The Accounting Equation | O Level Accounting 7707 & IGCSE Accounting 0452 | Detailed Free Notes To Score An A Star (A*)

Basic Accounting Equation

• Let’s start with the basic accounting equation
  • Assets = Liabilities + Owner’s Equity
  • Assets
    • Owned or possessed by the business
    • Used in generating revenue
  • Liabilities
    • Owed by the business to others
  • Owner’s Equity
    • The owner’s part in the business.
• Assets
  • Current Assets
    • Assets that will be used up or converted to cash within or up to one year.
      • Cash
      • Bank
        • Business cash held at the business bank account
      • Accounts Receivable
        • When sales are made on credit, people owe money to your business.
        • It ONLY generates from the sales of inventory (the primary stuff that a business sells to make money) on credit.
        • Accounts receivable are usually verbal
        • Notes receivable are written
        • Both are together called trade receivables.
      • Prepaid Expenses
        • Expenses that you have paid for but have not consumed the benefit of.
        • For example, you pay 1100 for electricity expense, when the expense this month was 700. The extra 400 is for the expense you still have to incur but have already paid for.
      • Inventory
        • The stock of the primary items that a business purchases or produces to sale ahead and generate revenue.
        • It does NOT include anything that a business owns which is not primary for selling ahead for revenue.
  • Non-Current Assets
    • Assets that provide benefit for more than one year.
    • Usually include plant, machinery, equipment, vehicles etc.
    • They are prone to depreciation
      • Gradual decrease in the value of non-current assets over time due to wear and tear, use and obsolescence.
    • These asset are not primary for sale to generate revenue
    • They may be sold if redundant but it will not be called SALES according to accounting terms.
• Liability
  • Current liabilities
    • Liabilities that are paid up within up to one year.
    • Usually include bank overdraft
    • Accrued expenses
      • Expenses that you have already consumed the benefit of, but have not paid for them
      • For example, an overdue electricity bill of 1000.
    • Accounts Payable
      • When business purchases products to sell ahead to generate revenue, but have not paid for them.
      • Accounts payable are verbal
    • Notes payable
      • Same concept, just written
    • Both accounts and notes payable are together called trade payables
      • ONLY on purchase of goods for sale ahead ON credit.
      • Not on any other asset.
  • Non-Current Liability
    • Liabilities that must be paid in more than one year
    • For example, long-term bank loan, mortgages, etc.
    • Usually, there is an interest expense involved on these loans that must be paid yearly (Commonly missed transaction by many students un the exam paper)
• Owner’s Equity
  • The owner’s contribution in the business
  • It includes the capital money that a owner has put in the business
  • It includes retained profits, that are profits after everything has been paid that are still available in the business
  • At corporate level, it includes share premium and general provision
  • It also includes the current account of partnerships as well.

Concept Behind Accounting Equation

• Assets are the resources of the business
• Naturally, the business should have generated these resources from some money sources
• Those sources are owner’s equity and liabilities
• Therefore Assets = Liabilities + Owner’s Equity
• In other words
  • Current Assets + Non-Current Assets = Current Liabilities + Long-Term Liabilities and Owner’s Equity
• Long-Term Liabilities + Owner’s Equity is also collectively called capital employed.