ACC103A

FINANCIAL ACCOUNTING I

Week 2 – The Accounting Equation

The elements of financial statements
(Assets, Liabilities, Equity, Income, Expenses)
Learning Objectives

1. Describe the key elements of financial statements

2. Identify how these key elements ‘fit together’
3. The Accounting equation defined
4. Identify and describe the key financial statements –
• Statement of Financial Position (Balance sheet)
• Statement of Financial Performance (Profit & Loss Statement/ Income Statement)
• Statement of Cash Flows
5. Identify the information that these statements provide and how we would use it
Recap - The Conceptual Framework
To provide General purpose Fundamental Cost constraint

Constraint and Assumptions

Qualitative Characteristics
Objective

Financial information
financial financial reports - Relevance Accrual Accounting
information that is which provide - Faithful Going Concern
useful to existing information on the
and potential entity’s economic representation
inventors, lenders resources, claims Enhancing
and other and changes in - Comparability
creditors in resources and - Verifiability
making decisions claims
- Timeliness
about providing
resources to the - Understandability
entity

Elements Assets Liabilities Equity Income Expenses

KEY ELEMENTS OF FINANCIAL STATEMENTS

Owners’
Assets Liabilities Income Expenses
Equity

4
WHAT IS AN ASSET?

• Present economic resources

controlled by the entity
• result of past events
• Economic resource is a right
that has the potential to
produce economic benefits
Assets

Examples – cash, inventory,

plant and equipment, motor
vehicles

5
WHAT IS A LIABILITY?

• present obligations of an entity

• arising from past transactions
or events
• settlement is expected to result
in an outflow of resources from
the entity.
Liabilities
Examples – bank loan,
amounts due to suppliers
(accounts payable), amounts
due to employees
6
WHAT IS OWNERS’ EQUITY?

The residual interest of the

owner/s in the assets (less
liabilities) of the entity

Owners’
Equity
Examples – share capital, retained
earnings (= accumulated profits –
dividends paid to shareholders),
reserves

7
THE BALANCE SHEET

The statement of
financial
position(balance
sheet):
• Reports financial position of Alternative formats:
an entity at a specific point in
time. • account format
• Shows assets, liabilities and • narrative format.
equity of the entity.
• Represents the accounting
equation:
• Assets = Liabilities +
Equity

8
EXAMPLE: BLACKMORES LIMITED (page 80) 9
STATEMENT OF FINANCIAL PERFORMANCE
(PROFIT AND LOSS STATEMENT)

Income Expenses

10
INCOME (OR REVENUE)
Income
• increases in economic benefits
• inflows or enhancements of assets
• decreases of liabilities
• results in equity
• separate to those relating to equity
participants.

Income
Examples – sales, fee income,
consultancy fees, interest income

11
EXPENSES
Expenses:
• decreases in economic benefits
• outflows or incurrences of liabilities
• result in decreases in equity
• separate to those relating to equity
participants.

Expenses
Examples – cost of sales, salaries and
wages, interest expense, rent,
marketing

12
EXAMPLE: BLACKMORES LIMITED (page 80) 13
CALCULATION OF PROFIT

I – E = PROFIT

Income - Expenses= Profit

14
LINKING THE PROFIT AND LOSS STATEMENT TO
THE BALANCE SHEET

15
Source: Harrison, W. (2017). Financial Accounting: International Financial Reporting: The Components of Retained Earnings. Pearson
THE STATEMENT OF 16

“Linking”
CHANGES IN EQUITY statement between the
Income Statement and the Balance Sheet

from
Income Statement
(Slide 20)

to
Balance Sheet
(Slide 11)
THE COMPLETE ACCOUNTING EQUATION

A – L = OE + I – E
Asset - Liability = Owner’s Income - Expense
Equity +

Balance Sheet Profit & Loss Statement

17
 Transaction Analysis
• Accounting Transactions can be analysed using the accounting
equation.
• Equity is affected by and therefore includes income & expenses
• Accounting equation must remain balanced.

ASSETS = LIABILITIES + EQUITY

 Accounting equation | Let’s
interpret…
Let’s look at a few examples…
 Accounting equation | Let’s
interpret…
Let’s look at a few examples…
Class exercise

On 1 July, Ross Touche set up a business as an accountant. The following

transactions occurred during the month of July:
◦ Jul 1: Contributed $50,000 to the accounting practice.
◦ Jul 3: Bought office furniture and equipment on credit from RDB Office Supplies
for $28,000.
◦ Jul 5: Bought computer equipment for $10,000 cash; paid $1,000 for first
month’s rent of premises.
◦ Jul 7: Hired a secretary and agreed to pay her $400 per week, paid fortnightly.
◦ Jul 8: Completed tax returns for clients, charged $500, which is paid in full
immediately.
◦ Jul 12: Paid for office furniture and equipment purchased on July 3.
◦ Jul 21: Paid secretary $800.
◦ Jul 25: Billed a client, Johnson Bros., $2,425 for services rendered.
◦ Jul 30: Paid utilities of $300.
◦ Jul 31: Withdrew $1,200 for personal use.

Required: Show the effects of the transactions for the month of July on the
accounting equation. Ignore the effects of GST.

1-21
 Assets   Liabilities Equity

Date Cash Accounts Office furniture & = Accounts R. Touche,

Receivable equipment Payable Capital

Jul 1 +$50,000         +$50,000

Jul 3     +$28,000    +$28,000   

Jul 5 -$10,000    +$10,000       

Jul 5  -$1,000         -$1,000(Rent

expense) 
Jul 8    +$500       +$500 (Tax
revenue) 
Jul 12  -$28,000     -$28,000   
 
Jul 21 -$800          -$800 (Salaries
expense) 
Jul 25   +$2,425        +$2,425 (Tax
revenue) 
Jul 30 -$300          -$300 (Utilities
expense) 
Jul 31  -$1,200       -$1,200
  (Drawings) 
Sources
References

Deegan, C. (2019), Australian Financial

Accounting, (9th ed.) McGraw Hill.
Basioudis, I. G. (2019). Financial
Accounting: The Basics. Routledge.
Harrison, W. (2017). Financial
accounting: International financial
reporting standards. (11th Global ed.).
Pearson.
Hoggett, J., Medlin, J., Chalmers, K.,
Beattie, C., Hellmann, A. and Maxfield,
J., (2018). Accounting (10th ed.). John
Wiley and Sons
Robinson, P., Bazley, M. & Hancock, P.
(2020), Contemporary accounting: a
strategic approach for users. (10th ed).
Cengage
 Thank you

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