2. Amity Business School
Accounting Equation
Five groups of accounts
■ Assets are items of value owned/controlled by a business;
examples are cash, inventories, buildings and motor vehicles.
■ Liabilities are amounts owed to people or to organisations
outside of the business; examples are amounts owed to
Creditors control for purchases, or to a bank for a loan,
overdraft or mortgage.
■ Equity is represented by the business’s assets less its liabilities
(or the amount that the business owes to the owner). Equity is
the amount originally invested in a business plus extra cash
introduced, plus profits and less losses and drawings of cash or
inventories from the business by the owner.
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3. Amity Business School
■ Revenue items are the earnings of a business; examples are
income from sales of trading stock, interest, commission, rent
and discount received.
■ Expenses are outflows from a business; examples are payment
for wages or salaries, purchases of trading stock, payments for
advertising, freight, motor vehicles expenses and discount
allowed.
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5. Amity Business School
Accounting equation
• The financial position of a company is measured by the
following items:
• Assets (what it owns)
• Liabilities (what it owes to others)
• Owner’s Equity (the difference between assets and liabilities)
• The accounting equation (or basic accounting equation)
offers a simple way to understand how these three amounts
relate to each other.
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6. Amity Business School
• The Accounting Equation can be presented as:
Assets − Liabilities = Equity.
By simple transposition the Accounting Equation can also be
shown as:
1. Assets = Liabilities + Equity (A = L + EQ)
2. Assets − Equity = Liabilities (A − EQ = L).
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7. Amity Business School
• If a company keeps accurate records, the accounting equation
will always be “in balance,” meaning the left side should always
equal the right side. The balance is maintained
because every business transaction affects at least two of a
company’s accounts.
• For example, when a company borrows money from a bank, the
company’s assets will increase and its liabilities will increase by
the same amount. When a company purchases inventory for cash,
one asset will increase and one asset will decrease. Because there
are two or more accounts affected by every transaction, the
accounting system is referred to as double entry accounting.
• A company keeps track of all of its transactions by recording
them in accounts in the company’s general ledger. Each account
in the general ledger is designated as to its type: asset, liability,
owner’s equity, revenue, expense, gain, or loss account.
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