chap2 accounting conceps equation

Chapter 2Accounting Concepts, Equation

and Double EntryBBA1113/BBA1114| Financial Accounting Fundamentals

Prepared by Maniam

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ALL RIGHTS RESERVEDNo part of this document may be reproduced without written approval from Limkokwing University of Creative Technology Worldwide

FACULTY OF BUSINESS MANAGEMENT AND GLOBALIZATION

BBA1113/BBA1114|Fin. Acc. Fundamentals

Outline

• Accounting concepts • Accounting equation• Chart of Accounts• Debits and Credits• Double entry accounting• Accounting equation and analysis

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ACCOUNTING CONCEPTS

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Separate Economic Entity The business is accounted for separately from other business entities,

including its owner.

The reason for this principle is that separate information about each business is necessary for good decisions.

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Monetary Unit

Only transaction data that can be expressed in terms of money be included in accounting records.

Assume that the value of the monetary unit never changes.

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Growing Concern…

The business is assumed continue to operate in the future, meaning that a business will continue long enough to recover the cost of its assets.

Financial statements should be prepared on a going concern basis unless management either intends to liquidate the enterprise or to cease trading, or has no realistic alternative but to do so.

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Time Period….

The economic life of business can be divided into artificial time period for the purpose of financial reporting.

For example: monthly, quarterly, half-yearly, and yearly reports. This assumption provides that financial information be reported at regular

intervals so that decision makers can compare business operations over time to assess the success or failure of the business.

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Historical Cost

Purchased assets recorded at cost. Cost is measured on a cash or cash equivalent basis. It means if cash is

given for a service, its cost is measured as the amount of cash paid. If something besides cash is exchanged (such as a car traded for a truck),

cost is measured as the cash value of what is given up or received. The historical cost principle emphasizes reliability, and information based

on cost is considered objective.

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Revenue Recognition

It provides guidance on when a company must recognize revenue. To recognize means to record it. Recognized early, a company would look more profitable than it is &

recognized too late, a company would look less profitable than it is. Generally, revenue is recognized when it is earned and not before.

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Revenue Recognition

Revenue is recorded in the period it is earned, that is when: 1. the ownership has been transferred from the seller to the buyer

(sale of goods);2. the services has been completely provided to the customer

(rendering of services);3. percentage of completion method (construction project);4. cash is received from the customer (installment method).

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Matching or Accrual

It means that expenses are matched against revenues, and recorded in the same period in which the related revenues are earned.

As such, adjustments need to be done to allocate the proper amount to relevant periods.

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Full Disclosure

It requires that a company's financial statements report enough information for users to make knowledgeable decisions about the company.

In order to satisfy the disclosure principle, companies add to the financial statements notes that disclose significant accounting policies, probable losses, and accounting changes.

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Materiality

Accountants are required to accurately account for significant items and transactions.

Information is significant (or material) if it is likely to cause a statement user to change a decision because of that information.

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For example, the accounting treatment for a RM2 pencil sharpener is not likely to affect any decisions; the pencil sharpener is immaterial.

However, failing to record a RM1 million liabilities would affect the decisions of many users and the amount is material.

The definition of materiality varies from company to company. A large corporation such as Tenaga Nasional might consider RM1,000 to be immaterial, while the grocery store would consider RM1, 000 to be very material.

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Materiality




The Accounting Equation

• Resources used in business = Resources obtained

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Assets = Capital

Firm start trading and need resources. Initially, the owner supplied them all.

Resources supplied are called as capital

Actual resources are used in business are called as assets.




Assets = Liabilities + Capital

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After running the business, more funds or resources needed. Now, other person has supplied and need to be repaid. This is called as liability.

2 sides of equation are always same even amount of each component changes.





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Business is to earn profit. Profit is earned from expense spent out of revenue. Now, the equation is;

Assets = Liabilities + Capital

Assets = Liabilities + Capital+ Income – Expenses

OR

Assets + Expenses = Liabilities + Capital+Income





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Assets are economic resources owned by a company and that have expected future benefits such as buildings, machinery, stocks, debtors, cash and bank balances.

Liabilities consist of money owing for goods supplied or services provided to the firm, such as loans and creditors.

Capital is often called the owner's equity or net worth; claim on a company's assets. Equity is the owners’ residual interest in the assets of a business after deducting liabilities.





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Revenues are what the business earns for providing goods or services. Expenses are the cost of assets the business uses to generate revenues

(payroll, depreciation, rent, utilities, and taxes)





How It Works?

• John is a sole trader. He seeking your help on how to apply the accounting equation for the following transactions:– He invested RM100,000 into the business.– He borrows RM50,000 from the bank to buy a van.

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Solutions

Assets(RM)

Liabilities(RM)

Owners’ Equity(RM)

100, 000 0 100,000

50, 000 50,000 0

150,000150,000 50,00050,000 100,000100,000

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Chart of Accounts

No.System

Accounts Category

101-199 Asset

201-299 Liability

301-399 Equity

401-499 Revenue

501-599 Expense

List of all accounts that includes an identification number assigned to each account.

A small business might use the following numbering system for its accounts:

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Debit and Credit

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• A T-account represents a ledger account• Tool used to understand the effects of one or more transactions. • The layout of a T - account is:

1. the account title on top,2. a left, or debit (Dr.) side, and 3. a right, or credit (Cr.)




(Debit) (RM) (Credit) (RM)

(Left side) (Right side)

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(Account Title)

Debit and Credit




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• Debit is not increase or credit is not decrease. • In an account where a debit is an increase, the credit is a decrease; in

an account where a debit is a decrease, the credit is an increase.• The difference between total debits and total credits, including any

beginning balance, is the account balance.

Debit and Credit




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• When the sum of debits exceeds the sum of credits, the act has a debit balance.

• It has a credit balance when the sum of credits exceeds the sum of debits.

• When the sum of debits equals the sum of credits, the account has a zero balance.

Debit and Credit




Double Entry

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• It requires that each transaction affect, and be recorded in, at least two accounts.

• It also means the total amount debited must equal the total amount

credited for each transaction.




Debit forIncreases

Credit forDecreases

Debit forDecreases

Credit forIncreases

Debit forDecreases

Credit forIncreases

AssetOwner’s EquityLiability

Double Entry




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• Net increases or decreases on one side have equal net effects on other side.

• Second, the left side is the normal balance side for assets, and the right side is the normal balance side for liabilities and equity.

Double Entry




Accounting Equation and Double Entry Analysis

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• Investment by owner Transaction: James invests RM100,000 cash in James Trading.

Double Entry: Dr. = Cash AccountCr. = Capital Account

Assets = Liabilities + EquityCash = 0 + Capital

+RM100,000 = 0 + RM100,000




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• Purchase supplies for cash Transaction: James Trading pays RM2, 500 cash for supplies

Double Entry: Dr. = Supplies AccountCr. = Cash

Account

Assets = Liabilities + EquityCash Supplies = 0 + 0

-RM2,500 +RM2,500 = 0 + 0





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• Purchase equipment for cash Transaction: James Trading pays RM26, 000 cash for equipment.

Double Entry: Dr. = Equip. AccountCr. = Cash Account

Assets = Liabilities + EquityCash Equipment = 0 + 0

-RM26,000 +RM26,000 = 0 + 0





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• Purchase supplies on credit Transaction: Trading purchases RM7,100 of supplies on credit from a

supplier.

Double Entry: Dr. = Supplies AccountCr. = Acc. Pay. Account

Assets = Liabilities + EquitySupplies = Acc.Payables + 0+RM7,100 +RM7,100 = 0 + 0





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• Sold for cash Transaction: James Trading sold goods for RM4, 200 in cash.

Double Entry: Dr. = Cash AccountCr. = Sales Account

Assets = Liabilities + EquityCash = 0 + Sales

+RM4,200 = 0 + RM4,200





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• Payment of expense in cash Transaction: James Trading pays RM1,000 cash for rental.

Double Entry: Dr. = Rental AccountCr. = Cash Account

Assets = Liabilities + EquityCash Rental= 0 + 0

-RM1,000 +RM1,000 = 0 + 0


chap2 accounting conceps equation

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