Common Mistakes

Common Mistakes: Classification of Accounts and the Accounting Equation

This chapter is the foundation of the whole Principles of Accounting subject, yet students often misclassify accounts, fail to keep the accounting equation balanced, and mishandle drawings and Contra Entries. This guide lists the common mistakes and how to avoid each one.

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Classifying Revenue and Expenses: Operating vs Non-Operating

Mistake: Treating every inflow as operating revenue. Avoid it by asking whether the money comes from the main activity. Sales (goods business) or service fees (service business) are operating revenue; interest received, rent received and commission received are non-operating revenue because they are not the core activity.
Mistake: Classifying capital or a loan received as revenue. Avoid it by remembering that capital is owner's equity and a loan is a liability. Neither is earned income, so neither enters the Income Statement.
Mistake: Treating a non-operating expense as an operating expense. Avoid it by identifying core costs (purchases, wages, shop rent, rates) as operating expenses, while interest on a loan and loss on disposal of an asset are non-operating expenses.
Mistake: Using the same classification for goods and service businesses. Avoid it by realising an item can be classified differently by business type: rent received is non-operating revenue for a retail shop, but operating revenue for a business whose core activity is renting out property.

Classifying Assets and Liabilities (Current vs Non-Current)

Mistake: Classifying an asset only by its physical type. Avoid it by using the time factor: Current Assets are expected to be converted to cash or used up within one accounting period (inventory, debtors, cash), while Non-Current Assets are held for long-term use (buildings, vehicles, fittings).
Mistake: Assuming the same asset is always classified the same way. Avoid it by looking at the purpose of holding: a vehicle is a Non-Current Asset for a retail shop that uses it for deliveries, but is inventory (a Current Asset) for a car dealer because it is held for resale.
Mistake: Putting every business debt under Current Liabilities. Avoid it by checking the repayment period: creditors and bank overdraft are Current Liabilities (settled within one period), while a long-term bank loan and a mortgage are Non-Current Liabilities.
Mistake: Overlooking the portion of a long-term loan due this year. Avoid it by realising a Non-Current Liability can become a Current Liability as its repayment date nears: a loan instalment due within the current accounting period is classified as a Current Liability.

The Accounting Equation and the Effect of Transactions

Mistake: Writing the formula the wrong way round. Avoid it by memorising the basic form Assets = Liabilities + Owner's Equity, and the extended form Assets = Liabilities + Owner's Equity + (Revenue − Expenses); equity rises with revenue and falls with expenses.
Mistake: Changing only one side of the equation for a transaction. Avoid it by remembering every transaction must keep the balance: buying furniture for cash increases one asset and decreases another, so the total stays the same.
Mistake: Computing an unknown value without rearranging the formula correctly. Avoid it by substituting the given figures: if Assets are RM80,000 and Liabilities RM30,000, then Owner's Equity = 80,000 − 30,000 = RM50,000.
Mistake: Forgetting the effect of revenue and expenses on equity. Avoid it by adding revenue to equity and subtracting expenses from equity when showing the effect of transactions that involve income and spending.

Owner's Drawings of Goods and of Assets

Contra Entries and the Chart of Accounts

Mistake: Not understanding what a Contra Entry is. Avoid it by remembering a Contra Entry is one transaction affecting two accounts within the same books, where one account is debited and the other credited with no outside party involved.
Mistake: Confusing which accounts are involved in a Contra Entry. Avoid it by memorising the common examples: banking cash (Cash Account credited, Bank Account debited) and withdrawing cash from the bank for office use (the reverse).
Mistake: Not noticing the effect if a Contra Entry is omitted. Avoid it by understanding that if cash is banked but no Contra Entry is made, the Cash Account is overstated and the Bank Account understated, giving inaccurate balances.
Mistake: Treating the Chart of Accounts as just a list of names. Avoid it by understanding that the Chart of Accounts is a systematically coded list of accounts in accounting software, which standardises and speeds up the identification and classification of accounts when recording transactions.

Effect of Transactions on the Accounting Equation

Transaction	Assets (RM)	Liabilities (RM)	Owner's Equity (RM)
Owner starts the business with cash	50,000	0	50,000
Buy furniture for cash	0	0	0
Buy inventory on credit	5,000	5,000	0
Cash drawings by owner	-2,000	0	-2,000

Notice each transaction keeps the balance: Assets = Liabilities + Owner's Equity.

How do I know whether a revenue is operating or non-operating?

Ask whether the revenue comes from the main activity of the business. For a goods business, sales are operating revenue; for a service business, service fees are operating revenue. Interest received, commission received and rent received are usually non-operating revenue, unless renting things out is the core activity of that business.

Why do drawings reduce owner's equity instead of being recorded as an expense?

An expense is a cost incurred to run the business and earn revenue. Drawings, however, are assets or goods taken by the owner for personal use, so they reduce the owner's investment in the business. Drawings are therefore deducted from owner's equity, not put into the Income Statement.

What is the real effect if a Contra Entry is forgotten?

The balances of the two accounts involved will be misstated. For example, if cash is banked but no Contra Entry is made, the Cash Account will be overstated and the Bank Account understated. The Statement of Financial Position then will not reflect the true cash and bank positions.

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