Lesson Two　Accounting Elements and Accounting Equation

Learning Objectives：

1.Define the accounting elements.

2.Use the accounting equation to analyze business transactions.

Text

Accounting objects are classified into the categories of assets，liabilities，owners’equity，revenues，expenses，and net earnings（or net loss）.These six categories are referred to as accounting elements.A good understanding of the accounting elements will be a good start in learning accounting.

Assets

Assets are the economic resources that are measurable by monetary value，owned or controlled by an enterprise，and expected to benefit future operations.Cash，receivables，properties and equipment are examples of assets.Assets can be classified into current assets and non-current assets.

Current assets are those that are expected to be converted to cash，sold，or consumed within one year or one business’normal operating cycle if longer than a year.Examples of current assets include cash，marketable securities，receivable，prepayments and inventory.

In contrast to current assets，non-current assets refer to those assets that will be realized or consumed after one year or one operating cycle（if longer）.Examples of this type of asset include land，buildings，intangible assets and deferred assets.

Liabilities

Liabilities refer to obligations that legally bind an individual or company to settle a debt.They represent creditors’claim or equity in a business.When a business is liable for a debt，it is responsible for paying the debt，which will result in outflow of economic resources.Liabilities fall into current liabilities and long-term liabilities.

Currents liabilities are the debts that are due within one year or the normal operating cycle，whichever is longer.Examples of current liabilities include accounts payable，notes payable，accrued expenses，taxes payable，and so on.Long-term liabilities are the debts whose maturity period is longer than one year.Examples of long-term liabilities include bonds payable，long-term notes payable，permanent customer deposit，mortgages payable，certain types of lease obligations，deferred income taxes，etc.

If a business cannot pay its liabilities when they are due，the creditors may legally force the liquidation of the business.In that case，the law requires that creditor claims be paid before ownership claims.

Owner’s Equity

Owner’s equity is defined as the excess of total assets over total liabilities.It is a residual amount that represents the book value of the owners’interest in the business.Owner’s equity includes owners’investment in a business and accumulated operating results since the beginning of its operation.Capital，proprietorship，net assets（net worth）and shareholders’equity are the other terms for owner’s equity.

Revenue

Revenues are increases in economic benefits during the accounting period from delivering goods or services to customers.Examples of Revenue include sales revenue，service revenue，rent revenue and interest revenue.Increase in revenues will increase owner’s equity.

Expenses

Expenses are the costs of assets consumed or services used in the process of earning revenue.They are decreases in owner’s equity that result from operating activities.Examples of expense include cost of goods sold，administrative expenses，selling expenses，and financial expenses.

Net Earnings（or Net Loss）

Net earnings（or Net loss）are the result of matching revenues with expenses.When revenues exceed expenses，net income occurs.Conversely，a net loss occurs when expenses exceed revenues.

Basic Accounting Equation

As explained above，assets are basically the economic resources owned by a business，liabilities and owner’s equity are the rights or claims against these economic resources.The basic rule for a business is that what it owns should equal what it owes，which can be expressed as：

Assets=Claims

Thus，the relationship of assets，liabilities and owner’s equity can be expressed as an equation shown below：

This equation is known as the basic accounting equation.In this equation，revenues and expenses are shown as subdivisions of owner’s equity，because revenues result in increase of owner’s equity，and expenses are decreases of owner’s equity，as stated above.

The Effects of Business Transactions on the Accounting Elements

To illustrate the effects of business transactions on the accounting elements，let’s look at the first seven transactions completed by G.Hopes Software Company（abbreviated G.Hopes）during July，2012，the first month of its operation.After each transaction，changes of the specific items of each accounting element affected are shown under the basic accounting equation.

Transaction（1）：July 1，G.Louise invested$12，000 cash in business.This transaction results in$12，000 increase of an asset cash，and an equal increase of G.Louise，Capital，an owner’s equity item.As Exhibit 2—1 shows：

Transaction（2）：July 1，purchased computer equipment for$5，000 cash.The effects of this transaction are shown below，following transaction（1）.As Exhibit 2—2 shows：

Transaction（3）：July 2，$720 is paid for a one-year insurance policy that will expire next year on June 30.One asset cash is decreased，another asset，prepaid insurance，is increased by$720.As Exhibit 2—3 shows：

Transaction（4）：July 4，paid office rent for July in cash$1，200.Cash is decreased，an expense item—Rent Expense is increased，which results in decrease of G.Louise，Capital by$1，200.As Exhibit 2—4 shows：

Transaction（5）：July 5，a$1，800 cash advance is received from S.Paul，a client，for software development project expected to be completed by August 31.Cash is increased，a liability item，Unearned Revenue is increased by$1，800.As Exhibit 2—5 shows：

Transaction（6）：July 6，an estimated three-month’s office supply is purchased on account from Bullin Supply for$180.Office Supply，an asset item is increased，and Accounts Payable，a liability item is equally increased.As Exhibit 2—6 shows：

Transaction（7）：July 7，G.Louise withdraws$600 cash for personal use.This transaction results in a decrease in asset cash and an equal decrease in owner’s equity item G.Louise，Capital.As Exhibit 2—7 shows：

From the above analysis，it should be noted that assets must equal the sum of liabilities and owner’s equity after each transaction.In other words，each business transaction produces at least two effects on the accounting equation which always keeps balance after all the transactions.In addition，each business is assumed as a separate unit from its owners，the accounting equation includes only business assets and equities.

New Words and Terms

■asset资产■

■defer延期，递延■

■accounts payable应付账款■

■accrued应计的■

■accounting equation会计恒等式■

■accounting elements会计要素■

■administrative expenses管理费用■

■current流动的，当期的■

■claims要求权■

■capital资本■

■expense费用■

■equity权益■

■financial expense财务费用■

■balance平衡■

■inventory存货■

■net earning净收益■

■obligation责任，义务■

■owner’s equity所有者权益■

■revenue收入■

■supplies物料用品■

■selling expenses销售费用■

■on account赊账■

Notes to the Text

Accounting elements会计要素，即财务报表要素，包括资产、负债、所有者权益、收入、费用和利润。六要素是根据国际会计准则委员会（International Accounting Standard Committee，IASC）的规定划分的。

Words and Terms Study

For each term listed in the left column，find the corresponding description in the right column and place the appropriate letter in the blank.

Review Exercises&Problems

A.Decide whether the following statements are true（T）or false（F）.

1.All assets are things owned by a business.（　　）

2.Accrued expenses are examples of current liabilities.（　　）

3.Revenues decrease owners’equity.（　　）

4.Whenever an expense is incurred，the owners’equity will be increased.（　　）

5.A business transaction produces only two effects on the accounting equation.（　　）

B.Questions.

1.Identify the accounting elements and explain their relationship by using the basic accounting equation.

2.Explain the difference between assets and liabilities.

3.Define and give three examples of expense.

4.Explain the dual effects of business transactions in accounting.

C.Translation.

In the accounting equation，assets must equal the sum of liabilities and owner’s equity.Because creditors are paid before ownership claims if a business is liquidated，liabilities are shown before owner’s equity in the basic accounting equation.The accounting equation applies to all economic entities regardless of size，nature of business，or form of business organization.It applies to a small proprietorship such as a corner grocery store as much as it does to a large corporation.The equation provides the underlying framework for recording and summarizing the economic events of a business enterprise.