Accounting Equation

and
Financial Statements

Maria Immanuvel S
2 LEARNING OBJECTIVES

▹ Explain Accounting Equation

▹ Analyse the effect of transaction on
the accounting equation
▹ Describe the financial statements
and explain how thery are related
▹ Basics of financial statements
▹ Main items ina company’s financial
statements
3 Chapter 2 Financial Statements

Learning Objective
Explain the 1
accounting
equation
4 The Accounting Equation

▹ It shows the relationship between

the economic resources of a
business and the claims against
those resources

Economic
Claims
Resources
Sources of
Funds
= Application
of Funds
5 Accounting Equation

Assets Liabilities Owners’ Equity

Assets Liabilities Capital Retained Earnings

Assets Liabilities Capital Revenue Expense

Drawings/Dividends
6 The Accounting Equation
7 The Accounting Equation

▹ The accounting equation can be expressed

in 3 ways:
▹ Assets = Liabilities + Owners’ Equity
▹ Liabilities = Assets – Owners’ Equity
▹ Owners’ Equity = Assets – Liabilities
8 Accounting Equations - Problem

S.No Assets Liabilities Equity

1 28,000 8,000 20,000

2 89,200 9,200 80,000
3 86,000 0 86,000
4 45,000 22,000 23,000
5 39,000 9,000 30,000
6 33,500 6,500 27,000
9 Accounting Equations - Problem

1. Hot chocolate has assets of Rs.87,000 and liabilities

of Rs. 53000. How much is the equity?

1. ABC ltd has Liabilities of Rs.62000 and Equities of

Rs. 48000. How much is the Assets?
10 Accounting Equations - Problem

Abraham Company’s September 30 balance sheet

contained the following items: loan payable Rs.12,000;
Expense payable Rs. ?; Owner’s Equity Rs. 77,300; Cash
Rs.5000; Trade receivables Rs. 17,000; Supplies
Rs.9000; Equipment Rs.19,000; building Rs.21,800; land
Rs.21,000.
What was the amount of expenses payable?
11 Accounting Equations - Problem

Coffee corner’s equity is twice its liabilities. Its assets

are Rs.81000. Prepare it balance sheet.
Assets =81000 = Liabilities +Equity
= Liabilities + (2*Liabilities)
81000 = 3 * Liabilities
Liabilities = 27000
12 Accounting Equations - Problem

Compute the missing figures using the formula of accounting

equation in the following:
Liabilities = $20,000, Owner’s equity = $30,000, Assets = $50,000
Liabilities + Owner’s equity = $300,000, Assets = $300,000
Assets = $100,000, Liabilities = $40,000, Owner’s equity = $60,000
Assets = $120,000, Owner’s equity = $80,000, Liabilities = $40,000
13 Chapter 2 Financial Statements

Learning Objective
Analyse the effects 2
of transactions on
the accounting
equation
14 Business Transaction - 1

A business proposed to be started by Mr. Raju

Capital + Liabilities = Assets

0 + 0 = 0
15 Business Transaction - 2

He brought in Rs. 1,00,000 as his capital contribution

for the business. (Started Business with a Capital of Rs.
1,00,000.)
Capital + Liabilities = Assets

Cash
1,00,000 + 0 =
(1,00,000)
16 Business Transaction - 3

He then purchased some furniture for Rs. 25,000.

(Bought Furniture for cash Rs. 25,000)

Capital + Liabilities = Assets

Cash (75,000) +
1,00,000 + 0 =
Furniture (25,000)
17 Business Transaction - 4

He then purchased some goods for cash for Rs. 25,000

from M/s Robert Brothers. (Bought Goods for cash Rs.
25,000) – Vendor Name is irrelevant
Capital + Liabilities = Assets
Cash (50,000) +
1,00,000 + 0 = Furniture (25,000)
+ Stock (25,000)
18 Business Transaction - 5

He then purchased some goods valued Rs. 10,000 from

Mr. Shankar on credit (Bought Goods from Mr. Shankar
on credit for Rs. 10,000) – Vendor name is relevant

Capital + Liabilities = Assets

Cash (50,000) +
Mr. Shankar
1,00,000 + = Furniture (25,000) +
(10,000)
Stock (35,000)
19 Business Transaction - 6

He then sold some goods for cash for Rs. 20,000 to Mr.
Peter. (Sold Goods for cash Rs. 20,000) – Buyer name is
irrelevant
Capital + Liabilities = Assets

Cash (70,000) +
Mr. Shankar
1,00,000 + = Furniture (25,000)
(10,000)
+ Stock (15,000)
20 Business Transaction - 7

He then sold some more goods on credit to M/s Bharat

& Co., for Rs. 10,000. (Sold Goods on credit to M/s
Bharat & Co., for Rs. 10,000) – Buyer name is relevant
Capital + Liabilities = Assets
1,00,000 + Mr. Shankar =
(10,000) Cash (70,000) + Furniture
(25,000) + Stock (5,000)
+ M/s Bharat & Co (10,000)
21 Business Transaction - 8

He then opened a bank account and paid Rs. 60,000 cash

into the bank account (Paid Cash into Bank Rs. 60,000)
Capital + Liabilities = Assets
1,00,000 + Mr. Shankar = Cash (10,000) + Furniture
(10,000) (25,000) + Stock (5,000)
Bank (60,000) + M/s Bharat &
Co (10,000)
22 Business Transaction - 9

He then paid Rs. 5,000 cash to Mr. Shankar (Paid Cash

to Mr. Shankar, Rs. 5,000)

Capital + Liabilities = Assets

1,00,000 + Mr. Shankar = Cash (5,000) + Furniture
(5,000) (25,000) + Stock (5,000)
Bank (60,000) + M/s Bharat & Co
(10,000)
23 Business Transaction - 10

He then received Rs. 8,000 payment from M/s Bharat &

Co. (Received cash from M/s Bharat & Co., on account,
Rs. 8,000)
Capital + Liabilities = Assets
1,00,000 + Mr. Shankar =
(5,000) Cash (13,000) + Furniture (25,000)
+ Stock (5,000)
Bank (60,000) + M/s Bharat & Co
(2,000)
24 Expanded Accounting Equation

Owner’s Equity is divided into two components

Revenues and Expenses
Revenues increase Owner’s Equity
Expenses decrease Owner’s Equity
Drawings or Dividends decrease Owner’s Equity:

Assets = Liabilities + Owner’s Equity + Revenues – Expenses –

Drawings / Dividends
25 Expanded Accounting Equation

I. The business sells goods for $1,200 cash

II. The business pays its rent monthly rent of $950
using a company check
III. The business’ owner withdraws $2,000 for his
personal use
26
ACCOUNTING
EQUATION

One minitue Quiz 2.4

Page 53
 Accounting Equation
27 One Minute quiz 2.4

What is the effect of the transaction “Paid rent for last

months” on the accounting equation?

Assets Liabilities Equity

A Decrease Decrease Decrease
B Decrease Decrease No Effect
C Decrease No effect Decrease
D No effect Decrease Decrease
 Expanded Accounting Equation -
28 Problem 1
Assume the following transactions:
1. Mr. Alex invested $20,000 to start a printing business,
2. The company obtained a loan from a bank, $30,000,
3. The company purchased printers and paid a total of $1,000.
4. Rendered services and received the full amount in cash, $500
5. Rendered services on account (receivable from customer), $750
6. Purchased office supplies on account (payable to supplier), $200
7. Had some equipment repaired for $400, to be paid after 15 days
8. Mr. Alex, the owner, withdrew $5,000 cash for personal use
9. Paid one-third of the loan obtained in transaction #2
10. Received customer payment from services in transaction #5
 Expanded Accounting
29 Equation - Solution
Transaction Assets = Liabilities + Owners Capital
1. Owner's investment = +
2. Loan from bank = +
3. Purchased printers = +
4. Service revenue for cash = +
5. Service revenue on account = +
6. Supplies on account = +
7. Repair of equipment = +
8. Owner's withdrawal = +
9. Payment of loan = +

10. Collection of accounts = +

Balance = +
 Expanded Accounting
30 Equation - Solution
Transaction Assets = Liabilities + Owners Capital
1. Owner's investment 20,000.00 = + 20,000.00
2. Loan from bank 30,000.00 = 30,000.00 +
3. Purchased printers 1,000.00 = +
(1,000.00)
4. Service revenue for cash 500.00 = + 500.00
5. Service revenue on account 750.00 = + 750.00
6. Supplies on account 200.00 = 200.00 +
7. Repair of equipment = 400.00 + (400.00)
8. Owner's withdrawal (5,000.00) = + (5,000.00)
9. Payment of loan (10,000.00) = (10,000.00) +

10. Collection of accounts 750.00 = +

(750.00)
Balance 36,450.00 = 20,600.00 + 15,850.00
 Expanded Accounting Equation -
31 Problem 2
Mr. John established a company called "John T-shirts" to sell T-shirts. He
carried out the following actions within first month of business:
1. Mr. John gave his company a $15,000 financial investment. 2. He bought
a structure for $5,000 cash to use for commercial purposes. 3. A $1,500 cash
purchase of furniture for commercial use. 4. Paid a producer $3,000 cash to
buy T-shirts. 5. T-shirts that were sold for $1,000 in cash had a $700 cost. 6.
T-shirts worth $2,000 were bought with credit. 7. T-shirts that were sold for
$800 on credit and cost $550 each. 8. Paid his creditors $1,000 in cash. 9.
Gathered $800 in cash from his accounts receivable. 10. Someone stole the
$100 shirts from the store. 11. Mr. John paid his phone bill in cash of $150.
12. $5,000 was borrowed for business purposes from City Bank.
32 Exercise

Effect of
Test Your Accounting
Understanding 2.1 Equation
Page : 49
 Test your understanding 2.1
33 Effect on Accounting Equation

Give an example of a transaction that has the following

effect on the accounting equation:
Assets Liabilities Equity
A Increase Increase -
B Increase, Decrease - -
C Increase - Increase
D Decrease Decrease -
E Decrease - Decrease
34 Chapter 2 Financial Statements

Describe the
Learning Objective
financial 3
statements and
explain they are
interelated
35
Balance Sheet

Shows the financial

position at a point in
time
36
Statement of
Profit and Loss
Reports the financial
performance in a
period
37
Statement of
Cash Flows
Summarizes the cash
inflows and outflows
resulting from operating,
investing and financing
activities in a period
38
Statement of
Changes in Equity
Explains how equity
changed as a result of
net profit, dividends,
return of capital and
other transactions in a
period
 Interrelationship between
39 financial statements

▹ Transactions affect more than one financial

statement.
▸ Providing services for cash
▸ Collecting past invoices
▸ Taking a bank loan
40
EFFECT OF TRANSACTIONS
ONFINANCIAL STATEMENTS

One minitue Quiz 2.5

Page 56
 One minitue Quiz 2.5
41 Page 56

Which of the financial statements would be affected by the

transaction “Paid Dividend”?
I. Statement of changes in equity; Statement of cash flows.
II. Statement of profit and loss; Statement of changes in equity;
Statement of cash flows.
III. Balance sheet ; Statement of changes in equity; Statement of
cash flows.
IV. Balance sheet ; Statement of profit and loss; Statement of
changes in equity; Statement of cash flows.
42 Exercise

Computing
Test Your profit from
the Balance
Understanding 2.2
Sheet
Page : 56
43 Chapter 2 Financial Statements

Learning Objective
Basics of financial 4
statement analysis
 Basics of Financial
44 Statement Analysis

▹ Is the company making good money from sales?

▹ Is the company earning reasonable return on
investment?
▹ Is the company using its assets efficiently?
▹ Are customers taking too long to pay?
▹ Ratio of borrowed fund to own fund?
▹ Ratio of dividend to profit?
45 Chapter 2 Financial Statements

Learning Objective
Main items in a 5
company’s
financial
statements
 Main items in company’s
46 Financial Statements

▹ Schedule III Companies Act 2013 (Section 129) specifies

the form of financial statements for companies
▹ Balance sheet contains three sections: Assets, Liabilities
and Equity
▹ The items within assets, liabilities and equity follow the
order of Permanency
 Balance Sheet Format – PART I-BALANCE SHEET
47 Schedule III Name of the Company…………………….
Balance Sheet as at………………………
Particulars Note No. Figures as at the Figures as at the end
end of current of previous reporting
reporting period period

I. EQUITY AND LIABILITIES

1) Shareholder’s Funds(a) Share Capital
(b) Reserves and Surplus
(c) Money received against share warrants
(2) Share application money pending allotment

(3) Non-Current Liabilities(a) Long-term borrowings

(b) Deferred tax liabilities (Net)
(c) Other Long term liabilities
(d) Long term provisions
(4) Current Liabilities(a) Short-term borrowings
(b) Trade payables
(c) Other current liabilities
(d) Short-term provisions
Total
 Balance Sheet Format –
48 Schedule III
Particulars Note No. Figures as at the Figures as at the end
end of current of previous reporting
reporting period period

II.Assets
(1) Non-current assets(a) Fixed assets
(i) Tangible assets
(ii) Intangible assets
(iii) Capital work-in-progress
(iv) Intangible assets under development
(b) Non-current investments
(c) Deferred tax assets (net)
(d) Long term loans and advances
(e) Other non-current assets
(2) Current assets(a) Current investments
(b) Inventories
(c) Trade receivables
(d) Cash and cash equivalents
(e) Short-term loans and advances
(f) Other current assets
Total
 Profit and Loss statement PART-II – PROFIT & LOSS STATEMENT
49 Format – Schedule III Name of the Company……………………..
Profit and Loss statement for the year ended………….
Particulars Note No. Figures as at the end Figures as at the end
of current reporting of the previous
period reporting period
CONTINUING OPERATIONS(1)
I Revenue from operations (gross)
II Other income
III Total revenue (1+2)
VI Expenses(a) Cost of materials
consumed
(b) Purchases of stock-in-trade
(c) Changes in inventories of finished
goods, work-in progress and stock-in-
trade
(d) Employee benefits expense
(e) Finance costs
(f) Depreciation and amortisation
expense
(g) Other expenses
Total expenses
 Profit and Loss statement PART-II – PROFIT & LOSS STATEMENT
50 Format – Schedule III Name of the Company……………………..
Profit and Loss statement for the year ended………….
Particulars Note No. Figures as at the end of Figures as at the end of
current reporting period the previous reporting
period
V Profit before exceptional and extraordinary items
and tax (III-IV)
VI Extraordinary items
VII Profit / (Loss) before extraordinary items and tax
(V+VI)
VIII Extraordinary items
IX Profit before tax (Vl (-/+)VIII)
X Tax expense:(I) Current tax expense for current year
(II) Deferred tax
XI Profit / (Loss) from continuing operations (IX+X)

XII Profit V(loss) from discontinuing operations

XIII Tax expense of discontinuing operations
XIV Profit/(loss) from Discontinuing operations (after tax)
(XII-XIII)
XV Profit (Loss) for the period (XI + XIV)
XVI Earnings per equity share:(1) Basic
(2) Diluted
 Expanded Accounting Equation -
51 Problem 2
Mr.X opened a consulting firm and completed these transactions during November2023
(a) Invested Rs 4,00,000 cash and office equipment with Rs 1, 50,000 in a business called Call me
Consulting.
(b) Purchased land and a small building . The land was worth Rs. 1, 50,000 and the building worth Rs
3,50,000. The purchase price was paid with Rs 2,00,000 cash and a long term note payable for Rs
3,00,000. ; (c) Purchased office supplies on credit for Rs 12,000.
(d) Mr.X transferred title of motor car to the business. The motor car was worth Rs 90,000.
(e) Purchased for Rs 30,000 additional office equipment on credit.
(f) Paid Rs 7,500 salary to the office manager. ; (g) Provide services to a client and collected Rs
30,000. ; (h) Paid Rs 4,000 for the month's utilities. ; (i) Paid supplier created in transaction (c).
(j) Purchase new office equipment by paying Rs 93,000 cash and trading in old equipment with a
recorded cost of Rs 7,000. ; (k) Completed services of a client for Rs 26,000. This amount is to be paid
within 30 days. ; (l) Received Rs 19,000 payment from the client created in transaction (k).
(m) Bobbie withdrew Rs 20,000 from the business. Analyse the above stated transactions on various
financial statements prepared.
 Basics of Financial Statement
52 Analysis - Exercise

Arrange assets in the order of permanence:

▹ Sundry Debtors, Stock, Investment, Land and Building,
Cash in Hand, Motor Vehicle, Bills Receivables, Cash at
Bank, Goodwill, Plant and Machinery, Furniture, Loose
Tools, Marketable Securities, Trade receivables,
 Expanded Accounting Equation -
53 Problem 3
You are the accountant for a startup mobile app developer, Kids Learn Online (KLO). Here are the
business transactions from the current month:

1. Issues $20,000 of share equity in exchange for cash.

2. Purchases computer equipment on account (to be paid for later) for $3,500, payment due within the
month.
3. Receives $4,000 cash in advance from a customer for an app not yet developed (we will offer these
services at a later date).
4. Provides $5,500 in app development services to a customer on credit (the customer will pay the
business at a later date)
5. Pays a $300 electricity bill with cash.
6. Distributed $100 cash in dividends to shareholders.
We now analyse each of these transactions, paying attention to how they impact the accounting
equation and corresponding financial statements.
 Expanded Accounting
54 Equation - Problem 3
 Expanded Accounting Equation -
55 Problem 3
You are the accountant for a startup mobile app developer, Kids Learn Online (KLO). Here are the
business transactions from the current month:

1. Issues $20,000 of share equity in exchange for cash.

2. Purchases computer equipment on account (to be paid for later) for $3,500, payment due within the
month.
3. Receives $4,000 cash in advance from a customer for an app not yet developed (we will offer these
services at a later date).
4. Provides $5,500 in app development services to a customer on credit (the customer will pay the
business at a later date)
5. Pays a $300 electricity bill with cash.
6. Distributed $100 cash in dividends to shareholders.
We now analyse each of these transactions, paying attention to how they impact the accounting
equation and corresponding financial statements.
56 Chapter 2 : Assignment

▹ Quick Question: Assets , Liabilities,

Revenues and expenses
▹ Manufacturing, Merchandising and
Services

▹ Problems: 2.5 , 2.7 , 2.9 , 2.11

57

End of Chapter 2
58
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