Chap 3:Accounting Equation and Financial statements elements

 All right, after the accounting information system, lets us embark on another section, which is the Accounting equation:) : -

Balance Sheet

Assets = Liabilities + Equities 

A business needs assets such as job equipment, cash and stock in order to operate. Asset are resources owned by the company.

While on the other side liabilities can be further split to Non- Current liab such as Long Term Borrowings and Current liab such as creditors. Liabilities are funds borrowed from other people, they can be bank or natural person.

Equities are resources or funds contributed to the business by its owner.

Income Statement 

Profit/(loss) = Total Income -Total expenses

Income could be in the form of  trading/service/Sales revenue. Other income such as scrap proceed, bank interest income could be another form too.

Expenses are outflow of funds of the business such as depreciation/rental/electricity expenses to name a few.

All right, having known the 5 major elements of the financial, lets us get to know the impact transaction will have on the elements.

1. Cash sales of goods worth $1,000 for $1,500 

Dr Cash (Balance sheet-current asset increase)     $1,500

Cr Sales revenue (Income statement - revenue increase) $1,500

& for the cost of goods

Dr Cost of goods (Income statement - Cost of Goods sold increase) $1,000

Cr Inventory (Balance sheet - current asset reduces) $1,000 

We need to account for the sales of $1,500 in revenue in income statement and also cash/bank in balance sheet. The $1,000 will need to be reduced from inventory and increase to the Cost of goods sold account in income statement. 

2. Purchase of Goods on Credit for $2,000 from Mr POA

Dr Inventory (Balance sheet - Current asset increases)  $2,000

Cr Trade Creditor - Mr POA (Balance sheet - Current Liab increases) $2,000

When a business purchase goods, inventory will increase, correspondingly Trade creditor or cash will increase/reduce correspondingly depending if the purchase is paid on credit or in cash.

3. Return of Goods worth $500 to Mr POA 

Dr Trade Creditor - Mr POA (Balance sheet - current liability (reduces)  

Cr Return Outwards( Income statment - reduces expenses/purchases)

Upon return of goods to Mr POA, the business inventory/purchases reduces, how do we reflect it?

We reflect it by increasing Return outwards account, the return outwards is shown below in the income statement: -

Income Statement as at 31 Dec 20X2

                                                $

Total Purchases                2,000

Less:Return Outwards    (500)

Net purchases.                  1,500

From all 3 transactions,notice 2 things:-

i. The bal sheet & income statement still balances after each transaction:-

In the case of payment to a trade creditor,If I reduces cash which is an current asset,I also reduces trade creditor which is a current liab.....and since 

Total Assets = Total Liab + Total Equity 

By reducing asset & Liab,the equation will ⚖️ balance:)

2. It will have a Debit & Credit entry,no Debit only or Credit only entry.

Test your understanding by trying out the double entries for these transactions:

Example

1. Accrual of rental Exp $1,500

Dr.              ....Total Exp/Rev increase/decrease......               $1,500

Cr               ....Total assst/liab increase/decrease......                         $1,500

2.Payment to trade debtor Mr B $500

3. Owner,Mr POA adds $10,000 of cash to the business

4. Return of goods by customer Mr B $100

5. Depreciation of Machinery $1,000 for the year of 20X1

6.Owner take out $3,000 of cash for personal usages

7.Purchase of $700 of goods on credit from supplier,Mr D

8.Dividend payment of $0.01/share or $1,000 declared for the year ended 31 Dec 20X2.

Do these above and think of the transactions impact on each part of the financial statement same as the example for (a):)

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