CHAPTER 2

Assets, Liabilities and the Accounting

Equation
Contents

Business definition

Assets

Liabilities

The accounting equation

Illustration
Business definition

1 2 3
An organization A business is an Invests money in
which uses organization resources (eg it
economic providing jobs for buys buildings,
resources to people to work in. machinery etc; it
create goods or pays employees)
services which in
customers will order to make
buy. even more money
for its owners.

 A business owns assets and owes liabilities.

A business from different
perspectives
A business

Legal: Accounting:

•Separate legal •Must always be

entity treated as a
•No distinction separate entity
with its owners. from its
owners.
Assets

Non-current Current
assets Assets assets

Text Text

Something valuable which a business owns or has the use of.

Items belonging to a business and used in the running of the

business.
Assets classification
Classified by period of holding

Non-current Current assets

•Held and used in •Held for only a

operations for a long shorter time.
time, normally more
than 1 years. •E.g.: Cash and
banks, inventories,
•E.g.: factories, office receivables, etc.
building, plant and
machinery, cars, etc.
Liabilities

Non-current Current
Liabilities Liabilitie Liabilities
s
Text Text

Something which is owed to somebody else.

Sums of money owed by a business to outsiders

Liabilities classification
Classified by period of liabilities

Non-current Current liabilities

•Payable in a long •Payable in a shorter

time, normally more time.
than one year.
•E.g.: short term
•E.g.: long term loans borrowings from
or borrowings from banks, overdrafts,
banks, etc. payables to suppliers,
etc.
The accounting equation

A Business

Assets Capital Liabilities

(Cash
= (Owners’ equity + (Bank loans,
Receivables
Retained Trade payables
Buildings
earnings) Tax payables)
Cars)

 Very simple equation to keep in mind

Example 1: Accounting
equation
 On 1 September 20X8, Courtney
Wilder decides to open up a stall in
the market, to sell West Indian fruit
and vegetables.
 He has saved up some money and

has $1,000 to put into his business.

 How’s the accounting equation?
Answer 1: Accounting
equation

Assets = Capital Liabilities

$1,000 cash $1,000
+ $0
Example 2: Different assets
 Courtney Wilder purchases by cash a
market stall which costs $600.
 He also purchases some fruit and

vegetables from a trader in the

wholesale market at $340.
 Of the remaining cash balance of $60,

he keeps $30 in the bank and draws

out $30 in small change, ready for his
first day of market.
 How does the accounting equation
Answer 2: Different assets

Assets Capital Liabilities

Stall 600 Initial capital $1,000

F&V 340 = + $0
Cash at bank 30
Cash in hand 30
-----
$1,000
Example 3: Profit
 On 3 Sep, Courtney is able to sell all
of his fruit and vegetables, for $500
cash.
 How do we reflect this in the

accounting equation?
 Since he has sold goods costing $340

to earn revenue of $500, he has

earned a profit of $(500 – 340) =
$160 on the day's trading.
Answer 3: Profit
Assets

Stall
Capital Liabilities
600
F&V
Initial capital 1,000
= Earned profit 160 + $0
0
Cash (30+30+500)
-----
560
$1,160
-----

$1,160
Example 4: Drawings

Amounts taken out of a business by its owner.

 We will suppose that Courtney decides to

pay himself $100 as 'wages', a fair reward
for his day's work.
 What’s the accounting treatment?
 And how’s the accounting equation?
Answer 4: Drawings
Assets Capital

Initial capital
Stall
1,000
Liabilities
600
Earned profit
F&V
= 160 + $0
0
Drawings
Cash (560-100)
(100)
460

-----
-----
$1,060
$1,060

 Any amounts paid by a business to its owners are

treated by accountants as withdrawals, not as
expenses incurred by the business.
Accounting equation 2

A Business

Capital
introduced
Assets = + earned + Liabilities
profit -
drawings
Accounting equation 3

A Business

Capital
introduced +
profit retained
in previous
Assets = periods+ + Liabilities
profit earned
in current
period -
drawings
Q: Equation analysis
(a) The bank tells the business it no longer
owes the bank $100 in bank charges.
(b) The business finds it has been
overcharged $50 for some furniture it
bought on credit.
(c) A gas bill of $200 is received by the
business.
(d) The owner withdraws $500 from the
business.
(e) Cash is introduced into the business by its
owner.
(f) A car is bought by the business, for
A: Equation analysis
Example 5: More profit
 On 10 Sep, Courtney purchases more
F&V for cash, at a cost of $400. His
aunt, Sheila, offers to help and he
agrees to pay a wage of $50.
 They sell all their goods for $760

cash.
 Courtney pays Sheila her wage of $50

and draws out $150 for himself.

 Update the accounting equation now?
Answer 5: More profit
 Before trading:

Assets Capital Liabilities

Initial capital 1,000

Stall 600 = +
Retained profit 60 $0
F&V 400
Cash (460-400) 60
-----
-----
$1,060
$1,060
Answer 5: More profit (con
’t)
 After trading:
Assets

Stall

600
Capital Liabilities
F&V
Capital b/f 1,060
0 = Earned profit + $0
Cash (760-400-50) 310
Drawings (150)
(60+760-50-150)
-----
620 $1,220

-----

$1,220
Example 6: More capital
introduced
 Suppose on 10 Sep, in addition to all
the other transactions, Courtney
decides to hire a van at a cost of $30
to transport the fruit and vegetables,
paying for the hire out of cash from
his own pocket.
 How would this affect the accounting

equation at the end of 10 September?

Answer 6: More capital
introduced

Assets Capital Liabilities

Capital b/f 1,060
Stall 600
= Capital introduced 30 +
F&V 0 $0
Earned profit (760
Cash (60+760+30
-400-50-30) 280
-50-30-150) 620
Drawings (150)
-----
-----
$1,220
$1,220
Accounting equation 4
A Business

Capital introduced in
previous periods
+ Profit retained in
previous periods
+ Profit earned in
Assets = + Liabilities
current period
+ Capital introduced in
current period
– Drawings in current
period
The business
equation

Increase/dec
Profit Capital
rease in net Drawings in
earned in introduced
= assets in + current -
current in current
current period
period period
period
Credit transactions

A sale or a purchase which occurs some

time earlier than cash is received or paid.

Credit sales Purchases on

credit
•Creates an
account •Creates an
receivable account payable

•Settled when •Settled when

cash is received cash is paid to
from customer supplier
Example 7a: Credit
transactions
(a) Courtney makes the following
arrangements.
(i) He invests immediately a further $200
of his own capital.
(ii) He persuades his cousin Gary to lend
him $400 immediately. Gary tells him that
he can repay the loan whenever he likes,
but in the meantime he must pay him
interest of $3 per week each week at the
end of the market day. They agree that it
will probably be quite a long time before
Answer 7a: Credit
transactions

Liabilities

Assets Capital Loan

400
Stall 600 Capital b/f 1,220
Goods 0 = Capital introduced 200 +
Cash
(620+200+400) 1,220
----- ----- -----
$1,820 $1,420
$400
Example 7b: Credit
transactions
(b) Courtney is very pleased with the
progress of his business, and decides that
he can afford to buy a second-hand van to
pick up fruit and vegetables from his
supplier and bring them to his stall in the
market. He finds a car dealer, Carrie
Carver, who agrees to sell him a van on
credit for $550. Courtney agrees to pay for
the van after 30 days' trial use.
Answer 7b: Credit
transactions
Liabilities

Loan
Assets Capital
400
Capital b/f 1,220 Creditor
Stall 600 = +
Capital introduced 200
Van 550
550
Cash 1,220
-----
-----
$2,370
$1,420
-----

$950
Example 7c: Credit
transactions
(c) During the week before the next market
day (which is on 17 September), Courtney's
Uncle Viv telephones him to ask whether
he would be interested in selling him some
special West Indian spices and equipment
for his kitchen. Courtney tells him that he
will look for a supplier. After some
investigations, he buys what Uncle Viv has
asked for, paying $250 in cash to the
supplier. Uncle Viv accepts delivery of the
goods and agrees to pay $320 at a later
Answer 7c: Credit
transactions
Liabilities

Assets Capital Loan

400
Capital b/f 1,220
Stall 600 Creditor
= Capital introduced 200 +
Van 550
Profit from Viv
Receivable 320 550
(320-250) 70
Cash (1,220-250) 970
-----
-----
$2,440
$1,490
-----

$950
Example 7d: Credit
transactions
(d) The next market day approaches, and
Courtney buys fruit and vegetables costing
$650. Of these purchases $550 are paid in
cash, with the remaining $100 on 14 days'
credit. Courtney decides to use his aunt
Sheila's services again as an assistant on
market day, at an agreed wage of $50.
Answer 7d: Credit
transactions
Liabilities

Loan
Assets Capital 400
Payable for van
Stall 600
Capital b/f 1,220
Goods 650 = + 550
Capital introduced 200
Van 550 Payable for goods
Profit from Viv 70
Receivable 320
Cash (970-550) 420 100
-----
-----
$1,490
$2,540

-----

$1,050
Example 7e: Credit
transactions
(e) For the third market day running, on 17
September, Courtney sells all his goods,
earning $1,050 (all in cash). He decides to
take out drawings of $200 for his week's
work. He also pays Sheila $50 in cash. He
decides to make the interest payment to
his cousin Gary the next time he sees him.
Answer 7e: Credit
transactions
Liabilities

Loan

400
Assets Capital Payable for van

550
Stall 600 Capital b/f 1,490
Payable for goods
Van 550 = Profit for week (1,050 +
Receivable 320 -650-50-3) 347
100
Cash (420+1,050-50 Drawings (200)
Interest payable
-200) 1,220
----- -----
3
$2,690 $1,637

-----

$1,053
Question
 Liza Doolittle has $2,500 of capital invested
in her business. Of this, only $1,750 has
been provided by herself, the balance
being provided by a loan of $750 from
Professor Higgins. What are the
implications of this for the accounting
equation?
Answer
 Assets of $2,500 (cash), balanced by
liabilities of $2,500.
 $1,750 owed to Liza clearly falls into the
capital.
 $750 owed to the Professor?
 Sharing the risks and rewards of the business, then $750
is 'capital’.
 Expect only a repayment of his 'loan' plus some interest,
$750 should be classified under liabilities.
Double entry bookkeeping
Duality: Every transaction has two accounting entries,
A business
a debit and a credit.

Debit: Credit:
•Increases assets •Decreases assets
•Decreases liabilities •Increases liabilities
•Decreases capital •Increases capital
•Decreases income •Increases income
•Increases expenses •Decreases expenses

Means left hand side Means right hand side

Discussion
Explain the dual effects of each of the following
transactions.

(a) A business receives a loan of $5,000 from its

bank

DR assets (cash) and CR liabilities (owed to the

bank) by $5,000.

(b) A business pays $800 cash to purchase goods for

resale

CR assets (cash) and DR assets (inventory) by

$800.
Discussion
(c) The proprietor of a business removes $50 from
the till to buy her husband a birthday present
CR assets (cash) and DR capital by $50.

(d) A business sells goods costing $300 at a profit of

$140
DR assets (cash) by $440; CR assets (inventory)
by $300; and CR capital (the profit earned) by
$140.

(e) A business repays a $5,000 bank loan, plus

interest of $270
CR assets (cash) by $5,270; DR liabilities (the
bank loan) by $5,000; and DR capital by $270.
 MCQ 1
A business had net assets at 1 January and 31
December 20X9 of $75,600 and $73,800
respectively. During the year, the proprietor
introduced additional capital of $17,700 and
withdrew cash and goods to the value of $16,300.

What profit or loss was made by the business in

20X9?

A $3,200 loss
B $400 loss
C $400 profit
D $3,200 profit
MCQ 1
A business had net assets at 1 January and 31
December 20X9 of $75,600 and $73,800
respectively. During the year, the proprietor
introduced additional capital of $17,700 and
withdrew cash and goods to the value of $16,300.

What profit or loss was made by the business in

20X9?

A $3,200 loss (73,800-75,600-17,700+16,300)

B $400 loss
C $400 profit
D $3,200 profit
MCQ 2
A business had net assets at 1 January and 31
December 20X9 of $47,100 and $54,200
respectively. During the year the proprietor
introduced additional capital of $22,000 and made
drawings of $200 per week.

What profit or loss was made by the business in

20X9?

A $18,700 loss
B $4,500 loss
C $4,500 profit
D $18,700 profit
MCQ 2
A business had net assets at 1 January and 31
December 20X9 of $47,100 and $54,200
respectively. During the year the proprietor
introduced additional capital of $22,000 and made
drawings of $200 per week.

What profit or loss was made by the business in

20X9?

A $18,700 loss
B $4,500 loss (54,200 – 47,100 -22,000 +
200*52)
C $4,500 profit
D $18,700 profit
MCQ 4
The net assets of Kate's business were $15,000 at 1
January 20X3 and $25,000 at 31 December 20X3.
During the year Kate paid lottery winnings of $2,500
into the business bank account and withdrew $1,000.
What was her net profit for the year ended 31
December 20X3?

A $7,500
B $8,500
C $9,500
D $11,500
MCQ 4
The net assets of Kate's business were $15,000 at 1
January 20X3 and $25,000 at 31 December 20X3.
During the year Kate paid lottery winnings of $2,500
into the business bank account and withdrew $1,000.
What was her net profit for the year ended 31
December 20X3?

A $7,500
B $8,500 (25,000 – 15,000 -2,500 + 1,000)
C $9,500
D $11,500
QB 3

Answer: C