ACC406 - Chapter 3

CHAPTER 3
ACCOUNTING EQUATION &

ACCOUNTING CLASSIFICATION
LEARNING OUTCOMES
At the end of the lesson, students should be able to:
Identify the elements of financial statements
Describe the basic accounting equation
Describe the expanded accounting equation
Relate the components in the statement of financial
position and statement in profit or loss to the
accounting equation
WHAT IS FINANCIAL STATEMENTS?
 Structured reports of a business’s
financial activities.
 Prepared on a regular basis-
monthly/quarterly/half-yearly/yearly.
 Provide overall picture of a business’
“health” and “wealth”
ELEMENTS OF FINANCIAL STATEMENTS
 There are FIVE ELEMENTS of complete set of
financial statements:
 Statement of Financial Position (sofp)
 Statement of profit or loss (sopl)
 Statement of Changes in Equity
 Statement of Cash Flows
 Notes to the accounts
EXAMPLES OF ANNUAL REPORT
1. Statement of
Financial Position (SOFP)
Shows the financial position of a business
at a particular point of time.
Financial position means disclosing or

showing the total amount of assets that
are owned by the business and the amount
of contributions from the owners (capital)
and borrowings (liabilities).
Elements
of SOFP
• ASSETS
• LIABILITIES
• OWNER’S
EQUITY
ASSETS
ASSET
• Assets are resources or
items of value that the
business owns and expected
to generate economic benefit
in the future.
ICE CREAM ‘GULA APONG’
ASSETS
CURRENT ASSETS
Cash and other assets which are short-
NON-CURRENT/FIXED ASSETS term in nature
Kept and used on long-term basis Normally can be converted into cash
(>12 months) (<12 months)
Ex: inventories (stock), accounts
receivable (debtor), cash, and bank.
TANGIBLE
INTANGIBLE
Assets that have physical LONG-TERM INVESTMENTS
Non-physical assets
substance Bought for the purpose of
Ex: goodwill, franchises,
Ex: land, building, plant & earning interest or dividend
patents, trademarks and
machinery, fixtures and fittings. Ex: fixed deposit
copyrights.
equipment, motor vehicles
LIABILITIES
LIABILITY 2. External
parties’ claim to
the business
assets.
1. The obligations
of an entity to
3. Amounts owed by
other entities.
a business to
outside parties.
LIABILITIES
Non Current Liabilities

Current Liabilities
* Debts Repayable in more than a
year ( > 12 months) * Debt which are repayable within
the year
Eg; Long term loan, mortgage,
debentures ( < 12 months )
Eg; accounts payable (CREDITORS),
BANK OVERDRAFT, short-term
loans
Owner’s equity
• Owner’s claim on the business assets.
 Capital : amounts contributed by the owner
to the business (in the form of cash or other
assets).
 Accumulated Profits : profits earned (or
minus the loss incurred) and retained in the
business.
 Drawings are the cash or goods taken by the
owner for personal use.
Owner’s equity = Capital + Accumulated Profits - Drawings

2. Statement of
Profit or loss
Shows the financial performance of
a business during a period.
Financial performance is measured

by the profit earned or loss incurred
during that period.
Elements
of SOPL
= REVENUES
= EXPENSES
Revenues
• Income generated by the business,
either from trading or normal operating
activities.
REVENUES
FROM THE USE OF THE

SALES OF RENDERING OF BUSINESS’ ASSETS BY OTHERS
GOODS SERVICES • Rental income
Ex: KFC - Sales Ex: Fees from • Interest income (cash
of fried chicken tuition fees deposit in a bank)
• Royalties (copyright)
• Dividend income
(investment in share)
Expenses
• Cost incurred in the normal course of
business to generate revenues.
EXPENSES
COST OF SALES
Purchases of stock
SELLING AND DISTRIBUTION
Eg- Freight, insurance and
Eg-Salesman’s commissions
transport cost (carriage inwards)
for bringing the goods to the
business premise
ADMINISTRATIVE
Eg- Electricity and FINANCE COSTS
water, rental expense, Eg- Interests on loans,
salaries and wages bank service charges
Accounting equation
Basic Accounting Equation:
ASSETS = OWNER’S EQUITY + LIABILITIES
Expanded Accounting Equation:
ASSETS + DRAWINGS + EXPENSES = CAPITAL + REVENUES +

LIABILITIES
*[ADE=CRL)
Accounting equation
Basic Accounting Equation:
Expanded Accounting Equation:
ASSETS + DRAWINGS + EXPENSES = CAPITAL + REVENUES +

LIABILITIES
*[ADE=CRL)
ACCOUNTING EQUATION
= +
ACCOUNTING EQUATION
40,000
50,000
300,000
35,400
35,000
399,998
EXAMPLE OF TRANSACTIONS AND ITS EFFECT ON THE
ACCOUNTING EQUATION
The followings are the transactions at the beginning of the business for Insyirah Enterprise:
DATE TRANSACTIONS ASSETS

= LIABILITIES + OWNER’S EQUITY
2009 Ali started a business with Cash Capital
Jan 1 RM10,000 cash in hand +RM10,000 +RM10,000
Effect: Cash increase and capital
increase
2 The business deposited RM8,000 Cash

of the cash into the bank account -RM8,000
Effect: Cash decrease and bank Bank
increase +RM8,000
EXAMPLE OF TRANSACTIONS AND ITS EFFECT ON THE
ACCOUNTING EQUATION
DATE TRANSACTIONS ASSETS LIABILITIES OWNER’S EQUITY
2009 Received loan by cheque Bank Loan

Jan 3 RM5,000 +RM5,000 +RM5,000
Effect: Bank increase and loan
increase
4 Purchased furniture worth Bank
RM1,000 by cheque -RM1,000
Effect: Furniture increase and Furniture
bank decrease +RM1,000
5 The owner took cash RM100 for Cash Drawings
his own use -RM100 -RM100
Effect: Cash decrease and
capital decrease
SOURCES
• Nichol, E.O., Joseph, C., Ismail, F. & Noyem, J. A. (2013). Essentials of Business
Accounting. (3rd Edition). PENERBIT UITM.
• Google images
• http://www.bemoneyaware.com/blog/four_corner_stones/
thanks!
Any questions?

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CHAPTER 3

ACCOUNTING EQUATION &

Financial position means disclosing or

Non Current Liabilities

Owner’s equity = Capital + Accumulated Profits - Drawings

Financial performance is measured

FROM THE USE OF THE

ASSETS = OWNER’S EQUITY + LIABILITIES

Expanded Accounting Equation:

ASSETS + DRAWINGS + EXPENSES = CAPITAL + REVENUES +

ASSETS = OWNER’S EQUITY + LIABILITIES

Expanded Accounting Equation:

ASSETS + DRAWINGS + EXPENSES = CAPITAL + REVENUES +

DATE TRANSACTIONS ASSETS

2 The business deposited RM8,000 Cash

2009 Received loan by cheque Bank Loan

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