Accounting Equation & Elements of Financial Position

Learning Focus

• Understand the three major accounts: Assets, Liabilities, Owner’s Equity (OE)
• Apply the basic accounting equation: (Assets = Liabilities + Owner\'s\ Equity)

Basic Accounting Equation

• Statement of Financial Position must always balance
• Any change to one side must be matched on the other side

Elements of the Equation

Assets

• Resources owned/controlled with measurable monetary value
• Used to settle debts

Liabilities

• Present economic obligations to outsiders
• Require future transfer of assets or services

Owner’s Equity

• Residual claim of owner after liabilities
• Increases: investments, profits
• Decreases: losses, withdrawals

Asset Classification

Current Assets

• Expected to be converted to cash or consumed within 1 year / operating cycle
• Typical items: cash, trading securities, notes & accounts receivable, inventories, prepaid expenses

Non-current Assets (PPE)

• Tangible, used >1 period, not for resale
• Must have physical existence, be used in operations, depreciate (except land)
• Examples: land, building, equipment, furniture & fixtures

Liability Classification

Current Liabilities

• Due within 1 year / operating cycle
• Examples: accounts payable, taxes payable, accrued expenses, unearned income

Non-current (Long-term) Liabilities

• Due after 1 year
• Examples: long-term notes, mortgage payable, bonds payable, instalment contracts

Owner’s Equity Details

• Capital: owner’s investment balance at reporting date
• Withdrawals (Drawings): owner takes assets from business
  • Permanent: directly reduce capital
  • Temporary: recorded in drawing account; closed against capital later