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Tutorial 1a The Accounting Equation

J. E. Cairnes School of Business and Economics NUI Galway

J. E. Cairnes School of Business & Economics

ASSETS

Definition:

‘an asset is owned by its owner and is worth something to its owner’

‘any right which is of economic value to its owner’

(Gillespie & Lewis, Principles of Financial Accounting)

J. E. Cairnes School of Business & Economics

ASSETS

Fixed Assets (>12mths): •  Acquired by the business with the intention of

retaining them within the business to help generate profit

•  Tangible assets (Land and Buildings, Equipment etc.)

•  Investment property (For rental income or for sale at profit)

•  Intangible assets (Goodwill, R&D Investment etc.)

•  Financial assets (Shares in other companies etc.)

J. E. Cairnes School of Business & Economics

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ASSETS

Current Assets (<12mths): •  Assets which arise from day to day trading activities

e.g. cash or assets that the business intends to turn into cash

•  Stock

•  Debtors

•  Cash/Bank

•  Prepaid expenses

J. E. Cairnes School of Business & Economics

LIABILITIES

Defintions:

‘the source of funds from outsiders’

‘amounts owed to people or firms outside the business’

(Gillespie & Lewis, Principles of Financial Accounting)

J. E. Cairnes School of Business & Economics

LIABILITIES

Creditors falling due after more than one year: •  Long term loans

•  Debentures

Creditors falling due within one year: •  Creditors

•  Short Term Borrowings

•  Taxation (<12 months)

•  Accrued Expenses J. E. Cairnes School of Business & Economics

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Ownership Interest

The liability of the entity to the owners of the entity

Often referred to as ‘Capital’, ‘Capital Employed’, ‘Equity’ or ‘Shareholders Funds’

J. E. Cairnes School of Business & Economics

Ownership Interest

Definitions:

‘the owners claim on the business’

‘the assets less liabilities of the business’

(Gillespie & Lewis; Principles of Financial Accounting)

J. E. Cairnes School of Business & Economics

THE ACCOUNTING EQUATION

ASSETS = LIABILITES

ASSETS LIABILITES = OWNERSHIP INTEREST

+

ASSETS = LIABILITES - OWNERSHIP INTEREST

J. E. Cairnes School of Business & Economics

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The Accounting Equation

•  John decides to set up a taxi business •  He uses €10,000 savings and borrows €15,000 from the

bank to buy a car for €25,000

•  Assets: Car - €25,000 •  Liabilities: Loan from bank - €15,000 •  Capital: John’s investment - €10,000 •  25000 = 15000 + 10000

J. E. Cairnes School of Business & Economics

Profits/Gains & Losses

Profits/Gains are increases in ownership interest not resulting from contributions from owners

Losses are decreases in ownership interest not resulting from distributions to owners

J. E. Cairnes School of Business & Economics

Accounting Equation Examples

Allison

1.  Invests €10,000 in cash in a new business.

2.  Purchases a stock of 100 pairs of shoes for €8,000.

3.  Sells 50 pairs of shoes for €7,000 in cash.

J. E. Cairnes School of Business & Economics

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Accounting Equation Examples

1. Bank Capital

€10,000 €10,000

Initial

J. E. Cairnes School of Business & Economics

Accounting Equation Examples

2. Bank 100 Shoes Capital

€2,000 €8,000 €10,000

Initial

J. E. Cairnes School of Business & Economics

Accounting Equation Examples

3. Capital Bank 50 Shoes

€9,000

€4,000

€10,000

Initial

J. E. Cairnes School of Business & Economics

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Accounting Equation Examples

4. Bank 50 Shoes Profit Capital

€9,000 €4,000 €10,000 €3,000

Initial

J. E. Cairnes School of Business & Economics

Accounting Equation Examples

5. The Entity Ownership Interest Bank 50 Shoes Profit Capital

€9,000 €4,000 €10,000 €3,000

J. E. Cairnes School of Business & Economics

Accounting Equation Examples

1.  Brian inherits a boat worth €20,000 and decides to start a boat hire business.

2.  In the first month €2,000 of hire fees are received in cash.

3.  At the end of the first month Brian owes €500 in berthing fees currently unpaid.

4.  Brian takes €750 from the business as a capital withdrawal.

J. E. Cairnes School of Business & Economics

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Accounting Equation Examples

1. Boat Capital

€20,000 €20,000

Initial

J. E. Cairnes School of Business & Economics

Accounting Equation Examples

2. Boat Bank (Profit) Capital

€20,000 €2,000 €20,000 €2,000

Initial

J. E. Cairnes School of Business & Economics

Accounting Equation Examples

3. Boat Bank Fees Due (Profit) Capital

€20,000 €2,000 €20,000 €1,500 (€500)

Initial

J. E. Cairnes School of Business & Economics

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Accounting Equation Examples

4. Boat Bank Fees Due Profit Capital

€20,000 €1,250 €19,250 €1,500 (€500)

Residual

J. E. Cairnes School of Business & Economics

Accounting Equation Examples

5. The Entity Ownership Interest

Boat Bank Fees Due Profit Capital

€20,000 €1,250 €19,250

€1,500 (€500)

J. E. Cairnes School of Business & Economics

The Accounting Equation

•  Assets – Liabilities = Capital + Revenue - Expenses - Drawings

J. E. Cairnes School of Business & Economics

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The Accounting Equation

Assets – Liabilities = Capital +Revenue - Expenses - Drawings

or Debit (Dr) Credit (Cr) Assets = Capital + Expenses +Revenue + Drawings +Liabilities

J. E. Cairnes School of Business & Economics

Accounting Equation Debits & Credits

THE SUM OF ALL DEBITS (Dr’s)

= THE SUM OF ALL

CREDITS (Cr’s) J. E. Cairnes School of Business & Economics

Steps in preparing set of accounts

•  1. Record all transactions •  2. Extract a list of balances at the end of the period

(called a trial balance) •  3. Prepare a Profit and Loss account and Balance Sheet

from list of balances

J. E. Cairnes School of Business & Economics

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How do we record all transactions?

By using T Accounts with Dr. and Cr. entries for individual accounts.

J. E. Cairnes School of Business & Economics

Accounting Equation T – Accounts

ASSET Dr. Cr.

INCREASE ASSET

REDUCE ASSET

J. E. Cairnes School of Business & Economics

Accounting Equation T - Accounts

LIABILITY Dr. Cr.

INCREASE LIABILITY

REDUCE LIABILITY

J. E. Cairnes School of Business & Economics

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Accounting Equation T - Accounts

REVENUE Dr. Cr.

INCREASE REVENUE

REDUCE REVENUE

J. E. Cairnes School of Business & Economics

Accounting Equation T - Accounts

EXPENSE Dr. Cr.

INCREASE EXPENSE

REDUCE EXPENSE

J. E. Cairnes School of Business & Economics

Rules for Recording Transactions through Double Entry

J. E. Cairnes School of Business & Economics

1.  Dr Assets Cr Liabilities 2.  Dr Expenses Cr Gains •  With Increases •  The opposite applies for decreases

3.  Dr Bank/Cash In Cr Bank/Cash Out

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Let’s look at some examples of Recording Transactions through Double Entry

J. E. Cairnes School of Business & Economics

•  In Tutorial 1b we will look at Michael Green •  In Tutorial 1c we will look at Kate Convey

•  See: http://www.nuigalway.ie/cairnes/leavingcert/ for tutorials on other topics

Interested in pursuing an accounting career? Study at NUI Galway

J. E. Cairnes School of Business & Economics

•  CAO Course Codes •  GY201 B Comm •  GY202 B Comm (International) with French •  GY203 B Comm (International) with German •  GY204 B Comm (International) with Spanish •  GY207 B Comm (Accounting) •  GY208 B Comm (Gaeilge) •  For further information,

contact:accounting@nuigalway.ie