Chapter 2: The Accounting Equation

Question 1

What is the accounting equation?

Answer 1

Assets = Liabilities + Owner’s Equity

Question 2

How is a bank overdraft recorded in a balance sheet?

Answer 2

It is not recorded until it is used, whereby it goes in the credit column of the bank ledger, and is recorded as a current liability

Question 3

What does a balance sheet detail and what is its purpose?

Answer 3

Details assets, liabilities and owners equity at a particular point in time, allowing the owner to assess the firm’s current financial position

Question 4

What does the title of a balance sheet state?

Answer 4

Who it has been prepared for, what kind of report it is and when it was prepared

Question 5

What is a current asset?

Answer 5

A present economic resource controlled by an entity as a result of past events, that is reasonably expected to be converted to cash, sold or consumed within the next 12 months

Question 6

What are some examples of current assets?

Answer 6

Bank, inventory, accounts receivable, prepaid expenses

Question 7

What is a non-current asset?

Answer 7

A present economic resource controlled by an entity as a result of past events, that is not held for resale and is reasonably expected to be used for more than the next 12 months

Question 8

What are some examples of non-current assets?

Answer 8

Vehicles, computers, equipment, premises, fixtures/fittings

Question 9

What is a current liability?

Answer 9

A present obligation of an entity to transfer an economic resource as a result of past events, that is reasonably expected to be settled within 12 months

Question 10

What are some examples of current liabiliites?

Answer 10

Accounts payable, loan repayments within 12 months, accrued expenses and GST owing

Question 11

What is a non-current liability?

Answer 11

A present obligation of an entity to transfer an economic resource as a result of past events, that is not required to be settled within 12 months

Question 12

What are some examples of non-current liabilities?

Answer 12

Loan repayments after 12 months and mortgages

Question 13

What are the advantages of a classified balance sheet?

Answer 13

It is more relevant and understandable for an owner, because it makes decision making easier and allows working capital to be calculated

Question 14

What is working capital?

Answer 14

The amount left over when the current liabilities are subtracted from the current assets

Question 15

What is the working capital ratio?

Answer 15

Current Assets / Current Liabilities

Question 16

What are the two rules of double-entry accounting?

Answer 16

Every transaction will affect at least two items in the accounting equation, and the accounting equation must always balance

Question 17

Why must the accounting equation be redrawn after every transaction?

Answer 17

Two items of the equation are always changed due to double-entry accounting

Question 18

What is an advantage of double-entry accounting?

Answer 18

It provides an extra checking mechanism before data is recorded

Question 19

What happens to the accounting equation when the owner deposits $375,000 to start the business?

Answer 19

Assets increase by $375,000

Owner’s equity increases by $375,000

Question 20

What happens to the accounting equation when the business buys an office desk for $2000 cash?

Answer 20

Assets increase by $2000

Assets decrease by $2000

Question 21

What happens to the accounting equation when inventory is purchased for $10,000 on credit?

Answer 21

Assets increase by $10,000

Liabilities increase by $10,000

Question 22

What happens to the accounting equation when the business pays $10,000 for advertising?

Answer 22

Assets decrease by $1000

Expenses increase by $1000

Question 23

What happens to the accounting equation when $2000 is repaid to accounts payable?

Answer 23

Assets decrease by $2000

Liabilities decrease by $2000