Chapter 2 The Accounting Elements and Accounting Equation v2

INTRODUCTION TO
FINANCIAL
ACCOUNTING

Accounting Elements

……………………………………………..

Accounting Elements
There are five elements in accounting:
1. Asset Accounts

Assets are things of value owned by a business because they bring future
benefits to the business entity. They are acquired for business to carry out its
day to day activities. Assets can be classified into fixed assets ( non current
assets ) and current assets

Assets

Fixed Assets Current Assets

(non current
assets)

Examples:
Fixed Assets
Machinery and Equipment , Fixtures and Fittings, Vehicle and Building

Current Asets
Debtors (account receivables/ customer ), Cash in hand, Closing stock
(inventory), Prepaid Expenses and Accrued Revenue

2. Liability Accounts
Liabilities are amounts owed by the business to outside parties. In the running
of the day to day activities, the business may buy goods on credit, borrow
money to buy fixed assets like premises and land, or have electricity and
telephone bills that have not been settled.

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Liabilities can be classified into long term liabilities ( loan amount to be paid
more than 1 year) and current liabilities (loan amount to be paid less than
one year).

Liabilities

Current Long Term
Liabilities Liabilities

Examples:
Current Liabilities
Creditors ( account payable,customer), Accrued Expenses (unpaid
expenses/ outstanding expense), Prepaid Revenue , short term loan (less
than12 months)

Long term liabilities
Long term loan ( more than 1 year), mortgage ( housing loan)

3. Owner’s Equity
The owner’s equity or capital is the investment made by the owner. It
represents the owner’s interest in the business. It is actually the net worth of
the business and can be obtained by subtracting the liabilities from the assets.

Example:
Capital ( initial implementation of business), Profit ( revenue-expenses) ,
withdrawal

4. Revenues
Revenues are earned (or recognised) when a business sells goods/services to
its customers, which results in an inflow of assets such as cash or debtors.
In other words, revenues are earned when a firm has provided goods/services
to its customers.

Examples accounts in revenue category:
Sales, Turnover, Interest Received, Commissions received, Rent received and
Discount received

5. Expenses
Expenses (including costs) incurred refer to the using up of assets in earning
revenues. In other words, expenses incurred can be defined as the sacrifice
made to produce revenue.

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Examples expenses account:
Purchases ,Wages, Salaries, Insurance, Electricity, Postage, Legal Fees, Audit
Fees, Audit Fees, Interest expense, Rent expense, and Discount allowed.

Element of
accounts

Assets Liabilities Equities

Fixed Current Current Long Term Revenue Expenses
Assets Assets Liabilities Liabilities

Business Entity and Accounting Equation

The business entity concept implies that the affairs of a business are to be treated as
being quite separate from the non-business activities of its owner(s).

The items recorded in the books of the business are, therefore, restricted to the
transactions of the business. No matter what activities the proprietor(s) get up to
outside the business, they are completely disregarded in the books kept by the
business.

The only time that the personal resources of the proprietor(s) affect the accounting
records of a business is when they introduce new capital into the business, or take
drawings out of it.

The Accounting Equation
By adding up what the accounting records say belongs to a business and deducting
what they say the business owes, you can identify what a business is worth according

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to those accounting records. The whole of financial accounting is based upon this
very simple idea. It is known as the accounting equation
It can be explained by saying that if a business is to be set up and start trading, it will
need resources. Let’s assume first that it is the owner of the business who has
supplied all of the resources. This can be shown as:

T

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T

Debit Credit

What is Statement of Financial Position ?
What is a Profit and Loss?

The statement of financial position also known as a Balance Sheet represents the
Assets, Liabilities and Equity of a business at a point in time.

A Profit and Loss Report (P&L) is a report that shows your total Income and your total
Expenses in a specific period of time. It’s a really useful report as it shows you your
net Profit (or loss) based on your Income & Expenses, and that can be used to come
up with some cost cutting strategies.Profit & Loss Reports go by a few names, so it
might be referred to as an “Income Statement”, a “Statement of Operations”, a
“Statement of Financial Results” and “Income & Expense Statement”. Let’s stick with
Profit & Loss Report.

Revenue and Capital Expenditure

Capital expenditures are for fixed assets, which are expected to be productive assets
for a long period of time.

Revenue expenditures are for costs that are related to specific revenue transactions
or operating periods, such as the cost of goods sold or repairs and
maintenance expense

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Chapter 2
Introduction to Financial Accounting

The Accounting Element and
Accounting Equation

QUESTION
1. Classify the following items as asset, liabilities or owner equity:

i) Office Equipment _____________________________

ii) Withdrawal _____________________________

2. Classify the following items into current assets, fixed assets, current
liabilities and long-term liabilities.

No Accounts Classification
1. Office machinery
2. Fixtures and fittings
3. Debtors
4. Cash at bank
5. Land and buildings
6. Leasehold premises
7. Long-term Loan form MyBank
8. Motor vehicles
9. Creditors
10. Bank overdraft

3. Classify the following items into expenses and revenue.

No Account Classification
1. Transportation expense
2. Advertising expense
3. Discounts received

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4. Selling expenses
5. General expense
6. Interest received
7. Taxes
8. Printing & Stationery
9. Rent revenue
10. Postage expense
11. Dividends from investments
12. Discounts allowed
13. Bank charges
14. Commissions received
15. Dividend revenue

4. Classify the following items into current assets, fixed assets, current
liabilities, long-term liabilities, owner’s equity, expenses and revenue.

No Account Classification
a. Capital
b. Van
c. Refrigerator
d. Freehold land & buildings
e. 3-year loan from Bank Selamat
f. Equipment
g. Ordinary shares
h. Salaries
i. Interest received
j. Discount allowed
k. Commissions received
l. Insurance
m. Rent paid
n. General expenses
o. Inventories
p. Repairs to office machinery
q. Rent received
r. Mortgage on plant & machinery
s. Debtors
t. Creditors

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5. In the table below, identifying the category the various items belong to
and tick (/) in the appropriate column. The first one has been done for
you.

NO PARTICULARS Asset Liability Equity Revenue Expenses

a. Wages paid /
b. Commission

received
c. Office

equipment
d. Bank

overdraft
e. Loans
f. Interest on

loans
g. Stationery
h. Creditors
i. Debtors
j. Service fees

received
k. Sales
l. Cash

invested by
the owner
m. Purchases of
goods for
resale
n. Stock

6.

For the business of K. Yun, a wholesale chemist, classify the following between
‘capital’ and ‘revenue’ expenditure:

a. Purchase of an extra motor van.
b. Cost of rebuilding a warehouse wall which has fallen down.
c. Building extension to a warehouse.
d. Painting extension to the warehouse when it was first built.
e. Repainting extension to the warehouse three years later than that done

in

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f. Carriage costs on bricks for new warehouse extension.
g. Carriage costs on sales.
h. Legal costs of collecting debts.
i. Legal charges on acquiring new premises for office.
j. Fire insurance premium.
k. Costs of erecting a new machine.

7.
For the business of H. Wang, a foodstore owner, classify the following between
‘capital’ and ‘revenue’ expenditure.

a) Repairs to a meat slicer.
b) New tyres for van.
c) An additional shop counter.
d) Renewing signwriting on the store.
e) Fitting partitions in the store.
f) Roof repairs.
g) Installing thief detection equipment.
h) Wages of store assistant.
i) Carriage on returns outwards.
j) A new cash register.
k) Repairs to office safe.
l) Installing an extra toilet.

8. LIABILITIES CAPITAL
Fill in the blanks: 1,800 A
4,900 B
ASSETS C
12,500 D 12,500
28,000 6,300 16,450
16,800 11,650 19,200
19,600 16,900 39,750
17,200
E I G
F 15,400 34,400
55,000 28,500
H
36,100 J
119,500

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( HINT : ASSET = LIABILITIES +CAPITAL )

9.
Fill in the missing amount in each of the following accounting equations.

ASSETS CAPITAL LIABILITIES REVENUES EXPENSES
(RM) (RM) (RM) (RM) (RM)
25,000 14,000 20,350 (a) 30,000

(b) 20,300 16,400 7,770 5,000

66,945 (c) 10,600 20,775 37,775

79,888 9,000 (d) 41,002 22,222

101,600 66.780 16,000 253,000 (e)

10.
Al Walid is setting up a new business. Before actually selling anything, he bought a
van for RM13,000, a transportable market stall for RM1,050; a computer for RM450;
and an inventory of goods for RM8,000. He did not pay in full for his inventory of
goods and still owes RM3,000 for them. He borrowed RM10,000 from Bedah. After
the events just described, and before trading starts, he has RM1,400 cash in hand
and RM4,700 in the bank. Calculate the amount of his capital.

11.
B Wise is setting up a new business. Before actually selling anything, he bought a van
for RM4,500, a market stall for RM2,000 and a stock of goods for RM1,500. He did not
pay in full for his stock of goods and still owes RM1,000 in respect of them. He
borrowed RM5,000 from C Fox. After the events just described, and before trading
starts, he has RM400 cash in hand and RM1,100 cash at bank. Calculate the amount
of his capital.

12.
F Flint is starting a business. Before actually starting to sell anything, he bought fixtures
for RM1,200, a van for RM6,000 and a stock of goods for RM2,800. Although he has

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paid in full for the fixtures and the van, he still owes RM1,600 for some of the goods. B
Rub lent him RM2,500. After the above, Flint has RM200 in the business bank account
and RM175 cash in hand. You are required to calculate his capital.

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