THE ACCOUNTING EQUATION

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1 Where are we headed? After completing this chapter, you should be able to: define identify explain calculate explain define identify prepare apply analyse CHAPTER 2 THE ACCOUNTING EQUATION KEY TERMS After completing this chapter, you should be familiar with the following terms:

2 22 CAMBRIDGE VCE ACCOUNTING UNITS 3&4 2.1 ASSETS, LIABILITIES AND OWNER S EQUITY Assets bank debtors stock fixtures and fittings vehicles premises Liabilities bank overdraft creditors loan Owner s equity firm owner

CHAPTER 2 THE ACCOUNTING EQUATION 23 The accounting equation equities external parties owner accounting equation equities claims on the assets of the business, consisting of both liabilities and

3 CHAPTER 2 THE ACCOUNTING EQUATION 23 The accounting equation equities external parties owner accounting equation equities claims on the assets of the business, consisting of both liabilities and owner s equity accounting equation the rule that states that assets must always equal liabilities plus owner s equity The relationship between assets, liabilities and owner s equity is described by the accounting equation Accounting equation Assets = Liabilities + Owner s equity greater less

4 24 CAMBRIDGE VCE ACCOUNTING UNITS 3&4 REVIEW QUESTIONS Define 2 List 3 Define 4 List 5 Define 6 explain 7 State 2.2 THE BALANCE SHEET Balance Sheet an accounting report that details the business s assets, liabilities and owner s equity at a particular point in time Balance Sheet Figure 2.1 The accounting equation and the Balance Sheet Assets = Liabilities + Owner s equity Assets Liabilities plus Owner s equity TOTAL ASSETS TOTAL EQUITIES Figure 2.2 Balance Sheet MORGAN S MERCHANDISE Balance Sheet as at 30 June 2015 Assets $ $ Liabilities $ $ Bank Creditors Stock Loan MHB Bank Debtors Owner s Equity Vehicles Capital Morgan Total Assets Total Equities

5 CHAPTER 2 THE ACCOUNTING EQUATION 25 who what when REVIEW QUESTIONS Explain 2 Explain 3 State 4 Explain 2.3 CLASSIFICATION IN THE BALANCE SHEET Classification classification grouping together items that have some common characteristic Current versus non-current assets current assets non-current assets in the next 12 months for more than 12 months current asset a resource controlled by the entity as a result of past events, from which a future economic benefit is expected to flow to the entity in the next 12 months non-current asset a resource controlled by the entity as a result of past events, from which a future economic benefit is expected to flow to the entity for more than the next 12 months

26 CAMBRIDGE VCE ACCOUNTING UNITS 3&4 If it is expected that an asset will be sold, used up or turned into cash within a year (such as stock held for resale in a warehouse) it should be classified as

liability a present obligation of the entity arising from past events, the settlement of which is expected to result in an outflow of resources embodying economic benefits in the next 12 months

6 26 CAMBRIDGE VCE ACCOUNTING UNITS 3&4 If it is expected that an asset will be sold, used up or turned into cash within a year (such as stock held for resale in a warehouse) it should be classified as a current asset An asset that is expected to provide an economic benefit for more than the next 12 months (such as a business s premises or truck) should be classified as a non-current asset current liability a present obligation of the entity arising from past events, the settlement of which is expected to result in an outflow of resources embodying economic benefits in the next 12 months non-current liability a present obligation of the entity arising from past events, the settlement of which is expected to result in an outflow of resources embodying economic benefits in more than 12 months Current versus non-current liabilities Current liabilities in the next 12 months will can non-current liabilities in more than 12 months

7 CHAPTER 2 THE ACCOUNTING EQUATION 27 Loans Figure 2.3 Classified Balance Sheet MORGAN S MERCHANDISE Balance Sheet as at 30 June 2015 Current Assets $ $ Current Liabilities $ $ Bank Creditors Stock Loan MHB Bank Debtors Non-Current Liabilities Non-Current Assets Loan MHB Bank Vehicles Owner s Equity Capital Morgan Total Assets Total Equities STUDY TIP Uses of the classified Balance Sheet Relevance

8 28 CAMBRIDGE VCE ACCOUNTING UNITS 3&4 REVIEW QUESTIONS Distinguish 2 List 3 Distinguish 4 List 5 Explain 6 Explain 2.4 DOUBLE-ENTRY ACCOUNTING double-entry accounting a system that records two effects on the accounting equation as a result of each transaction double-entry accounting Rules of double-entry accounting 1 Every transaction will affect at least two items in the accounting equation: a double entry. 2 After recording these changes, the accounting equation must still balance. EXAMPLE Imelda s Shoe Shop has presented the following transactions: Figure 2.4 Accounting equation 1 Assets $ $ Liabilities $ $ Bank nil Owner s Equity Capital Imelda Total Assets Total Equities

9 CHAPTER 2 THE ACCOUNTING EQUATION 29 Figure 2.5 Accounting equation 2 Assets $ $ Liabilities $ $ Bank Creditors Stock Owner s Equity Capital Imelda Total Assets Total Equities Figure 2.6 Accounting equation 3 Assets $ $ Liabilities $ $ Bank Creditors Stock Owner s Equity Shop Fittings Capital Imelda Total Assets Total Equities REVIEW QUESTIONS Explain 2 State

10 30 CAMBRIDGE VCE ACCOUNTING UNITS 3&4 WHERE HAVE WE BEEN? EXERCISES EXERCISE 2.1 CLASSIFYING ITEMS W B page 18 Classify

11 CHAPTER 2 THE ACCOUNTING EQUATION 31 EXERCISE 2.2 BALANCE SHEET W B page 19 * Required a Explain b Calculate c Prepare d explain EXERCISE 2.3 BALANCE SHEET W B page 20 Item $ Item $ Term Deposit (matures 2020) Bank 700 Debtors Creditors Wages Owing 600 Motor Vehicle Stock Loan from ANZ due (repayable $2 000 p.a.) * Required a b c d Calculate Prepare explain Discuss

12 32 CAMBRIDGE VCE ACCOUNTING UNITS 3&4 EXERCISE 2.4 BALANCE SHEET W B page 21 Item $ Item $ Bank Overdraft Shelving Stock Mortgage Creditors Debtors Premises GST Payable Note: * Required a Prepare b Explain c Explain d State EXERCISE 2.5 TRANSACTIONS AND THE ACCOUNTING EQUATION W B page 23 State EXERCISE 2.6 TRANSACTIONS AND THE BALANCE SHEET W B page 24 Assets $ Equities $ Bank Creditors Debtors Wages Owing Fixtures and Fittings Delivery Van Stock Capital Pete? Total Assets Total Equities

13 CHAPTER 2 THE ACCOUNTING EQUATION 33 Apr. 1 Paid $3 000 to a creditor. 2 Borrowed $ cash from the NAB, which was used to purchase another van. The loan is to be repaid in monthly instalments of $1 000, commencing in May Received $2 400 from a debtor. 4 Pete withdrew $1 500 worth of paint for his own purposes. 5 Paid the wages owing. 6 Pete contributed to the business his personal computer. Pete had paid $4 600 but its agreed value on this date was $ * Required a Calculate b Explain c Prepare d Prepare EXERCISE 2.7 TRANSACTIONS AND THE BALANCE SHEET W B page 26 Assets $ Equities $ Debtors Bank Overdraft Fixtures and Fittings Creditors Stock Loan ANZ (repayable $6 000 p.a) Fridges Capital Sam? Total Assets Total Equities Oct. 1 Paid $2 000 to a creditor. 2 Sam contributed $5 000 of his own money to the business. 3 Paid $3 000 off the loan principal. 4 Purchased stock on credit for $ Sam took $2 500 of the fixtures and fittings home for personal use. 6 Paid $1 200 rent in advance for the next 6 months. * Required a Prepare b Prepare c explain

SOLUTIONS TO END-OF-CHAPTER QUESTIONS CHAPTER 3

SOLUTIONS TO END-OF-CHAPTER QUESTIONS CHAPTER 3 DEVELOP YOUR UNDERSTANDING Question 3.1 1. Abi s capital account balance at 1 September 2017 Remember that assets liabilities = capital (equity) Assets Inventory