the accounting equation slides - national university … tutorial 1a the accounting equation j. e....

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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)


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.)


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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


LIABILITIES

Defintions:

‘the source of funds from outsiders’

‘amounts owed to people or firms outside the business’

(Gillespie & Lewis, Principles of Financial Accounting)


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’


Ownership Interest

Definitions:

‘the owners claim on the business’

‘the assets less liabilities of the business’

(Gillespie & Lewis; Principles of Financial Accounting)


THE ACCOUNTING EQUATION

ASSETS = LIABILITES

ASSETS LIABILITES = OWNERSHIP INTEREST

+

ASSETS = LIABILITES - OWNERSHIP INTEREST


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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


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


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.


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1. Bank Capital

€10,000 €10,000

Initial



2. Bank 100 Shoes Capital

€2,000 €8,000 €10,000

Initial



3. Capital Bank 50 Shoes

€9,000

€4,000

€10,000

Initial


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4. Bank 50 Shoes Profit Capital

€9,000 €4,000 €10,000 €3,000

Initial



5. The Entity Ownership Interest Bank 50 Shoes Profit Capital

€9,000 €4,000 €10,000 €3,000



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.


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1. Boat Capital

€20,000 €20,000

Initial



2. Boat Bank (Profit) Capital

€20,000 €2,000 €20,000 €2,000

Initial



3. Boat Bank Fees Due (Profit) Capital

€20,000 €2,000 €20,000 €1,500 (€500)

Initial


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4. Boat Bank Fees Due Profit Capital

€20,000 €1,250 €19,250 €1,500 (€500)

Residual



5. The Entity Ownership Interest

Boat Bank Fees Due Profit Capital

€20,000 €1,250 €19,250

€1,500 (€500)



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


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Assets – Liabilities = Capital +Revenue - Expenses - Drawings

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


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


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How do we record all transactions?

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


Accounting Equation T – Accounts

ASSET Dr. Cr.

INCREASE ASSET

REDUCE ASSET


Accounting Equation T - Accounts

LIABILITY Dr. Cr.

INCREASE LIABILITY

REDUCE LIABILITY


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REVENUE Dr. Cr.

INCREASE REVENUE

REDUCE REVENUE



EXPENSE Dr. Cr.

INCREASE EXPENSE

REDUCE EXPENSE


Rules for Recording Transactions through Double Entry


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


•  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


•  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,

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