CHAPTER 3

Accounting Equation &

Accounting Classification
 Learning Objectives
After completing this chapter, you should be able to:

•Understand the basic accounting equation

•State the expanded accounting equation
•Explain the term assets, liabilities and owner’s equity
•Show the effects of transactions on the accounting
equation
INTRODUCTION
Accounting equation reflects the relationship between the total
assets, liabilities and owner’s equity of a business on a certain
date.
4. Revenue 5. Expenses Drawings
1. Assets
• are resources owned by the business and are
expected to provide present and future
economic benefits to the business.
• Classification of assets:

Property owned by the business

 are resources
owned by a
business, held for a
a) Non-Current Assets long period of time
usually more than
1) Tangible Non-Current Assets twelve months.
◦ Assets that have physical existence
◦ Example : Land, Building, Vehicles, Machinery, Furniture

2) Intangible Non-Current Assets

◦ Assets that have no physical existence, cannot be seen and
touched physically
◦ Example : Patents, Goodwill, Trademarks
b) Non-Current Investment
- Money placed in other organisations in the hope of getting
return
◦ Example : Fixed deposit

c) Current Assets
- take the forms of either cash or assets that can be converted
into cash within twelve months or less.
o Example : Inventories, Debtors or Account receivable, Cash
in hand and cash at bank
 2. Liabilities
• are existing debts and financial obligations of the
business to the outsiders.
• Classification of liabilities:

Financial obligation of the business to external parties

Liabilities
Non current Liabilities
 Financial debts and obligations which are expected to be
settled after more than 1 year
 Long term loans, Mortgages

Current Liabilities
 Short term debts and obligations which are expected to be
settled within 1 year/12 months
 Creditors or Accounts Payable, Bank overdrafts, Short-term
Loans
3. Owners’ equity
- Equity is the residual interest in the entity’s assets after
deducting all its liabilities
- is the ownership claim on total assets.
- consists of four components - capital, revenue, expenses
and drawings.

◦ Keywords in transactions : brought into the business, started

the business, for the purpose of business
Exercise
Classify the following items into assets, liabilities and capital.

Fixtures and fittings Office equipment Term loan from Maybank

Account receivable Cash in hand Land and buildings

Leasehold premises Bank overdraft Account payables

inventory Motor vehicles Capital by owner

Cash at bank Debentures Mortgage on land and building

 ANSWER

Fixtures and fittings Office equipment Term loan from Maybank

(NON CURRENT ASSET) (NON CURRENT ASSET) (NON CURRENT LIABILITIES)

Account receivable Cash in hand Land and buildings

(CURRENT ASSET) (CURRENT ASSET) (NON CURRENT ASSET)

Leasehold premises Bank overdraft Account payables

(NON CURRENT ASSET) (CURRENT LIABILITIES) (CURRENT LIABILITIES)

Inventory Motor vehicles Capital by owner

(CURRENT ASSET) (NON CURRENT ASSET) (OWNER EQUITY)

Cash at bank Debentures Mortgage on land and building

(CURRENT ASSET) (NON CURRENT (NON CURRENT LIABILITIES)
LIABILITIES)
Basic Accounting Equation
 Exercise: Determine the
missing figure
ASSETS (RM) LIABILITIES (RM) OWNER’S EQUITY (RM)

1. 130,000 70,000 ???

2. 890,000 ??? 500,000

3. ??? 32,444 566,335

4. 111,989 ??? 99,775

5. 333,995 112,331 ???

Example no. 1 -

ANSWER : 60 000, 390 000, 598 779, 12 214, 221 664

 4. Revenue
• Represents the monetary value of goods and services that have been supplied
to the customers.
• Revenues will increase the owner’s equity.
• Classifications – (1) operating revenues and (2) non-operating revenues.
 5. Expenses
• Represent the cost of assets used or services used in generating the revenues.
• Expenses will decrease owner’s equity.
• Classifications – (1) operating revenues and (2) non-operating revenues.
Operating Expenses
Profit and the Expanded Accounting
Equation
As business begins, goods are purchased and subsequently sold,
expenses are incurred and revenues are earned.
Profit belongs to the owner and increases owner’s equity.
 *Profit is the difference between revenue over expenses.

ASSETS = LIABILITIES + OWNER’S EQUITY + * PROFIT OR

ASSETS = LIABILITIES + OWNER’S EQUITY + (REVENUE – EXPENSES)

Expanded Accounting Equation
Profit belongs to the owner and increases owner’s equity.

ASSETS + EXPENSES = LIABILITIES + OWNER’S

EQUITY + REVENUE
OR
ASSETS = LIABILITIES + OWNER’S EQUITY + PROFIT
OR
ASSETS = LIABILITIES + OWNER’S EQUITY +
REVENUE – EXPENSES
 Contribute

Withdraw

Owner Company Owner

Capital acc. Drawing acc.

Owner Equity (Increase) Owner Equity (Decrease)

Note : 1st – Accounts involved; 2nd – Effects (Bold)

Business Transaction
Example
 RULE OF THUMB – Accounting
Equation
OWNER
ASSET EXPENSES LIABILITY REVENUE
EQUITY

DEBIT NATURE CREDIT

(Dr) (Cr)

EFFECT
(Dr) (Cr)

Follow nature AE LOR

Against nature
Debit Credit Debit Credit
Example (Dr) (Cr)

a. Pay electricity bills by cash RM40

Account/Journal Entries Effect
Dr Electricity bills Expenses
Cr Cash Asset

b. Paid creditor (As Trading) using cheque RM100

Account/Journal Entries Effect
Dr Creditor (As Trading) Liability
Cr Bank Asset

c. Rent received from Ali RM450 by cash

Account/Journal Entries Effect
Dr Cash Asset
Cr Rent received Revenue

NOTE : Debit will be mentioned first and followed by credit

 Effects Of Transactions on the Accounting Equation
Transactions Accounts Effect Journal entries

Example : Cash Asset increase Dr Cash

Kassim introduces Capital Owner equity Cr Capital
RM10,000 cash into increase
business
Sell goods RM1,200 Sales
to Ramly on credit Debtor (Ramly)

Buy furniture Furniture

RM10,000 from Ah Creditor (Ah Seng)
Seng on credit

Amin invests Bank

RM100,000 into Capital
business bank
Issued RM10,000 Salary
cheque for Bank
employees’ salary
 Transactions Accounts Effect Journal entries

Issued RM15,000 Purchase

cheque to suppliers Bank
for purchased goods

Sell RM2,500 goods Sales

to Ming by cheque Bank

Furniture of Furniture
RM5,000 acquired Bank
and paid by cheque

Paid for stationery Stationery

by cash RM20 Cash

Owner took cash Drawing

RM200 for personal Cash
use
 Exercise
1. When a business receives payment from an account receivable, the
effect on the statement of financial position of the firm is ________
a. An increase in assets
b. A decrease in liabilities
c. An increase in liabilities
d. No change in the total amount of cash
Example: Effects of Transactions
1. Radzi invests RM50,000 cash into the business
2. Bought a motor van on credit from Lee Trading RM5,000
3. Bought goods for RM150 paying by cheque.
4. Bought goods on credit RM2,000 from Mini Sdn Bhd
5. Bought shop premises paying RM5,000 by cheque and loan from bank
RM25,000
6. Bought fixtures RM200 paying by cheque
7. Repaid by cash a loan owed to Raman RM1,000
8. Radzi introduces another RM500 cash into the firm
9. Radzi takes out RM1,000 cash for personal use
10. Business paid creditor RM190 by cheque
11. Cash sales of RM5,000
12. Sold goods on credit RM20,000
Accounting for stock
 Purchase & Sales of Goods
Purchase and sales of goods can be divided into 2 categories:

Transactions Accounts Involved

a. Cash Purchase Cash Account & Purchase Account
b. Credit Purchase Creditors Account & Purchases Account
c. Cash Sales Cash Account & Sales Account
d. Credit Sales Debtors Account & Sales Account
Purchase Return & Sales
Return of Goods
 Sales acc. Purchase acc.
Revenue Increase Expenses Increase

Sold goods Purchase goods

Return goods Return goods

Debtors / Creditors /
Account Receivables Account Payables
Company (Suppliers)
(Customers)

Sales Return / Return Purchase Return /

Inwards acc. Return Outwards acc.
Revenue Decrease Expenses Decrease

Note : 1st – Accounts involved; 2nd – Effects (Bold)

Movement of stock
MOVEMENT OF INVENTORY
Accounts Transactions Accounts involved
Purchase Goods bought from the supplier for Purchase acc & Cash / Bank acc
the purpose of resale Creditor acc (on credit)

Sales Sold goods to the customer Sales acc & Cash / Bank acc
Debtor acc (on credit)
Purchase Goods returned to supplier Purchase Return / Return
Return / outwards acc
Return Creditor acc
Outwards
Sales Return Goods returned by the customer / Sales Return / Return inwards
/ Return buyer acc
Inwards Debtor acc
Withdraw Owner take stock / inventory from the Drawing acc (Owner equity )
goods business Purchase acc
 3.6 DOUBLE ENTRY PRINCIPLES FOR
INVENTORY@STOCK@GOODS
The double entry are as follows:

Transactions Effects Double entry

Purchased of goods Expense Increase Debit Purchases a/c

Sales of goods Revenue Increase Credit Sales a/c

Purchases Returns / Return Expense decrease Credit Purchase Returns a/c

Outwards / Return Outwards a/c
Sales Returns / Return Revenue decrease Debit Sales Return a/c
Inwards / Return Inwards a/c

PURCHASE
ON CREDIT
KEYWORDS
KEYWORDS ACCOUNTS
1. Goods / Stocks / Sales / Purchase
Inventory
2. On credit Debtors / Creditors (Name of Individual @
Company)
3. Started / brought into Capital
the business
4. Cheque Bank
5. Owner took / personal Drawing
@ private use