Lessons 3 & 4 :

Accounting Equation & Transactions

ASSETS = LIABILITIES + OWNER’S EQUITY

• THE ACCOUNTING EQUATION :

– implies that something cannot be created from
nothing
– whatever the business owns must equal
whatever it owes, to either external parties, or
the owners
– any change in one item in the equation will be
matched by a corresponding change in another 1
 Recall

A = L + OE
OE = C-D+R-E
• Hence, the extended Accounting Equation is

A = L + [C - D + R – E]

Statement of
Comprehensive
A = L + C – D + NET INCOME Income

Statement of Financial Position 2

Is the equation, Assets – Liabilities = Owner’s Equity,
correct? Yes
How do you explain this equation?

The owners has claims on the net amount of

resources that the business has, after it has settled
its obligations to external parties.

3
Effects of Transactions on the Accounting Equation
Illustrative Example 1
July 1 Mei Ling invested $10,000 of her money and the business
borrowed another $5,000 from her mother to begin a sole
proprietorship.
business
From the business point
point of view
of view,
Asset - The business has cash of $15,000
Liability - The business owes Mei Ling's mother $5,000.
Owner‘ - The business owes Mei Ling $10,000.
Therefore: ASSETS = LIABILITIES + OWNER'S EQUITY
$15,000 = $5,000 + $10,000
All transactions will result in at least two items of the accounting
equation being changed.
4
The equation is kept balanced at all times.
Illustrative Example 2
a) Long's first transaction is to invest $10,000 in the name of Long Taxi to
start the business.
b) Long's next transaction is to purchase equipment, for which $7,500 in
cash is paid.
c) During the month, Long purchases $850 of gasoline and other
supplies from various suppliers on credit.
d) During the month, $400 is paid to creditors on account.
e) During the first month of operations, Long Taxi earned fares of
$4,500, receiving the amount in cash.
f) Various business expenses incurred and paid during the month were
as follows: wages, $1,125; rent, $850; utilities, $150; miscellaneous,
$75.
g) At the end of the month it is determined that the cost of the supplies on
hand is $250, the remainder ($850 - $250) having been used in the
operations of the business.
h) At the end of the month, Long withdraws from the business $1,000 in
cash for his personal use.

5
Lecture Example 2

6
Based on the transactions in Example 2 above, indicate how
each transaction affects the accounting equation.
At the end of the above example, it should be noted :
1. The effect of every transaction can be stated in terms
of increases and /or decreases in one or more of the
accounting equation elements.

2. The two sides of the accounting equation must always

balance or equal.

7
Financial statements of a Sole Proprietorship
•After the effect of the individual transactions has been
determined, the essential information is communicated
to the users.
•The accounting statements that communicate this
information are called financial statements.
Statement of Comprehensive Income
(Profit and Loss Account)
• Summary of the revenue and expenses of a
business entity for a specific period of time, usually a
year or a month.
• Shows financial performance of the business for
a period of time
Illustrative Example 3.
Using the example of Long Taxi, the Stmnt of
Comprehensive Income is as follows: 8
Long Taxi
Statement of Comprehensive Income
for the month ended 30 June 2016
$ $
Fares earned 4,500

Less Operating expenses:

Wage expense 1,125
Rent expense 850
Supplies expense (gasoline) 600
Utilities expense 150
Miscellaneous expense 75
__________

Total operating expense 2,800

__________ To Stmnt of
Financial
Net profit/income 1,700
__________ Position
9
Statement of Financial Position

• A list of assets, liabilities, and owner's equity of a

business entity as at a specific date.

• Shows financial position of the business at a

point in time

10
Long Taxi
Statement of Financial Position as at 30 June 2016
Assets $ $
Cash 3,400
Supplies 250
Equipment 7,500
11,150 A
Liabilities ======
=
Accounts payable 450 L
Owner’s Equity ** Detailed movement
John Long, Capital 10,000
1,700
+
Add Net profit # fr. Stmnt of CI
11,700
Less Drawings 1,000 10,700 OE
Capital for
11,150 next
11
====== period
Lecture Exercise 1:
The effect of every transaction can be stated in terms of
increases and /or decreases in one or more of the accounting
equation elements. E.g

Received cash from owner as additional investment, $15,000

→ Increase in asset (Cash), increase in owner’s equity
Capital).

12
The following transactions were completed by Calvin Delivery
Service during August 2016

1. Paid rental for August $2,500

→ increase in expense (rent); fall in asset (cash)

2. Billed customers for delivery services on account, $15,000

→ Increase in revenue (fee income); increase is asset
(acct receivable)

3. Received cash from cash sales (cash customer), $3,250

→ increase in revenue (fee income); increase is asset
(cash)

4. Paid advertising expense, $625

→ increase in expense (advertising); fall in asset (cash)
13
5. Purchased supplies with cash, $750
→ increase in asset (supplies); fall in asset (cash)

6. Received cash from customers on account, $700

→ increase in asset (cash); fall in asset (acct receivable)

7. Paid creditors, $550

→ fall in liability (creditor); fall in asset (cash)

8. Determined that $575 of supplies had been used in the month

→ increase in expense (supplies expense); fall in asset
(Supplies)

9. Paid cash to owner for personal use, $2,000

→ increase in drawings; fall in asset (cash)

10. Repaired trucks and owed BB Motors $1,200 for work done
14
→ increase in expense (repairs); increase in liabilities (acct payable)
The two sides of the accounting equation must
always balance or equal

• Using the transactions in Lecture Exercise 1,

complete the following table

15
Lecture Exercise 2 - Prepare financial statements
Using the information form Lecture Exercise 1, prepare the
Statement of Comprehensive Income (or profit & loss account)
of Calvin Delivery Services for the month of August and the
Statement of Financial Position as at that date.

16
Calvin Delivery
Statement of Comprehensive Income
for the month ended 31 August 2016
$ $
Service revenue 18,250

Less Operating expenses:

Rent expense 2,500
Advertising expense 625
Supplies expense 575
Repairs expense 1,200
__________

Total operating expense 4,900

__________

Net profit/income 13,350

__________
17
Calvin Delivery
Statement of Financial Position as at 31 August 2016
Assets $ $
Cash 12,525
Supplies 175
Accounts Receivable 14,300
27,000
Liabilities ======
Accounts payable 650

Owner’s Equity
Calvin, Capital 15,000
Add Net profit 13,350
28,350
Less Drawings 2,000 26,350
27,000 18
======
Illustrative Example 4
• Given a list of accounts and their balances on 31 Dec
2016 for JC Photocopying Services.
• For each of the account, indicate whether it is an
asset, liability, revenue or expense.
• Calculate the net profit and owner’s equity at the end
of the period.
• Does the Accounting Equation balance?

19
JC Photocopying Services
Statement of Comprehensive Income
for the month ended 31 December 2016
$ $
Service income 50,000

Less Operating expenses:

Interest on loan 5,600
Salary expense 16,000
Supplies expense-paper 3,650
Supplies expense-toner 2,200
Utilities expense 3,000
__________

Total operating expense 30,450

__________
19,550
Net profit/income __________ 20
JC Photocopying Services
Statement of Financial Position as at 31 December 2016
$ $
Fixed Assets
Binding machines 50,000
Motor Van 78,000
Photocopying machines 40,000
168,000
Current Assets
Accounts receivable 52,000
Cash at bank 32,000
Supplies-Paper 8,000
Supplies-Toner 6,000
98,000
266,000
Total assets ====== 21
Statement of Financial Position as at 31 December 2016 (Cont’d)
$ $
Current Liabilities
Accounts payable 48,000
CPF payable 6,400
Utilities payable 3,000
Unearned fees 8,000
65,400
Long Term Liabilities
Bank loan 80,000

Owner’s Equity
JC, Capital 103,050
Add Net profit 19,550
122,600
Less Drawings 2,000 120,600
266,000 22
======
Classification in
Statement of Financial Position
• Fixed assets
– Physical resources that are owned and used in the
business operations for more than one year.
• Current assets
– Cash or other assets that are expected to convert to
cash or sold or used up, usually within one year or
less, through the normal business operations
• Current liabilities
– Obligations that will be due and payable within one
year or less
• Long term liabilities
– Obligations that will be due and payable more than
one year later
23
 Financial Statement Terms
• Major change in Financial Statement
terminologies (please note when retrieving
CMS / online / older materials) :

Old Term New Term

Balance Sheet Statement of Financial Position

Income Statement / Statement of

Profit & Loss Statement Comprehensive Income
24