The Accounting Equation Slides

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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

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

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

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