
 Transaction Analysis
Borrowed $4,000 from 1st American
Bank.

The accounts involved are:

(1) Cash (asset)
(2) Notes payable (liability)
 Transaction Analysis
Borrowed $4,000 from 1st American
Bank.
 Transaction Analysis
The balances so far appear below. Note that the
Accounting Equation is still in balance.

Now let’s look at transactions involving

revenue, expenses and withdrawals.
 Increase (+)
1. Capital/Investment by the
owner in cash, or any kind
of assets to the business.
2. Income/Revenue
generated by the business
from sales, services, fees,
Decrease (-)
1. Expenses incurred by the
business – electricity,
water, insurance, rental,
utilities, telephone,
wages, salary, postal,
courier, license,
advertising…

Equity 3.
rental, interest earned,
dividend, gain.
Profit
2. Expenses due to assets
consumption or
utilization – supplies,
depreciation,
3. Cost of goods sold,
commissions, interests,
taxes
4. Withdrawals/Drawings
 Transaction Analysis
Rendered consulting services
receiving $3,000 cash.

The accounts involved are:

(1) Cash (asset)
(2) Revenues (equity)
 Transaction Analysis
Rendered consulting services
receiving $3,000 cash.
 Transaction Analysis
Paid salaries of $800 to employees.

The accounts involved are:

(1) Cash (asset)
(2) Salaries expense (equity)

Remember that the balance in the salaries

expense account actually increases.
But, equity actually decreases because expenses
reduce equity.
 Transaction Analysis
Paid salaries of $800 to employees.

Remember that expenses decrease equity.

 Transaction Analysis
Jokawa withdrew $500 from the
business for personal use.
The accounts involved are:
(1) Cash (asset)
(2) Jokawa, Withdrawals (equity)
Remember that the balance in the Jokawa,
Withdrawals account actually increases.
But, equity actually decreases because
withdrawals reduce equity.
 Transaction Analysis
Jokawa withdrew $500 from the
business for personal use.

Remember that withdrawals decrease equity.

RECAP…..RECAP….RECAP….RECAP…..
RECAP….
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Secret of identifying a transaction:

3 As: MUST be present

1. Actualized - it happened
2. Amount - Ringgit Malaysia (RM)
3. Accounts - a minimum 2 accounts
 Financial Statements
Let’s prepare the Financial Statements reflecting the
transactions we have recorded.

1. Statement of Profit or Loss

and Other Comprehensive
Income
2. Statement of Changes in
Owner’s Equity
3. Statement of Financial
Position
4. Statement of Cash Flows
 Profit is the
difference
between
Revenues and
Expenses.

The statement describes a company’s

revenues and expenses along with
the resulting profit or loss over a
period of time due to earnings
activities.
 The profit of
$2,200
increases
Scott’s capital
by $2,200.

The Statement
Changes in Owner’s
Equity explains
changes in equity
from profit (or loss)
and from owner
investments and
withdrawals for a
period of time.
The Statement
of Financial
Position
describes a
company’s
financial
position at a
point in time.
Owner’s Equity in The
Statement of Financial
Position
From Statement of Changes in
Owner’s Equity
The Statement of Cash Flows identifies cash inflows and cash outflows over a
period of time.
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?v
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End of Chapter 2