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ACC 106

CHAPTER 3
Accounting Equation and
Accounting Classification

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Chapters Outlines

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Basic Accounting Equation


Also known as balance sheet (statement of
financial position) equation:

ASSET = CAPITAL (OWNERS EQUITY) +


LIABILITIES
Basis for double entry bookkeeping
The equality always maintained regardless of the
number of transactions recorded
Any change in the amount of the total assets is
always followed by an equal change in the amount
of the total equity (capital) and liabilities

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Accounting Classification
Assets

Property own by the business or economic resources


which are of value to the business can be measured
in monetary term
Provide either present or future benefit to the
business-to assist in the earning of revenue to the
business
Two types:
Non Current Assets
Current Assets

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Non-Current Assets
Assets bought/purchased not for resale.
Used in the running of the business to get profit
Has useful life of more than 1 year

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Non-Current Assets
Tangible non-current assets
Those assets which have physical existence
e.g: land, motor car, building and plant

Intangible non-current assets


Those assets which do not have physical existence
e.g.: goodwill, trademark and patent

Investment
e.g.: quoted and unquoted investment and fixed
deposit (>1 year)

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Current Assets
Cash or Cash equivalent
Those assets which are expected to be converted
into cash within a year
e.g.: stocks and account receivable (debtors)

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Owners Equity

The financial obligation of the business to the


owner.

OE = Capital + /(-) Profit (Losses)


Drawings

Capital represent owner-supplied fund to the


business for the acquisition of assets for the
business
Drawing occur when the owner take whatever
assets of the business for his own use
Profit will increase the capital of the business
whereas losses and drawing will reduce the
capital

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Liabilities
Financial obligations of the business to external
parties.
Non-current liabilities:
Amount owing by the business that is not repaid
in within 1 year
e.g.: Long term loan, mortgage on premises,
debenture.
Current liabilities:
An amount owing by business that is to be paid
within 1 year
e.g: short term loan, bank overdraft, account
payable (creditors)

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Example 1
Fill in the following based on the accounting
equation:

1
.

Assets

Owners
Equity

45,000

12,400

13,333

33,000

10,000

2
.
3
.

21,200

45,678

34,567

Liabilities

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Expanded accounting Equation


Assets = Capital +/(-) Profit/Loss - Drawings + Liabilities

Assets = Capital + (Revenues Expenses) Drawings +


Liabilities
THEREFORE,
Assets + Expenses + Drawings = Capital + Revenues +
Liabilities

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Revenue
Increase in owners equity resulting from
activities entered into for the purpose of
earning income
Trading business- sale of goods
Service business- performance of services
e.g.: interest received, commission received,
rent received, discount received

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Expenses

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The cost of assets consumed or services used in


the process of earning revenue
e.g.: purchased of goods, salary, interest
expense, rent expense, insurance
expense,discount allowed, stationery, electricity,
postage

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Income Statement:
Profit or Loss
Net profit = Revenue > Expenses
Net loss = Revenue < Expenses

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Effects of transactions on the


accounting equation
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Every transaction will have a double effect on the


accounting equation
There will be either an increase or decrease in
assets, expenses, capital, revenues or liabilities

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Effects of Transactions
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Transactions

Effect

Accounts

Cash purchase

(+) E
(-) A

Purchases
Cash/bank

Credit purchase

(+) E
(+) L

Purchases
Creditors

Cash Sales

(+) A
(+) R

Cash/Bank
Sales

Credit Sales

(+) A
(+) R

Debtors
Sales

Purchase return/Return
outwards

(-) E
(-) L

Purchase Return
Creditors

Sales return/Return inwards

(-) R
(-) A

Sales Return
Debtors

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Movement of stock
Purchase
Goods bought by business for the purpose of resale

Sales
Sale of goods which the business bought with the
prime intention of resale

Purchase return or return outward


Goods returned to supplier

Sales return or return inwards


Goods returned by buyers

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Movement of inventory - Continue


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Purchase and sale of goods can be divided into


two categories:
Cash or credit purchase
Cash or credit sales.

Goods purchased that are not sold at the end of


the accounting period are known as closing
inventory.

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Credit notes (Sales return)


When goods sold previously being returned,
credit note will be sent to the buyer (debtors).
Buyer (debtors) account will be credited to show
the reduction in the amount owes.

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Debit note (Purchase return)


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When goods purchase previously being returned,


debit note will be sent to the supplier (creditors).
The supplier (creditors) account will be debited
to show the reduction in the amount owing to
the supplier.

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Discounts
Trade discounts
It is given when business
bought goods in large
quantity
no need to record i.e. NO
double entry
Shown as deduction from
total selling price in the
invoice

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Cash discounts
Encourage early payment
need to record where the
amount of discount is
deducted from sales or
purchased
Sales discounts allowed
Purchases discounts
received

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Cash Discounts

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Journal entries for cash discounts


Transaction

Effects

Accounts

Cash discount given to customer

(+) E
(-) A

Discount Allowed
Debtors

Cash discount received from supplier

(+) R
(-) L

Discount received
Creditors

NOTE: 5/7, n/30 means if customer pays within 7 days, he is


entitled to a discount of 5%. But if he made payment after 7 days
and within 30 days, he is not entitled for any discounts

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Carriage/freight
Transportation cost
Expenses to the business
Two types:
Carriage Inwards
Transportation cost relates to the purchase of
goods
Will be shown in trading a/c as increment to the
purchase cost
Carriage Outwards
Transportation cost related to the selling of goods
Will be shown in profit and loss a/c as an
expenses

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Accounting for Stock


Stock Diagram
Purchased goods
SUPPLIER
(CREDITOR)

BUSINESS

ABC

Return outwards

Sold goods
CUSTOMER
(DEBTOR)

Return inwards

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Continued

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STOCKS/GOODS

INCREASE (+)

Purchase of goods

Recorded in the
purchases a/c

Return inwards

DECREASE (-)

Sales of goods Return outwards

Recorded in the
Recorded in the Recorded in the
Return inwards a/c
Sales a/c
Return outwards a/c

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Cash and credit transactions for


purchases

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Cash and credit transactions for


sales