Accounting Classification & Accounting Equation

Accounting Classification

  • Business transactions involve five categories of accounts:
    • Asset accounts
    • Liability accounts
    • Capital or owner’s equity accounts
    • Revenue accounts
    • Expense accounts

Asset Accounts

  • Definition: Things or property owned by a business, presented in the statement of financial position.
  • Divided into non-current assets and current assets.
    • Non-current assets: Bought not for resale but for business operation with useful lives of more than one year.
      • Tangible (e.g., land, building, machinery, office equipment, motor vehicles).
      • Intangible (e.g., franchise, patent, trademark, goodwill).
      • Investment (e.g., fixed deposit with > 1 year maturity period).
    • Current Assets: Cash or items that can be converted into cash within one year.
      • E.g.: inventory/stock, Accounts receivable/debtors, cash at bank, cash in hand

Liabilities

  • Definition: Funds supplied by external parties to the business; a financial obligation to external parties.

  • Presented in the statement of financial position.

  • Two types: non-current and current liabilities.

    • Non-current liabilities: Amounts owed by the business repaid over more than one year (e.g., bank loan, long-term loan, mortgages, debentures).
    • Current liabilities: Amounts owed by the business to be paid within one year (e.g., bank overdraft, short-term loan, accounts payables/creditors).

  • Account receivable = Debtor

    • Asset; money you receive from selling goods and services.

  • Account Payable = Creditor

    • Liabilities; money owed to vendors and suppliers that results in cash outflow.

Owner’s Equity

  • Definition: The financial obligation of a business to the owner and the ownership claim on total assets.

  • Consists of capital, revenue, expenses, and drawings.

  • Increases with new capital and profits; decreases with losses and drawings.

  • CAPITAL: What the owner puts into the business.

  • DRAWINGS: What the owner takes out of the business for personal use.

  • Revenue: What the business earns.

  • Expenses: What the business pays.

Components:

  • Capital: Money invested by the owner; increases with more investment.
  • Drawings: Withdrawals of cash or assets by the owner for personal use; reduces owner's equity.
  • Revenues: Monetary value of goods/services supplied to customers; increases owner’s equity.
    • Operating Revenues: Eearned directly from the principal activity of a business.
    • Non-Operating Revenues: Earned indirectly or unrelated to the principal activity of a business.
  • Expenses: Cost of assets/services used in generating revenues; decreases owner’s equity.
    • Operating Expenses: Directly involved in day-to-day operations.
    • Non-Operating Expenses: Not directly involved in day-to-day transactions.

Accounting Equation

  • Basic Accounting Equation: ASSETS = OWNER’S_EQUITY + LIABILITIES
    • Resources owned by a business.
    • Assets are contributed by the owner (capital) and supplied by external parties (liabilities).
  • Every business transaction has double effects on the accounting equation.
  • Equality of the accounting equation is always maintained.
  • Expanded Accounting Equation: ASSETS = OWNER’S_EQUITY + LIABILITIES + CAPITAL + REVENUE – EXPENSES – DRAWINGS
  • Alternate form: ASSETS + EXPENSES = OWNER’S_EQUITY + REVENUE+ LIABILITIES