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The Accounting Equation Slides 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) J. E. Cairnes School of Business & Economics 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.) J. E. Cairnes School of Business & Economics 1 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 J. E. Cairnes School of Business & Economics LIABILITIES Defintions: ‘the source of funds from outsiders’ ‘amounts owed to people or firms outside the business’ (Gillespie & Lewis, Principles of Financial Accounting) J. E. Cairnes School of Business & Economics 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 2 Ownership Interest Often referred to as ‘Capital’, ‘Capital Employed’, ‘Equity’ or ‘Shareholders Funds’ The liability of the entity to the owners of the entity J. E. Cairnes School of Business & Economics Ownership Interest Definitions: ‘the owners claim on the business’ ‘the assets less liabilities of the business’ (Gillespie & Lewis; Principles of Financial Accounting) J. E. Cairnes School of Business & Economics THE ACCOUNTING EQUATION ASSETS = LIABILITES ASSETS = LIABILITES + OWNERSHIP INTEREST ASSETS - LIABILITES = OWNERSHIP INTEREST J. E. Cairnes School of Business & Economics 3 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 J. E. Cairnes School of Business & Economics 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 J. E. Cairnes School of Business & Economics 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. J. E. Cairnes School of Business & Economics 4 Accounting Equation Examples 1. Initial Bank Capital €10,000 €10,000 J. E. Cairnes School of Business & Economics Accounting Equation Examples 2. Initial Bank 100 Shoes Capital €2,000 €8,000 €10,000 J. E. Cairnes School of Business & Economics Accounting Equation Examples 3. Initial Capital Bank 50 Shoes €10,000 €4,000 €9,000 J. E. Cairnes School of Business & Economics 5 Accounting Equation Examples 4. Initial Bank 50 Shoes Profit Capital €9,000 €4,000 €3,000 €10,000 J. E. Cairnes School of Business & Economics Accounting Equation Examples 5. The Entity Ownership Interest Bank 50 Shoes Profit Capital €9,000 €4,000 €3,000 €10,000 J. E. Cairnes School of Business & Economics Accounting Equation Examples 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. J. E. Cairnes School of Business & Economics 6 Accounting Equation Examples 1. Initial Boat Capital €20,000 €20,000 J. E. Cairnes School of Business & Economics Accounting Equation Examples 2. Initial Boat Bank (Profit) Capital €20,000 €2,000 €2,000 €20,000 J. E. Cairnes School of Business & Economics Accounting Equation Examples 3. Initial Boat Bank Fees Due (Profit) Capital €20,000 €2,000 (€500) €1,500 €20,000 J. E. Cairnes School of Business & Economics 7 Accounting Equation Examples 4. Residual Boat Bank Fees Due Profit Capital €20,000 €1,250 (€500) €1,500 €19,250 J. E. Cairnes School of Business & Economics Accounting Equation Examples 5. The Entity Ownership Interest Boat Bank Fees Due Profit Capital €20,000 €1,250 (€500) €1,500 €19,250 J. E. Cairnes School of Business & Economics The Accounting Equation • Assets – Liabilities = Capital + Revenue - Expenses - Drawings J. E. Cairnes School of Business & Economics 8 The Accounting Equation Assets – Liabilities = Capital +Revenue - Expenses - Drawings or Debit (Dr) Credit (Cr) Assets = Capital + Expenses +Revenue + Drawings +Liabilities J. E. Cairnes School of Business & Economics 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 J. E. Cairnes School of Business & Economics 9 How do we record all transactions? By using T Accounts with Dr. and Cr. entries for individual accounts. J. E. Cairnes School of Business & Economics Accounting Equation T – Accounts Dr. ASSET Cr. INCREASE REDUCE ASSET ASSET J. E. Cairnes School of Business & Economics Accounting Equation T - Accounts Dr. LIABILITY Cr. REDUCE INCREASE LIABILITY LIABILITY J. E. Cairnes School of Business & Economics 10 Accounting Equation T - Accounts Dr. REVENUE Cr. REDUCE INCREASE REVENUE REVENUE J. E. Cairnes School of Business & Economics Accounting Equation T - Accounts Dr. EXPENSE Cr. INCREASE REDUCE EXPENSE EXPENSE J. E. Cairnes School of Business & Economics 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 J. E. Cairnes School of Business & Economics 11 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 J. E. Cairnes School of Business & Economics 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, contact:[email protected] J. E. Cairnes School of Business & Economics 12 .
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