Principles Of Accounting

Lecture 2
Accounting Equation
Two basic elements of a business are what it owns and what it owes.
Assets are the resources a business owns. For example , Meachine ,
furniture , equipment etc are general asset of a shop. Liabilities and
owner’s equity are the rights or claims against these resources. Claims
of those whom the company owes money (creditors) are called
liabilities. Claims owners are called owner’s equity. We can express the
relationship of aassets, liabilities and owner’s equity as an equation.
The eqution is given below:Assets

Assets= Liabilities + Owner’s quity

 Accounting Equation
The equation which was shown in the previous page is called Basic
Accounting Equation. According to it assets must equal the sum of
liabilities and owner’s equity. Liabilities appear before owner’s equity in
the basic accountnting eqution because they are paid frist if a business
is liquidated.
The accounting eqution applies to all economic entities regardless of
size, nature of business , or form of business organization. It applies to
a small proprietorship such as a corner grocery store as well as to a
giant company such as Pepsico.
 Expanded Accounting Equation

Assets= Liabilities + Owner’s Equity ( Owner’s Capital + Revenues - Expenses –

Owner’s Drawing)

In the accounting equation the owner’s equity is expanded by the entities those
which increase or decrease it. The entities those increase the owner’s equity
those are Owner’s Capital and Revenue of the business. On the other hand those
entities which decrease the owner’s equity they are Owner’s Drawing and
Expenses of the business. Let’s look in more details at the categories in the
expanded accountnting eqution.
Assets
As noted above, assets are resources a business owns. The business
uses its assets in carrying out such activities as production and sales.
The common characteristics possessed by all assets is the capacity to
provide future services or benefits. In a business , that service potential
or future economic benefit eventually in cash flows ( receipts). For
example , consider Campus Pizza , a local restaurant. It owns a delivery
truck that provides economic benefits from delivering pizzas. Other
assets of Campus Pizza are tables, chairs , jukebox, cash register, oven ,
tableware, and of course , cash.
Liabilities
Liabilities are Claims against assets – that is , existing debts and obligations.
Businesses of all sizes usually borrow money and purchase merchandise on
credit. These economic activities result in payables of various sorts:
• Campus Pizza, for instance, purchase cheese, sausage, flour, and beverages
on credit from suppliers. These obligations are called account payable.
• Campus Pizza has a note payable to Frist National Bank for the money
borrowed to purchase the delivery truck.
• Campus Pizza may also have salaries and wages payable to employees and
sales and real estate taxes payable to the local government.
All these persons or entities to whom Campus Pizza owes money are it’s
creditors. They may legally force the liquidation of a business that doesn’t
pay its debts. In that case, the law requires that creditor claims be paid
before ownership claims.
Owner’s Equity
The ownership claim on total assets is owner’s equity. It is equal to
total assets minus total liabilities. Here is why: The Assets of a business
are claimed by either creditors or owners. To find out what belongs to
owner’s, we subtract the creditors’ claims ( the liabilities) from assets.
The remainder is the owner’s claim on the assets - the owner’s equity.
Since the claims of creditors must be paid before ownership claims /
owner’s equity is often referred to as residual equity.
Investment By Owner
Investments by owner are the assets the owner puts into the
business.These investments increase owner’s equity. They are
recorded in a category called owner’s capital.

Revenues
Revenues are the gross increase in owner’s equity resulting from business
activities entered into for the purpose of earning income. Generally,
revenues results from selling merchandise, performing services, renting
property and lending money. Common sources of revenue are sales, fees,
services, commissions , interests, dividends, royalties and rent.
Revenues usually results in an increase in an asset. They may arise from
different sources and are called various names depending on the nature
of the business. Campus Pizza, for instance, has two categories of sale’s
renevoues- Pizza sales and beverage sales.
Drawings
An owner may withdraw cash or assets for personal use. We use a separate
classification called drawings to determine the total withdrawals for each
accountnting period. Drawings decrease owner’s equity. They are recorded
in a category called owner’s drawings.
Expenses
Expenses are the cost of assets consumed or services used in the process of
earning revenue. They are decrease in owner’s equity that results from
operating the business. For example, Campus Pizza recognises the following
expenses: cost of ingredients (meat, flour, cheese, tomato paste, mushrooms
etc.) ; cost of beverages; salaries and wages expenses; utilities expense
(electric, gas, and water expense); delivery expense (gasoline, repairs,
licenses, etc.); Supplies expense ( napkins, detergents, aprons, etc.); rent
expense; interest expense and property tax expense.
Transaction Analysis
Ray Neal starst a smartphone app development company which he names Softbyte. On September
1, 2017, he invests $15,000 cash in the business.
September 2, 2017: Softbyte purchases computer equipment for $7,000 cash.
September 5, 2017: Softbyte purchases for $1,600 from Mobile Solutions headsets and other
computer accessories expected to last several months. Mobile Solutions agrees to allow Softbyte to
pay the bill in October
September 8, 2017: Softbyte receives $1,200 cash from customers for app development services it has
performed.
September 9, 2017: Softbyte receives a bill for $250 from the Daily News for advertising on its online
website but postpones payment until a later date.
1. September 10, 2017: Softbyte performs $3,500 of app development services for the customers. The
company receives cash of $1,500 from customers, and it bills the balance on account.
2. September 11, 2017: Softbyte pays the following expenses in cash for September: Office rent
$600 , Salaries and wages of employees $900, and utilities $200.
3. September 15, 2017: Softbyte pays its Daily News bill in cash.
4. September 20, 2017: Softbyte receives $600 in cash from customer who had been billed for
services.
5. September 30, 2017: Ray Neal withdraws $1,300 in cash from the business for his personal use.
 TRANSACTION 10. WITHDRAWAL OF CASH BY OWNER Ray Neal
withdraws $1,300 in cash in cash from the business for his personal use.
Illustration 1-8
Assets = Liabilities + Owner's Equity
Trans- Accounts Accounts Owner's Owner's
Cash + + Supplies + Equipment = + + + Rev. - Exp.
action Receivable Payable Capital Drawings

1. +15,000 +15,000
2. -7,000 +7,000
3. +1,600 +1,600
4. +1,200 +1,200
5. +250 -250
6. +1,500 +2,000 +3,500
7. -1,700 -600
-900
-200
8. -250 -250
9. +600 -600
10. -1,300 -1,300
$8,050 + $1,400 + $1,600 + $7,000 = $1,600 + $15,000 + $1,300 - $4,700 - $1,950

$18,050 $18,050 LO 4