The Basic Accounting Equation Flashcards
What is Accounting?
Several definitions
- The recording, analysing and summarising of financial data of an entity.
- The identifying, measuring and communicating of economic information to permit informed judgements and decisions by users of the information.
What are the books of prime entry?
The books where transactions are recorded and analysed.
What are the ledger accounts?
They are where transactions are posted after having been recorded and analysed in the books of prime entry.
What are the financial reports?
Where transactions are summarised.
It is the last step after they have been recorded and analysed in the books of prime entry and posted in the ledger accounts.
The accounting process
The main elements of financial reports produced by an organisation are:
- Statement of Financial Position
- Income Statement
- Cash Flow Statement
What is the Statement of Financial Position?
(balance sheet)
A statement of assets owned and liabilities owed by the business at a certain date
What is the Income Statement?
(profit and loss account)
A record of the income earned and expenses incurred over a period of time
What is the Cash Flow Statement?
A record of the movement of cash over a period of time
What are assets?
Resources owned by a business
- Cash at bank,
- Goods,
- Buildings,
- Vehicles
What are liabilities?
Amount owed to third parties (obligations) (Dettes)
- Loans
- owed to supplier
- taxation owed
What is Equity ?
The investment that the owner makes and is owed to the owner (A type of liability)
(capitaux/fonds propres, capital)
Who are the main users of financial information relating to a business?
What are the two Branches of Accounting?
- Financial accounting for external users
- Management accounting for internal users
Financial Accounting Vs Management Accounting
Equity and Revenue Items :
- Revenue expenditure
- Capital expenditure
- Revenue income
- Capital Income
Revenue expenditure=
Purchase of raw material, salaries, rent etc.
Capital expenditure =
Purchase of non-current assets e.g. buildings, shop fittings etc.
Revenue income =
Proceeds from sale of goods, interest and dividends received
Capital Income =
Proceeds from sale of non-current assets e.g. buildings, machinery etc.
The Basic Accounting Equation
Assets = Liabilities + Equity
What does a Business Entity owns and owes ?
Owns
- Assets – Cash at bank, Goods, Buildings, Vehicles
Owes
- Equity – Amount introduced by owner
- Liability – Loans, owed to supplier, taxation owed
Movement in Assets and Liabilities
The Income Statement =
The purpose of the income statement (profit and loss account) is to measure and report how much profit or loss the business generated over an accounting period
Revenue =
Measure of inflow of economic benefits from ordinary activities
E.g. Sales of goods or services
Expenses =
Outflow of economic benefits arising from ordinary activities.
E.g. salaries, rent
The extended accounting equation
The basic accounting equation can be extended to incorporate any profit/loss transactions and stated as follows:
Basic Accounting Equation:
Assets = Liabilities + Equity
Extended Accounting Equation:
Assets = Liabilities + Equity + Profits
Assets = Liabilities + Equity + (Revenue–Expenses)
Income statement and statement of financial position
Example of the layout of an Income Statement
Example of the layout of a Statement of Financial Position as at 30 June 2016
Income Statement, Three types of profits
Gross profit - represents the profit from buying and selling goods before any other expenses
Operating profit – this is profit after deducting all operating expenses incurred in running the business (e.g. salaries)
Profit before tax - Operating profit is then adjusted for non-operating income/expenses such as finance cost
Recording Transactions
Debits and Credits
An account either receives or gives
- Debit means to receive
- Credit means to give
When a transaction takes place, it is necessary to ask the following two questions:
- Which account receives – to be debited
- Which account gives – to be credited
ALL Assets and Expenses are =
DEBIT
ALL Incomes and Liabilities are =
CREDIT
What is the Trial Balance?
- Once all the accounts have been balanced off, a Trial Balance (TB) is extracted
- A TB is a list of all the debit and credit balances from the Nominal Ledger accounts.
- A TB is compiled at the end of a specific accounting period
- The total of the debit balances should equal the total of the credit balances if double-entry book-keeping procedures have been carried out correctly.
An Example –
Trial Balance at 30 June 2016
A TB confirms that the following have been carried out:
- For every debit entry there appears to be a credit entry – dual aspect concept
- The amount for each debit and credit entry has been entered correctly in appropriate accounts
- The balance on each account has been calculated, extracted and entered correctly in the trial balance
- The debit and credit columns in the trial balance total to the same amount.
Errors not disclosed by the Trial Balance :
- Omission – A transaction completely omitted
- Wrong account
- Entered in the wrong account (e.g. purchases instead of stationery)
- Entered in the correct type of account but wrong personal account – Smith’s transaction entered in Jones’ account
- Compensating – identical addition errors in the debit and credit columns of two accounts – one cancelling the other (£90 instead of £900)
