Accounting: the equation, double entry and financial statements
What the Accounting domain tests
The Accounting domain tests the accounting equation, double-entry processing, the trial balance and the financial statements of a sole trader. It checks whether you can classify transactions and explain the accounting concepts behind them.
Core rules
- Accounting equation: Assets = Liabilities + Owner's equity. Equity rises with capital contribution and profit; it falls with drawings and loss.
- Double entry: Each transaction has two effects; total debits equal total credits. Assets and expenses normally have debit balances; liabilities, equity and income normally have credit balances.
- Trial balance: Proves debits equal credits, not that entries are correct. It misses errors of omission, wrong account, reversal and compensating errors.
- Income statement: Revenue minus expenses equals profit for a period, prepared on the accrual basis: record revenue when earned and expenses when incurred, not when cash moves.
- Balance sheet: Assets, liabilities and equity at a point in time; classify current and non-current.
- Depreciation: Allocates an asset's cost over its useful life; it is a non-cash expense.
Worked example
Owner contributes $10,000 cash; business buys equipment for $4,000 cash and takes a $5,000 bank loan. Assets: cash $11,000 plus equipment $4,000 equals $15,000. Liabilities $5,000; equity $10,000. Equation: 15,000 = 5,000 + 10,000. Later, cash sales $3,000 and cash expenses $1,200 give profit $1,800. Cash becomes $12,800, equity $11,800; assets $16,800 = liabilities $5,000 + equity $11,800. The equation still balances.
Traps
Drawings are not an expense; they reduce equity. GST collected is not revenue. A balanced trial balance does not prove accuracy. Depreciation does not put cash aside for replacement. Accrual profit is not the same as cash in the bank.