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CHAPTER 2: ACCOUNTING EQUATION

What is an asset?

An asset

is anything of value that is owned by or owed to the business
can be used to earn profits
is a resource controlled by the business and is beneficial to it (e.g. cash, stock, bank account, furniture & fittings)
can be classified according to how quickly the items can be turned into cash (i.e. their liquidity)
A current asset is an asset that is normally expected or intended to be converted into cash or used up within the accounting period
A long-term/fixed asset is an asset that normally takes more than the accounting period to be converted into cash or to be used up

What is a liability?

A liability

is anything that the business owes to external parties
is a claim on the business assets by an outside party (e.g. creditors, accounts payable)
A current liability is a liability that is asked to be repaid by external parties within one accounting period
A long-term liability is a liability that external parties are willing to be repaid for more than one accounting period

What is owner's equity or capital?

refers to the claim on the assets of a business by the owner or the internal party of the business
is the difference between the assets and liabilities of a business
When the owner takes out assets (i.e. cash or office supplies etc) from the business for his/her own use, this is known as drawings
Since drawings reduce the owner's claim on the assets of the business, it can be seen as the opposite of capital or 'negative' capital

Differences between Revenue & Expenses

Revenue	Expenses
Refers to what a business earns as a result of the sale of goods and/or services	Refers to the cost of goods and services used to earn revenue
Increases the capital of the business	Decreases the capital of the business
E.g. Thames' tuition agency's revenues would be the tuition fees collected from students E.g. G2000 is a multinational fashion retailer that earns its revenues through the sale of clothes	E.g. Thames' tuition agency will advertise for students. Hence, the cost of advertising is an expense to the business

The Accounting Equation

is built from the accounting entity concept that regards the business and the owner of the business as two separate persons or entities
looks at all the transactions from the viewpoint of the business
is stated as Assets = Liabilities + Owner's Equity (or Capital)

Effects of Business Transactions on the Accounting Equation

Besides the owner bringing in capital to the business, there are many transactions that would have an effect on the accounting equation
The example below will show you how various business transactions will have an effect on Thomas's business - Thomas Delivery Services

Thomas starts his own business, Thomas Delivery Services, by investing S$20,000 of his own savings into the business. He opens a bank account in the name of his business.
From the business' viewpoint, the business (Thomas Delivery Services) has an asset - a bank account, and the source of that asset is capital (the owner's claim on the asset)
The impact on the accounting equation is: