Accounting Equation
Basic Terminology
Entity: An entity means an economic unit that performs economic
activity.
Transaction: A transaction is an exchange in which each participants
receive or scarifies value.
Voucher: Voucher is a document which serves as an evidence of a
transaction.
Entry: Entry is the record made in the books of accounts in respect of
a transaction.
Cont..
Assets: Assets refers to tangible objects and intangible rights which
carry probable future benefits. It is an resource controlled by the
enterprise which carry from which future economic benefits are
expected to flow.
Current assets: current assets are those assets which are held
in the form of cash
For their conversion in to cash
For their consumption in the production process
Cont..
Fixed Assets: These assets are held for the purpose of providing or
producing goods and services and those that are not held for resale
in the normal course of business.
Tangible fixed assets
Intangible fixed assets
Liabilities: it refers to a financial obligation of an enterprise other
than owner’s fund.
Current liabilities: current liabilities are those which fall due for
payment in a relatively short period (normally a period not more
than 12 months)
Long term liabilities
Cont..
Capital: it is the amount invested by proprietor in the business.
Drawings: Any amount of cash, goods or any other assets withdrawn
by the proprietor for their personal use.
Purchase: total amount of goods purchase by an enterprise for
resale purpose.
Sales: The sales refers to the amount for which goods are sold and
services are rendered.
Cont..
Stock (Inventory): The term stock refers to tangible property held
for sales in normal course of business or consumption in the
production of goods and services for sales.
Trade debtors: A person from whom the amount is due for goods
sold and services rendered.
Trade creditors: A person to whom the amount is due for goods
sold and services rendered.
Income: it is the economic benefit during an accounting period.
Expenses: it is the expenditure during an accounting period.
Accounting Equation
Accounting equation is the statement of equality between the
resources and the sources which finance the resources.
Economic resources = Claims
Resources means the assets which refers to tangible objects or
intangible rights.
Sources of finance (Claims) means equity and liabilities.
Assets = Liabilities+ Owners Equity
Apply the accounting equation to business organizations
The financial statements are based on the accounting equation. This
equation presents the resources of a company and the claims to
those resources.
Assets are economic resources that are expected to produce a
benefit in the future.
Liabilities are “outsider claims.” They are debts owed to people
and organizations outside of the business (creditors).
Equity (also called capital, owners’ equity, or stockholders’ equity
for a corporation) represents the “insider claims” of a business.
Equity means ownership
Cont’d….
The equation, Assets = Liabilities + Equity can be rewritten as
Assets = Liabilities + Capital + Revenues – Expenses
Process for Developing Accounting Equation
Step 1- Ascertain the variables of an equation affected by a
transaction.
Step 2- Find out effect (in terms of increase and decrease) of a
transaction on the variables of an equation
Step 3- Show the effect on the appropriate side of an equation
Effect of Transactions
Assets: Increase, decrease, no effect
Liabilities: Increase, decrease, no effect
Equity: Increase, decrease, no effect
Classification of accounts
Accounting equation based classification
Assets accounts: These accounts are related to tangible and intangible
assets.
Liabilities accounts: These accounts are related with the financial
obligations of an business towards outsiders.
Capital accounts: These accounts are related to the owners of an
enterprise
Revenue accounts: These accounts are related with income and profits.
Expenses accounts: These accounts are related with expenses and losses
Financial Statements
▪Balance sheet
▪Statement of profit and loss
▪Statement of changes in equity
▪Statement of cash flows
▪How are the financial statements interrelated?
Financial Statement Analysis: The Basics
▪Profit margin
▪Return on assets, or return on investment
▪Asset turnover
▪Collection efficiency
▪Payment to suppliers
▪Return on equity
▪“Skin in the game”
Form and Content of Company Financial Statements
Balance sheet
■ Assets
■ Non-current assets
■ Tangible assets
■ Intangible assets
■ Financial assets
■ Deferred tax assets
■ Current assets
■ Inventories
■ Financial assets
Cont…
Balance sheet
■ Equity
■ Equity share capital
■ Other equity
Cont…
Balance sheet
■ Liabilities
■ Non-current liabilities
■ Financial liabilities
■ Provisions
■ Deferred tax liabilities
■ Current liabilities
■ Financial liabilities
■ Provisions
■ Current tax liabilities
Cont…
Statement of profit and loss
■ Income
■ Expenses
■ Tax expense
■ Profit for the period
■ Other comprehensive income
■ Comprehensive income
Cont…
Statement of changes in equity
■ Equity share capital
■ Retained earnings
■ Other comprehensive income
Cont…
Statement of cash flows
■ Operating activities
■ Investing activities
■ Financing activities
Smelling Fraud
▪ Qualified audit report
▪ Auditor, audit committee chair, independence director or CFO
resignation
▪ Contravention of the law
▪ Promise of excessively high profitability
▪ Payment problems
▪ High performance pressure and huge financial incentives
Thank you
