Chapter 2

Accounting Concepts, Equation

and Double Entry
BBA1113/BBA1114| Financial Accounting Fundamentals
Prepared by Maniam

FACULTY OF BUSINESS MANAGEMENT AND GLOBALIZATION

BBA1113/BBA1114|Fin. Acc. Fundamentals

Outline

Accounting concepts
Accounting equation
Chart of Accounts
Debits and Credits
Double entry accounting
Accounting equation and analysis

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ACCOUNTING
CONCEPTS

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Separate Economic Entity

The business is accounted for separately from other business entities, including its
owner.

The reason for this principle is that separate information about each business is
necessary for good decisions.

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Monetary Unit

Only transaction data that can be expressed in terms of money be included in

accounting records.

Assume that the value of the monetary unit never changes.

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Growing Concern

The business is assumed continue to operate in the future, meaning that a

business will continue long enough to recover the cost of its assets.

Financial statements should be prepared on a going concern basis unless

management either intends to liquidate the enterprise or to cease trading, or has
no realistic alternative but to do so.

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Time Period.

The economic life of business can be divided into artificial time period for the
purpose of financial reporting.

For example: monthly, quarterly, half-yearly, and yearly reports.

This assumption provides that financial information be reported at regular

intervals so that decision makers can compare business operations over time to
assess the success or failure of the business.

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Historical Cost

Purchased assets recorded at cost.

Cost is measured on a cash or cash equivalent basis. It means if cash is given for a
service, its cost is measured as the amount of cash paid.

If something besides cash is exchanged (such as a car traded for a truck), cost is
measured as the cash value of what is given up or received.

The historical cost principle emphasizes reliability, and information based on cost
is considered objective.

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Revenue Recognition

It provides guidance on when a company must recognize revenue.

To recognize means to record it.

Recognized early, a company would look more profitable than it is & recognized
too late, a company would look less profitable than it is.

Generally, revenue is recognized when it is earned and not before.

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Revenue Recognition

Revenue is recorded in the period it is earned, that is when:

1.

the ownership has been transferred from the seller to the buyer (sale of
goods);

2.

the services has been completely provided to the customer (rendering of

services);

3.

percentage of completion method (construction project);

4.

cash is received from the customer (installment method).

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Matching or Accrual

It means that expenses are matched against revenues, and recorded in the same
period in which the related revenues are earned.

As such, adjustments need to be done to allocate the proper amount to relevant

periods.

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Full Disclosure

It requires that a company's financial statements report enough information for

users to make knowledgeable decisions about the company.

In order to satisfy the disclosure principle, companies add to the financial

statements notes that disclose significant accounting policies, probable losses, and
accounting changes.

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Materiality

Accountants are required to accurately account for significant items and

transactions.

Information is significant (or material) if it is likely to cause a statement user to

change a decision because of that information.

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Materiality

For example, the accounting treatment for a RM2

pencil sharpener is not likely to affect any
decisions; the pencil sharpener is immaterial.
However, failing to record a RM1 million liabilities
would affect the decisions of many users and the
amount is material.
The definition of materiality varies from company
to company. A large corporation such as Tenaga
Nasional might consider RM1,000 to be
immaterial, while the grocery store would
consider RM1, 000 to be very material.
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The Accounting Equation

Firm start trading and need resources.

Initially, the owner supplied them all.

Resources used in business = Resources obtained

Resources supplied are called as capital

Actual resources are used in business are
called as assets.
Assets = Capital
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The Accounting Equation

After running the business, more funds or resources needed.

Now, other person has supplied and need to be repaid. This is called as liability.

Assets = Liabilities + Capital

2 sides of equation are always same even
amount of each component changes.

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The Accounting Equation

Business is to earn profit.

Profit is earned from expense spent out of revenue.

Now, the equation is;

Assets = Liabilities + Capital

OR
Assets = Liabilities + Capital+ Income Expenses
Assets + Expenses = Liabilities + Capital+Income
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The Accounting Equation

Assets are economic resources owned by a company and that have expected future
benefits such as buildings, machinery, stocks, debtors, cash and bank balances.

Liabilities consist of money owing for goods supplied or services provided to the firm,
such as loans and creditors.

Capital is often called the owner's equity or net worth; claim on a company's assets.
Equity is the owners residual interest in the assets of a business after deducting
liabilities.

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The Accounting Equation

Revenues are what the business earns for providing goods or services.

Expenses are the cost of assets the business uses to generate revenues (payroll,
depreciation, rent, utilities, and taxes)

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How It Works?

John is a sole trader. He seeking your help on how to apply the accounting
equation for the following transactions:
He invested RM100,000 into the business.
He borrows RM50,000 from the bank to buy a van.

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Solutions
Assets
(RM)

Liabilities
(RM)

Owners Equity
(RM)

100, 000

100,000

50, 000

50,000

150,000

50,000

100,000

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Chart of Accounts

List of all accounts that

includes an identification
number assigned to each
account.

No.
System
101-199
small
business might

Accounts Category

201-299

Liability

301-399

Equity

401-499

Revenue

501-599

Expense

A
use
the
following
numbering
system for its accounts:

Asset

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Debit and Credit

A T-account represents a ledger account

Tool used to understand the effects of one or more transactions.

The layout of a T - account is:

1.

the account title on top,

2.

a left, or debit (Dr.) side, and

3.

a right, or credit (Cr.)

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Debit and Credit

(Account Title)
(Debit)

(Left side)

(RM) (Credit)

(RM)

(Right side)

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Debit and Credit

Debit is not increase or credit is not decrease.

In an account where a debit is an increase, the credit is a decrease; in an

account where a debit is a decrease, the credit is an increase.

The difference between total debits and total credits, including any beginning
balance, is the account balance.

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Debit and Credit

When the sum of debits exceeds the sum of credits, the act has a debit balance.

It has a credit balance when the sum of credits exceeds the sum of debits.

When the sum of debits equals the sum of credits, the account has a zero
balance.

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Double Entry

It requires that each transaction affect, and be recorded in, at least two
accounts.

It also means the total amount debited must equal the total amount credited
for each transaction.

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Double Entry

Asset

Debit for
Increases

Liability

Credit for
Decreases

Debit for
Decreases

Credit for
Increases

Owners
Equity

Debit for
Decreases

Credit for
Increases

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Double Entry

Net increases or decreases on one side have equal net effects on other side.

Second, the left side is the normal balance side for assets, and the right side is
the normal balance side for liabilities and equity.

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Accounting Equation and Double Entry Analysis

Investment by owner

Transaction: James invests RM100,000 cash in James Trading.

Double Entry: Dr. = Cash Account

Cr. = Capital Account

Assets = Liabilities + Equity

Cash = 0
+ Capital
+RM100,000 = 0
+ RM100,000
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Accounting Equation and Double Entry Analysis

Purchase supplies for cash

Transaction: James Trading pays
RM2, 500 cash for supplies
Assets = Liabilities + Equity
Cash
Supplies = 0
+
0
-RM2,500
+RM2,500 = 0
+ 0
Double Entry: Dr. = Supplies Account
Cr. = Cash Account
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Accounting Equation and Double Entry Analysis

Purchase equipment for cash

Transaction: James Trading pays RM26, 000 cash for equipment.

Double Entry: Dr. = Equip. Account

Cr. = Cash Account

Assets = Liabilities + Equity

Cash
Equipment = 0
+
-RM26,000
+RM26,000
=0

0
+ 0

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Accounting Equation and Double Entry Analysis

Purchase supplies on credit

Transaction: Trading purchases RM7,100 of supplies on credit from a supplier.

Assets = Liabilities + Equity

Supplies = Acc.Payables
+
+RM7,100
+RM7,100
=0

0
+ 0

Double Entry: Dr. = Supplies Account

Cr. = Acc. Pay. Account

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Accounting Equation and Double Entry Analysis

Sold for cash

Transaction: James Trading sold goods for RM4, 200 in cash.

Assets = Liabilities + Equity

Cash
=0
+
Sales
+RM4,200
=0
+ RM4,200

Double Entry: Dr. = Cash Account

Cr. = Sales Account

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Accounting Equation and Double Entry Analysis

Payment of expense in cash

Transaction: James Trading pays RM1,000 cash for rental.

Assets = Liabilities + Equity
Cash
Rental= 0
+
0
-RM1,000 +RM1,000
=0
+0

Double Entry: Dr. = Rental Account

Cr. = Cash Account

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