Chapter 2- Accounting Equation Flashcards
What is the double entry principle?
- all transactions have a dual effect
What does the double entry principle rely on?
- in every commercial transaction there are two effects
What is the accounting equation?
Net assets = proprietors funds
Assets-liabilities = capital + profits (-losses) - drawings
What does net assets mean?
- total sum of a business’ assets minus the total sum of its liabilities
Why are drawings deducted from the proprietors funds?
- because these amounts are no longer owed by the business to its owner
Describe the calculation of gross profit
Sales - cost of sales
Cost of sales = opening stock+purchases-closing stock
What is profit?
- difference between the purchase price and sale proceeds
Who does the profit of a business belong to and how is it recorded in the balance sheet?
- profit belongs to the owners
- is recorded in proprietors funds under profits
- profit is recorded when sale is made and not when cash is received as assuming accrual basis
What can the accounting equation be used for?
- calculate missing figures by rearranging Net assets = capital introduced + profit - drawings
Describe how accounting equation can be applied in a situation where business has traded for many years
- increase in net current assets over a period must equal an increase in proprietors funds over the same period
Net assets at end of year - net assets at start of year = profits for the period + capital introduced at the period - drawings for the period
Conclude this chapter
- Every business transaction has two equal and opposite effects
- This in turn maintains the accounting equation
- Accounting equation states that net assets will equal proprietor’s funds
- Accounting equation is essentially a simple version of the balance sheet
