CHAPTER 2:

FINANCIAL ACCOUNTING
CONCEPTS AND
TERMINOLOGY
 OUTCOMES
At the end of this chapter students should be able to:

• Classify and define items as assets, liabilities or

owner’s equity.
 CHAPTER OUTLINE

2.1 How wealthy are you?

2.2 Accounting classifications
HOW WEALTHY ARE YOU?

Possessions = Debts + Wealth (paid-up items)

Wealth (net worth) = Possessions - Debts

 HOW WEALTHY ARE YOU?
ILLUSTRATIVE EXAMPLE:

Bheki Zwane, a student at the Durban University of Technology wants to know how much

he is worth as at 31 December 20x1. Bheki has the following possessions and debts as at

31 December 20x1

Possessions Debts
Item Price Item Price
Cellphone 2 500 University fees (3 700)
Clothing 3 000 Loan from dad (1 500)
Apple iPad 12 000
Total possessions 17 500 Total debts (5 200)
 HOW WEALTHY ARE YOU?
ILLUSTRATIVE EXAMPLE 1 (cont’d)

Required:

What is Bheki Zwane’s net worth as at 31 December 20x1?

SOLUTION

Possessions

Total possessions 17 500

Total debts (5 200)

Net worth 12 300

 HOW WEALTHY ARE YOU?

Bernard Arnault: $213.7B Elon Musk: $178.3B Jeff Bezos: $126.3B

 Top 10 richest people in the world

1. Bernard Arnault
2. Elon Musk
3. Jeff Bezos
4. Larry Ellison
5. Warren Buffet
6. Bill Gates
7. Carlos Slim Helu
8. Larry Page
9. Mukesh Ambani
10. Sergey Brin
 HOW WEALTHY ARE YOU?
How does this relate to business and accounting?

• While it is acceptable to use terms such as “wealth,” “possessions” and

“debts,” from a personal perspective, from a business perspective, we would

have to use the following terminology:

Possessions = “Assets”

Debts = “Liabilities”

Net worth = “Owner’s equity”

 ACCOUNTING CLASSIFICATIONS
Assets
Assets are resources controlled by an entity resulting from past
events out of which future economic benefits will flow.

An asset must have:

• Measurable value
• Expected future benefit for the entity by either;
Ø Producing cash inflows or;
Ø Reducing cash outflows
 ACCOUNTING CLASSIFICATIONS

Assets
There are two categories of assets;

Non-current assets
• A non-current asset is an item of value with a lifespan of more than one
year. For e.g. property, plant and equipment, intangible assets and
financial assets.

Current assets
• A current asset is an item of value with a lifespan of less than one year,
which is easily converted to cash. For e.g. cash in the bank and debtors.
 ACCOUNTING CLASSIFICATIONS

Liabilities
• Liabilities are present obligations resulting from past events, the
settlement of which leads to decreases in economic benefits.

• In other words, liabilities are measurable amounts that the entity

owes to lenders and creditors.

There are two categories of liabilities, namely:

• Non-current liabilities
• Current liabilities
 ACCOUNTING CLASSIFICATIONS
Non-current liabilities

• These are obligations of the business which are payable over a

period of more than one year.

• For e.g. bond from the bank on a property

Current liabilities

• These are obligations of the business which are payable within

one year.

• For e.g. bank overdraft and creditors

 ACCOUNTING CLASSIFICATIONS
Owners’ equity
• Owners’ equity refers to the owners’ claim to the business’s
resources.

• Also refers to the resources that were invested by the owners

of the entity.

• For e.g. capital contribution and drawings

 ACCOUNTING CLASSIFICATIONS
Owners’ equity (cont’d)
Owners’ equity is made up of two main components:

(1) Owner’s equity – equity paid in by the owner

(2) Earnings – “net profit” which has been earned by the business
 ACCOUNTING CLASSIFICATIONS
Owners’ equity
• The net profit (earnings) belong to the owner of the business
and so also falls under owner’s equity. Net profit consists of:

Income – Expenses = Net profit

• Income: consists of receipts by a business for its normal

operations, for e.g. sales, fees earned, rent received and
interest received. These increase economic benefits within a
current period.
 ACCOUNTING CLASSIFICATIONS
Owners’ equity
• The net profit (earnings) belong to the owner of the business and so
also falls under owner’s equity. Net profit consists of:

Income – Expenses = Net profit

• Expenses: amounts spent by a business during its normal

operations (but excluding capital expenses). For e.g. rent paid,
advertising, salaries and insurance. These decrease economic
benefits within a current period.
 ACCOUNTING CLASSIFICATIONS
Class example
Wendy starts an online store selling designer shoes imported from Italy.

To start the business, the following contributions are made towards the start-up:

Wendy’s personal FNB R50 000

account
Money borrowed from R100 000
Wendy’s mom
Money that can finance R150 000
business assets
 ACCOUNTING CLASSIFICATIONS
Class example (cont’d)
The table below summarises the financial performance of Wendy’s shoe business
for the first year:

Sales (Income) R70 000

Costs associated with importing the (R30 000)
shoes
Other expenses (R15 000)
Interest paid back to mom on loan (R10 000)
Net profit R15 000
 CHAPTER 3:
THE ACCOUNTING
EQUATION
 OUTCOMES
At the end of this chapter students should be able to:

• Understand the basic accounting equation and all the elements thereof;

• Analyse, record and summarise the effects of various transactions on the

basic accounting equation of both a service organisation and a retail
organisation.
 CHAPTER OUTLINE

3.1 The basic accounting equation (BAE)

3.2 The effect of transactions on the basic accounting equation (BAE)

 THE BASIC ACCOUNTING EQUATION
(BAE)
Basic Accounting Golden Rule

Assets = Liabilities + Owner’s equity

The financial position is measured by the following items:

1. Assets (what it owns)

2. Liabilities (what it owes)

3. Owner’s equity (the difference between assets and liabilities)

 THE BASIC ACCOUNTING EQUATION
(BAE)
Basic Accounting Golden Rule

Assets = Liabilities + Owner’s equity

• Assets = the resources controlled by an entity resulting from past events out of
which future economic benefits will flow.

• Both the owner and creditors (liabilities) have a claim to the entity’s resources
(because if it were not for them, the business would have no resources).

• The equation considers business activities and not the owner’s personal
activities.
 THE BASIC ACCOUNTING EQUATION
(BAE)
Basic Accounting Golden Rule

Assets = Liabilities + Owner’s equity

LEFT RIGHT
• Right side = represents all the money that is available to the business in
the long term from the owner and from outsiders. The money is then used
to purchase assets (left side).

• Therefore, the money raised from the owner and outsiders is converted
into assets. THE LEFT MUST EQUAL THE RIGHT.
 THE BASIC ACCOUNTING EQUATION
(BAE)
Example 1:

Mr Hayne, the owner of Prima Innovations, invests R140 000 in order to

start his business. Owner’s equity is therefore R140 000. He also
approaches a bank that lends him R100 000. Liabilities are therefore
R100 000.

Owner’s equity (R140 000) + Liabilities (R100 000) =

R240 000

What happens to this R240 000?

 THE BASIC ACCOUNTING EQUATION
(BAE)
Example 1 (cont’d):
What happens to this R240 000?

It will be used to purchase assets:

For e.g.
 THE BASIC ACCOUNTING EQUATION
(BAE)
Example 1 (cont’d):
Assets (R240K) = OE (R140K) + Liabilities (R100K)
Therefore, the accounting equation balances.

Example 2

The assets of Beauty Salon amount to R50 000 and its liabilities
(creditors) to R10 000.

REQUIRED:
Calculate the owner’s equity.
 THE BASIC ACCOUNTING EQUATION
(BAE)
Example 2 (cont’d):

Solution
A = L + OE;
R50 000 = R10 000 + OE;

OE = Assets – Liabilities;

OE = R50 000 – R10 000

Therefore, OE = R40 000
 THE BASIC ACCOUNTING EQUATION
(BAE)
Example 3:

K. Masondo is the owner of Mars Services, which offers a carpet

cleaning service. As at 31 March, Mars Services owns equipment
amounting to R120 000, clients owe R50 000 for services rendered and
Mars Services owes R25 000 to a supplier for parts purchased. Mars
also has R8 000 cash in the bank.

REQUIRED:
Complete the BAE for Mars and determine the owner’s equity.
 THE BASIC ACCOUNTING EQUATION
(BAE)
Example 3 (cont’d): Solution
Assets:
Equipment (R120K) + Debtors (R50K) + Cash (R8K) = R178K
Liabilities:
Supplier (R25K)

A = L + OE
R178K = R25K + OE
OE = R178K – R25K
OE = R153 000
Assets = Owner’s equity + Liabilities
NON-CURRENT Owner’s funds Income (Expenses) NON-CURRENT
ASSETS LIABILITIES
Land and buildings Capital Sales Purchases Long-term loans
Furniture Add: Net profit Fees earned Rent paid Mortgage bond
Equipment Less: Drawings Rental income Salaries and CURRENT
wages LIABILITIES
Motor vehicles Interest income Interest paid Creditors
(accounts
payable)
Fixed deposit Commission Stationery VAT
received used
CURRENT ASSETS Discount received Telephone Bank overdraft
Debtors (accounts Water and
receivable) electricity
Trading stock Bank charges
(inventory)
Bank Repairs
Petty cash Advertising
Petrol and oil
Discount
allowed
HOMEWORK
Chapters 2 & 3

Chapter 2 tutorial exercises: 2, 3, 4, 6 and 7

Chapter 3 tutorial exercises: 1, 2, 3 and 4