3.2 What is the accounting equation?

Question 1

HOM: Striving for Accuracy
Thinking Skill: Memorise
What is the accounting equation?

Answer 1

HOM: Striving for Accuracy
Thinking Skill: Memorise

Total assets (A) = Total Liabilities (L) + Total Equity (E)

Question 2

What does the accounting equation express?

Answer 2

It expresses the relationship between assets, liabilities and equity.

Question 3

What does a business need to operate?

Answer 3

Resources / Assets such as land, building, equipment, inventory, etc.

Question 4

What does the business need in order to obtain the assets / resources it requires to operate?

Answer 4

Funds.

Question 5

Where can the funds needed by a business to purchase assets / resources come from?

Answer 5

The funds could be:

1. borrowings from other businesses or people (liabilities), and / or
2. contributions from the owners (equity).

Question 6

What are the funds borrowed from other businesses or people called?

Answer 6

Liabilities.

Question 7

What are the funds from the owners called?

Answer 7

Equity.

Question 8

Must all the assets in the business be equal to all its liabilities and equity at any one time? or must:
A=L+E at any one time?

Answer 8

Yes. This is known as “balance”.

Question 9

What can the accounting equation be used for?

Answer 9

Since the accounting equation must balance, it can be used to calculate missing values of items.

Question 10

Example 1 (Textbook, Page 32)
Calculate the equity (capital) of the following business.
Inventory $8000
Cash at bank $4200
Fixtures and fittings $12000
Trade payables $2500
Long-term borrowing $5000

Answer 10

Total assets = inventory +cash at bank + fixtures and fittings = $8000+$4200+$12000 = $$24,200.

Total liabilities = Trade payables + Long term Borrowing = $2500 + $5000 = $7500

Equity = Total assets - Total Liabilities = $24200 - $7500 = $16,700.

Question 11

Can the accounting equation A = L+E be re-arranged?

Answer 11

It can be rearranged to:
E=A-L
L= A-E

Question 12

What is the difference between income and expenses?

Answer 12

Profit or loss.

Question 13

What results in a profit?

Answer 13

When income is greater than expenses.

Income > Expenses = Profit

Question 14

What results in a loss?

Answer 14

When income is less than expenses.

Income < Expenses = Loss

Question 15

Where is the profit or loss made by the business classified in?

Answer 15

The Equity section of the main accounting equation.

A = L + Equity

Question 16

HOM: Striving for Accuracy
Thinking Skill: Memorise
What is the expanded accounting equation for a sole proprietorship?

Answer 16

HOM: Striving for Accuracy
Thinking Skill: Memorise
Total Assets (A) = Total Liabilities (L) + Capital + (Income-Expenses) - Drawings

Question 17

HOM: Striving for Accuracy
Thinking Skill: Memorise
What is total equity (E)?

Answer 17

HOM: Striving for Accuracy
Thinking Skill: Memorise
Total Equity = Capital + (Income - Expenses) - Drawings
i.e.
Total Equity = Capital + Profit - Drawings
or
Total Equity + Capital - Loss - Drawings

Question 18

HOM: Striving for Accuracy
Thinking Skill: Memorise
What is the expanded accounting equity for a company?

Answer 18

HOM: Striving for Accuracy
Thinking Skill: Memorise
Total Assets (A) = Total Liabilities (L) + Issued Share Capital + (Income - Expenses) - Dividends

Question 19

HOM: Striving for Accuracy
Thinking Skill: Memorise
What is the formula for retained earnings?

Answer 19

HOM: Striving for Accuracy
Thinking Skill: Memorise
Retained Earnings = (Income - Expenses) - Dividends

Question 20

HOM: Striving for Accuracy
Thinking Skill: Memorise
What is the formula to calculate the Total Equity of a company?

Answer 20

HOM: Striving for Accuracy
Thinking Skill: Memorise
Total Equity (E) = Issued Share Capital + (Income - Expenses) - Dividends

Question 21

Textbook, Example 2 (Page 34)
The following are the assets, liabilities, income, expenses and drawings of a business as at 28 February 20X1:
Inventory $7200
Cash at Bank $9100
Fixtures and Fittings $13800
Trade payables $5200
Long term borrowing $5000
Drawings $2000
Sales revenue $19600
Salaries expense $3700
Utilities expense $4300
Rental expense $6400

Note: Beginning equity as at 1 Feburary 20X1 is $16700.

a. Calculate the profit for the period from 1 to 28 February 20X1.
b. Calculate the ending equity as at 28 February 20X1.

Answer 21

a. Profit for the period = Total income - Total expenses = $19600 - ($3700+$4300+$6400) = $5200
b. Ending equity as at 28 February = Equity on 1 February 20X1 + Profit for February - Drawings in February = $16700 + $5200 - $2000 =$ $19900 or

Ending equity as at 28 February as at 28 February 20X1 = Total Assets - Total Liabilities = ($7200+$9100+$13800) - ($5200+$5000) = $19,900.