Accounting Equation and Debits & Credits: Accounting Basic Foundations
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- Опубликовано: 10 сен 2024
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Accounting Equation and Debits & Credits: Accounting Basic Foundations.
Time Markers:
The Accounting Equation 0:44
Double-Entry Accounting 2:06
What the Accounting Equation Measures 3:56
Assets 5:03
Liabilities 6:50
Equity 8:02
Debits and Credits 12:55
A Few Example Transactions 19:56
THE ACCOUNTING EQUATION
The Equation: A = L + E.
Accounting is about Measurement.
Assets = Liabilities + Equity.
The Equation MUST always balance ...and this is linked to double-entry accounting.
DOUBLE-ENTRY ACCOUNTING
It’s history dates back to the 15th century.
Accounting is about measurement …and double-entry accounting is a system to record/measure transactions.
Every transaction will impact the accounting equation at least TWICE (hence the term ‘double-entry’).
Plus the accounting equation must always remained balanced.
They impact the accounting equation (Asset = Liabilities + Equity) via Debits (Dr.) and Credits (Cr.) ...and we will look at this specifically later.
WHAT THE EQUATION MEASURES
Accounting is about Measurement (Asset = Liabilities + Equity)
The Equation Measures: Resources controlled by the entity & Claims on those resources.
The left hand side (Assets) are the resources.
The right hand side (Liabilities & Equity) are the claims on the resources.
Liabilities are External claims Equity are Internal claims.
ASSETS: THE LEFT HAND SIDE
Resources:
1) Controlled
2) Past Event
3) Value Reliably Measured
4) Lead to an Inflow of Economic Resources
…Simply: Things the entity ‘owns’.
They are often the income generating side of the business.
Examples: Cash, Accounts Receivable, Building
LIABILITIES: THE RIGHT HAND SIDE
Obligations:
1) Past Event
2) Value Reliably Measured
3) Lead to an Outflow of Economic Resources
…Simply: Things the entity ‘owes’.
They external claims on the assets, i.e. obligations to outsiders (creditors) paid from assets.
Examples: Accounts Payable, Bank Loan
EQUITY: THE RIGHT HAND SIDE
What’s left over for the owners.
Residual interest in Assets once all Liabilities paid off.
Rearranging the Accounting Equation: Assets - Liabilities = Equity
Internal/insider claims on the assets.
The complexity of equity accounts is often dependent on entity size.
Examples: Owners Equity/Share Capital, Retained Earnings, Reserves
Note: Revenue & Expenses are Equity Accounts.
Revenue is a Credit to Equity Expenses are Debits to Equity.
A BIT OF ACCOUNTING LOGIC...
All assets are funded via liabilities or equity (hence their respective claims).
Assets then generate income which itself boosts assets levels.
These higher level of assets are then returned to the claimants.
DEBITS & CREDITS
Remembering that A = L + E must always balance…
And remembering that we use double-entry accounting to record all transaction... and these transactions impact the equation…
How then do we record transactions within the accounting equation?
The answer:
Debits (Dr.) & Credits (Cr.)
DEBITS & CREDITS EVERY transaction:
Broken down & categorised into a set of Debits & Credits.
And the debits value must ALWAYS equal the credits value.
DEBITS
A debit (or Dr.) represents:
An INCREASE in Assets or
A DECREASE in Liabilities or Equity
Note: There is an opposite effect either side of the equation
CREDITS
A credit (or Cr.) represents:
A DECREASE in Assets or
An INCREASE in Liabilities or Equity
Note: There is an opposite effect either side of the equation Note: The impact is the reflection/opposite of a debit
THUS
When in business and a transaction occurs:
Look underneath and try and find the (at least) 2 impacts on the accounting equation.
Does an asset change? Does a liability change? Does equity change?
THEN: Record the entry as follows
Debits are recorded first (write ‘Dr.’ then the account and finally the financial value).
Credits are recorded at the bottom (with same formatting but the credit line(s) are Tab indented).
Dr. ‘account’ $xxx
Cr. ‘account’ $xxx
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Why aren't the 80 dollars paid in cash counted towards the final equation? Wouldn't it be as asset, as they are adding to the business with the 80 dollars worth of property? If not, where does the 80 dollars go? I understand the 60 dollar liability pretty easily, however. Great video!!!
Hi Calvron, sorry it's taken me a week to reply. I just reviewed the video and I said at the start of the Example something like, "if I have done this tutorial well, you should be able to work this 'tricky' one out"....so I guess I'm not as good a tutor as my best friend tells me I am, lol! ...Okay, so here we go (and reply back if this message doesn't explain it properly): The $80 ARE in the equation, but where you're confused is that the $80 is being taken OUT of the business, and not put into it. Remember in the example that the book retailer pays for the kiosk with $80 in cash and $60 on credit? In other words, the book retailer is taking $80 out of his/her pocket and handing it over to the kiosk salesperson. Now, here's a question for you: If $80 (an asset) is being removed from a business is this a Debit (increase in Assets) or Credit (decrease in Assets)? That's right, it would be a $80 Credit ...and hence that part of the mixed journal entry (next to the $60 liability you know). But you asked where the $80 went: so in some respects, it's gone (a credit to assets), but in another respect the $80 (with the $60 liability) has been transformed into a $140 property asset (the kiosk)! That transformation is the some of the magic of the accounting equation ...you can classify any transaction on the planet as a single (or multiple type of) asset, liability or chunk of equity! As for the arithmetic of the equation in the Example: Assets start at $150, then you add $140 for the kiosk (= $290) and finally you subtract the $80 cash, the Credit, to equal $210 (the final figure of assets in the Example). Does this all make sense now? Or have I made it worse with my long windedness!? Let me know, I more than happy to try explaining it further or clarify anything else. Cheers mate, best of success!
I had the same question, but your answer cleared it up. I completely missed deducting the $80! Quite the accounting error ;) haha
I'm very glad that a that a reply from a year ago was still helpful when you needed it, Aaron. Feel free to get back in contact in future if you need any of your own questions answered directly, as of the past week or so I'm trying harder to keep up to date with all comments & reply. Best wishes.
@@accofina thanks a lot !!! i admire your work.
I was enjoying the video right up to the point where you did the examples, then the headaches started.
Thank you for your time Axle. I am studying to be a medical assistant. Now it is crunch time. So I am just refreshing on this class I has since last year. Thank you for your time again.
I see some people put the balance sheet in different formats as below:
Format 1
Fixed Assets
Current Assets
Current Liabilities
Net Current Liabilities
Long Term Liabilities
Net Liabilities
Shareholder Equity
Format 2
Current Assets
Fixed Assets
Total Assets
Current Liabilities
Long Term Liabilities
Shareholder Equity
Total Liabilities & Shareholder Equity
Which one is correct? Which one is better?
Gigi Gi Hi Gigi, I've actually never come across 'Format 1' and find it rather odd ...but maybe I'm wrong.
If it were up to me, alone, I would always use 'Format 2': assets should be ordered via liquidity and I've never used 'net current liabilities' (I don't even know what you would be netting).
In conclusion, while I stand to be corrected, I say go with Format 2 :-)
Cheers,
Axel
First comment posted! Please reply, comment or otherwise get in touch if I can be of any help or clarify anything...
Thanks for watching! If you enjoy the video please Subscribe at ruclips.net/user/accofina or visit accofina.com direct.
Cheers,
Axel
Re: Deferred Tax Liability Question
I/
In Accounting Book
Net Profit 100
Taxation Rate 16.5%
Taxation in accounting book: 16.5
Dr Taxation 16.5
Cr Tax payable 16.5
2/
In Taxation Book
Net Profit 50
Taxation Rate 16.5%
Taxation in taxation book: 8.25
-- Occur deferred tax liability: 8.25
3/
Should we do the below entry?
Dr Tax payable 8.25
Cr Deferred tax liability 8.25
Is that entry correct for deferred tax liability?
Gigi Gi Hi Gigi,
I would set it out differently but what you have done looks correct.
Personally, I would have ended up with (after earlier processes):
Dr Tax Expense 16.5
Cr Tax Payable 8.25
Cr Deferred Tax Liability 8.25
This is essentially what you have done too :-)
Cheers,
Axel