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Lesson 2-4 The Accounting Equation
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Lesson 2-4 The Accounting Equation

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  • 1. LESSONS: Orutt Academy Finance &2.THE ACCOUNTING EQUATION Accounting 3. ASSETS Unit 1: Basic Accounting 4. LIABILITIES Concepts 5. OWNER’S EQUITY
  • 2. THE ACCOUNTING Lesson 2 EQUATION
  • 3. THE ACCOUNTING EQUATION Accounting as a whole is based on a single equation: ASSETS = EQUITY + LIABILITIES
  • 4. EQUATION The word equation comes from the word equal. For any equation, one side always equals another.
  • 5. DOUBLE ENTRY The accounting equation should remain in balance at all times because of double-entry accounting or bookkeeping. Double-entry means that every transaction will af fect at least two accounts in the general ledger.
  • 6. EXAMPLES OF DOUBLE ENTRY Examples  An owners investment into the company will increase the companys assets and will also increase owners equity.  When the company borrows money from its bank, the companys assets increase and the companys liabilities increase.
  • 7. SO WHAT DOES THE ACCOUNTING EQUATION MEAN? Well, in order to answer that question we need to look at what each of the terms in the equation mean… 1. Assets 2. Liabilities 3. Owner’s Equity
  • 8. ASSETS Lesson 3
  • 9. WHAT IS AN ASSET? Official 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 .
  • 10. IN OTHER WORDS… 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.
  • 11. EXAMPLES Land Computer Vehicle Cash
  • 12. DEBTORS 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.
  • 13. ARE DEBTORS AN ASSET? 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.
  • 14. MEASURABLE VALUE 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, its nearly impossible to place a value on people – consequently employees are actually never included as assets in accounting - but only because we cant value them.
  • 15. SO THE FULL TEST OF WHETHER SOMETHING IS AN ASSET IS:1. DOES YOUR BUSINESS OWN/CONTROL IT?2. WILL IT BRING YOUR BUSINESS BENEFITS IN THE FUTURE?3. CAN YOU VALUE IT ACCURATELY?
  • 16. HOW TO VALUE AN ASSET The cost of an asset includes all costs necessar y 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.
  • 17. CHANGES IN ASSETSDecrease Assets Increase AssetsPurchasing Supplies (The asset account Purchasing Supplies (The asset accountCash decreases) Supplies increases)Owner Draws Owner ContributionsRepaying bank loans Receiving bank loans Credit purchases
  • 18. LIABILITIES Lesson 4
  • 19. WHAT IS A LIABILIT Y? 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.
  • 20. IN OTHER WORDS… a liability is simply... a debt of the business. The debt will result in assets (usually cash) leaving the business in the future .
  • 21. EXAMPLES 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.
  • 22. CHANGES IN LIABILITIESDecrease Liabilities Increase LiabilitiesRepaying a bank loan Receiving a bank loanCredit Payments Credit purchasesPaying Creditors Notes payable to creditors
  • 23. OWNER’S EQUITY Lesson 5
  • 24. WHAT IS OWNER’S EQUIT Y The residual interest in the assets of the enterprise af ter deducting all its liabilities.
  • 25. IN OTHER WORDS… The owner’s equity is simply the owner’s share of the assets of a business.
  • 26. OWNER’S EQUIT Y 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
  • 27. THE ACCOUNTING EQUATION ASSETS = EQUIT Y + LIABILITIES The 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).
  • 28. SHAREHOLDER’S EQUIT Y In the case of a corporation, which is publicly owned, equity is labeled shareholder’s equity
  • 29. CHANGES IN OWNER’S EQUIT YDecrease Owner’s Equity Increase Owner’s EquityExpenses RevenuesLosses GainsOwner withdraws Owner investments Beginning Capital
  • 30. REVENUES Income Example: a service company earns revenue when it provides services to its clients Recorded as an increases in owner’s equity and an increase in assets
  • 31. EXPENSES The costs the company incurs in carrying on operations in its ef fort to create revenue Decrease owner’s equity Can be paid for with cash (decreases assets) Or charged (increase liabilities)
  • 32. EXPENSES VS. EQUIPMENT The dif ference 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.
  • 33. NET INCOME VS. NET LOSS 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
  • 34. OWNER’S EQUIT Y Beginning Capital Net Income* PLUS Additional + Revenues -- Withdraws Investment -- ExpensesIf 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.
  • 35. THE ACCOUNTING EQUATION WORKSHEET1 . The basic accounting equation is assets = liabilities +______________ ______________.
  • 36. IDENTIFYING CHANGES IN THE ACCOUNTING EQUATIONFor each of the transactions in items 2 through 9, indicate thetwo (or more) ef fects on the accounting equation of thebusiness or company.#2The owner invests personal cash in the business. Assets: Increase Decrease No Effect Liabilities: Increase Decrease No Effect Owners (or Stockholders) Increase Decrease No Effect Equity:
  • 37. IDENTIFYING CHANGES IN THE ACCOUNTING EQUATION#3The owner withdraws business assets for personal use. Assets: Increase Decrease No Effect Liabilities: Increase Decrease No Effect Owners (or Stockholders) Increase Decrease No Effect Equity:
  • 38. IDENTIFYING CHANGES IN THE ACCOUNTING EQUATION#4The company receives cash from a bank loan. Assets: Increase Decrease No Effect Liabilities: Increase Decrease No Effect Owners (or Stockholders) Increase Decrease No Effect Equity:
  • 39. IDENTIFYING CHANGES IN THE ACCOUNTING EQUATION#5The company repays the bank that had lent money to the company. Assets: Increase Decrease No Effect Liabilities: Increase Decrease No Effect Owners (or Stockholders) Increase Decrease No Effect Equity:
  • 40. IDENTIFYING CHANGES IN THE ACCOUNTING EQUATION#6The company purchases equipment with its cash. Assets: Increase Decrease No Effect Liabilities: Increase Decrease No Effect Owners (or Stockholders) Increase Decrease No Effect Equity:
  • 41. IDENTIFYING CHANGES IN THE ACCOUNTING EQUATION#7The owner contributes her personal truck to the business Assets: Increase Decrease No Effect Liabilities: Increase Decrease No Effect Owners (or Stockholders) Increase Decrease No Effect Equity:
  • 42. IDENTIFYING CHANGES IN THE ACCOUNTING EQUATION#8The company purchases a significant amount of equipment on credit. Assets: Increase Decrease No Effect Liabilities: Increase Decrease No Effect Owners (or Stockholders) Increase Decrease No Effect Equity:
  • 43. IDENTIFYING CHANGES IN THE ACCOUNTING EQUATION#9The company purchases land by paying half in cash and signing a note payable forthe other half. Assets: Increase Decrease No Effect Liabilities: Increase Decrease No Effect Owners (or Stockholders) Increase Decrease No Effect Equity: