Accounting Practice

THE ACCOUNT

The account is the basic unit used in accounting to summarise business transactions. Accounts are classified as follows:

Øassets

Øliabilities

Øowner’s equity

Assets are economic resources owned or controlled by an entity as a result of past transactions, which are expected to be of benefit in the future. Exemples of assets are:

- cash (refers to coin, currency, cheques etc.)

- accounts receivable. When a business sells goods or services on credit, the

Accounts Receivable account records these transactions.

- land

- office equipment

- office furniture.

A separate account is kept for each type of asset.

Liabilities represents economic entity’s future obligation as a result of past transactions.

Examples of liabilities are:

- accounts payable. When a business purchases goods or services on credit,

the Accounts Payable accuont records these transactions. It is the opposite

of the Accounts Receivable account.

- mortgage

A separate account is kept for each type of liability.

Owner’s Equity is the owner’s claim on the assets of the business. Owner’s equity is increased with revenue and decreased by expenses or an owner’s withdrawal.

ACCOUNTING EQUATION

The relationship between the three basic accounting elements – assets, liabilities and owner’s equity – is expressed in the accounting equation, shown as follows:

Assets = Equities

Creditors Owner

Assets = Liabilities + Owner’s Equity

The equation shows assets are equal to equities. Equities are divided into liabilities and owner’s equity. When the amounts of any two of these elements (assets, liabilities or owner’s equity) are known, the third can be calculated, as follows:

Assets = Liabilities + Owners Equity

or

Owner’s Equity = Assets - Liabilities

or

Liabilities = Assets – Owner’s Equity

TRANSACTIONS AND THE ACCOUNTING EQUATION

In accountig terms, a transaction is defined as an event which affects the financial position of a business. It involves the exchange of money for money’s worth of goods or services between two parties. Buying and selling goods and receiving or paying money are transactions. There are two main types of transaction:

- cash – where money is received in exchange for goods or services

- credit – where goods or services are supplied or received on

agreement that payment will be made at a later date.

The transaction is the basic operating unit of the business. Cash is

used to purchase goods, these goods are then sold, and the cash received for them is used to purchase more goods which, in turn, are sold. This cycle of cash à goods à cash is called the operating cycle. Below is a simple illustration of the operating cycle for both cash and credit transactions.