Accounting Equation

The source document is the origin of a transaction and it initiates the accounting process, whose starting point is the accounting equation. Accounting equation is based on dual aspect concept (Debit and Credit). It emphasizes on the fact that every transaction has a two sided effect i.e., on the assets and claims on assets. Always the total claims (those of outsiders and of the proprietors) will be equal to the total assets of the business concern. The claims are also known as equities, are of two types: i.) Owners equity (Capital); ii.) Outsiders’ equity (Liabilities). Assets = Equities Assets = Capital + Liabilities (A = C+L) Capital = Assets – Liabilities (C = A–L) Liabilities = Assets – Capital (L = A–C) 4.2.1 effect of Transactions on Accounting equation : Illustration 1 If the capital of a business is Rs.3,00,000 and other liabilities are Rs.2,00,000, calculate the total assets of the business. Solution Assets = Capital + Liabilities Capital + Liabilities = Assets Rs. 3,00,000 + Rs.2,00,000 = Rs.5,00,000 Illustration 2 If the total assets of a business are Rs.3,60,000 and capital is Rs.2,00,000, calculate liabilities. Solution Assets = Capital + Liabilities Liabilities = Assets – Capital Assets – Capital = Liabilities Rs. 3,60,000 – Rs. 2,00,000 = Rs. 1,60,000
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Illustration 3 If the total assets of a business are Rs.4,50,000 and outside liabilities are Rs.2,50,000, calculate the capital. Solution: Capital = Assets – Liabilities Assets – Liabilities = Capital Rs. 4,50,000 – Rs. 2,50,000 = Rs.2,00,000 Illustration - 4 Transaction 1: Murugan started business with Rs.50,000 as capital. The business unit has received assets totalling Rs.50,000 in the form of cash and the claims against the firm are also Rs.50,000 in the form of capital. The transaction can be expressed in the form of an accounting equation as follows: Assets = Capital + Liabilities Cash = Capital + Liabilities Rs. 50,000 = Rs. 50,000 + 0 Transaction 2: Murugan purchased furniture for cash Rs.5,000. The cash is reduced by Rs,5,000 but a new asset (furniture) of the same amount has been acquired. This transaction decreases one asset (cash) and at the same time increases the other asset (furniture) with the same amount, leaving the total of the assets of the business unchanged. The accounting equation now is as follows: Assets = Capital + Liabilities Cash + Furniture = Capital + Liabilities Transaction 1 50,000 + 0 = 50,000 + 0 Transaction 2 (–) 5,000 + 5,000 = 0 + 0 equation 45,000 + 5,000 = 50,000 + 0
Transaction 3: He purchased goods for cash Rs.30,000. As a result, cash balance is reduced by the goods purchased, leaving the total of the assets unchanged. Assets = Capital + Liabilities Cash + Furniture + Stock = Capital +Liabilities (Goods) Transaction 1&2 45,000 + 5,000 + 0 = 50,000 + 0 Transaction 3 (-) 30,000 + 0 + 30,000 = 0 + 0 _______________________________________________________________ equation 15,000 + 5,000 + 30,000 = 50,000 + 0 ___________________________________________________________________
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Transaction 4: He purchased goods on credit for Rs.20,000. The above transaction will increase the value of stock on the assets side and will create a liability in the form of creditors. Assets = Capital + Liabilities Cash + Furniture + Stock = Capital +Creditors Transaction 1-3 15,000 + 5,000 + 30,000= 50,000 + 0 Transaction 4 0 + 0 + 20,000= 0 + 20,000 _______________________________________________________________ equation 15,000 + 5,000 + 50,000 = 50,000 + 20,000 ___________________________________________________________________ Transaction 5: Goods costing Rs.25,000 sold on credit for Rs.35,000. The above transaction will give rise to a new asset in the form of Debtors to the extent of Rs.35,000. But the stock of goods will be reduced by Rs.25,000 i.e., the cost of goods sold. The net increase of Rs.10,000 is the amount of revenue which will be added to the capital. Assets = Capital + Liabilities Cash + Furniture + Stock + Debtors = Capital + Creditors + Revenue Transaction 1-4 15,000 + 5,000 + 50,000 + 0 = 50,000 + 20,000 Transaction 5 0 + 0 + (-)25,000 + 35,000 = 10,000 + 0 ___________________________________________________________________ equation 15,000 + 5,000 + 25,000 + 35,000 = 60,000 + 20,000 ___________________________________________________________________ Transaction 6: Rent paid Rs.3,000. It reduces cash and the rent is an expense, it results in a loss which decreases the capital. Assets = Capital + Liabilities Cash + Furniture + Stock + Debtors = Capital + Creditors Transaction 1-5 15,000 + 5,000 + 25,000 + 35,000 = 60,000 + 20,000 Transaction 6 – 3,000 + 0 + 0 + 0 = (-) 3,000 + 0 ________________________________________________________________ equation 12,000 + 5,000 + 25,000 + 35,000 = 57,000 + 20,000 77,000 = 77,000 ________________________________________________________________
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From the above transactions, it may be concluded that every transaction has a double effect and in each case - Assets = Capital + Liabilities, i.e., ‘Accounting equation is true in all cases’. The last equation appearing in the books of Mr.Murugan may also be presented in the form of a statement called Balance Sheet. It will appear as below: Balance Sheet of Mr. Murugan as on . . . . . . . . . . . . . . Liabilities rs. Assets rs. Capital 57,000 Cash 12,000 Creditors 20,000 Stock 25,000 Debtors 35,000 Furniture 5,000 77,000 77,000 Note : Increase in one asset will be automatically either decrease in another asset or increase in liability or increase in capital. Likewise decrease in asset by way of either in increase in another asset or decrease in liability or capital. Illustration 5 Show the Accounting Equation on the basis of the following transactions and prepare a Balance Sheet on the basis of the last equation. Rs. 1. Maharajan commenced business with cash 1,00,000 2. Purchased goods for cash 70,000 3. Purchased goods on credit 80,000 4. Purchased furniture for cash 3,000 5. Paid rent 2,000 6. Sold goods for cash costing Rs.45,000 60,000 7. Paid to creditors 20,000 8. Withdrew cash for private use 10,000 9. Paid salaries 5,000 10. Sold goods on credit (cost price Rs.60,000) 80,000
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Solution :
Accounting equation
S. No.
Transaction Assets = Capital + Liabilities
1.
Maharajan commenced business with Rs. 1,00,000/
Cash + 1,00,000 +
Stock + 0 +
Furniture + 0 +
Debtors = 0 =
Capital + 1,00,000 +
Creditors 0
2.Purchased goods for cash
1,00,000 +0 +0 +0 =1,00,000 +0 (-) 70,000 + 70,000 +0 +0 =0 +0
3.Purchased goods on credit
30,000 +70,000 +0 +0 =1,00,000 +0 0 + 80,000 +0 +0 =0 +80,000
4.Purchased Furniture
30,000 +1,50,000 +0 +0 =1,00,000 +80,000 (-) 3,000 +0 +3,000 +0 =0 +0
5.Paid Rent
27,000 +1,50,000 +3,000 +0 =1,00,000 +80,000 (-) 2,000 +0 +0 +0 =(-) 2,000 +0
6.Sold goods for cash
25,000 +1,50,000 +3,000 +0 =98,000 +80,000 (+) 60,000 +(-) 45,000 +0 +0 =15,000 +0
7.Paid to creditors
85,000 +1,05,000 +3,000 +0 =1,13,000 +80,000 (-) 20,000 + 0 +0 +0 =0 +(-) 20,000
8.Withdrew cash for private use
65,000 +1,05,000 +3,000 +0 =1,13,000 +60,000 (-) 10,000 +0 +0 +0 =(-) 10,000 +0
9.Paid Salaries
55,000 +1,05,000 +3,000 +0 =1,03,000 +60,000 (-) 5,000 + 0 +0 +0 =(-) 5,000 +0 10.Sold goods on credit costing50,000 +1,05,000 +3,000 +0 =98,000 +60,000 Rs. 60,0000 +(-) 60,000 +0 +80,000 =(+) 20,000 +0 Equation 50,000 +45,000 +3,000 +80,000 =1,18,000 +60,000 1,78,000 = 1,78,000
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Explanation :
S. No.
Transactions
Accounts Affected Assets Capital & Liabilities
1. Capital brought in

Cash increases (comes in)
Capital increases (created)
2. Cash purchases Stock increases Cash decreases
__
3. Credit purchases Stock increases Creditors increase
4. Furniture bought Cash decreases Furniture increases (comes in)
__
5. Rent paid Cash decreases Capital decreases (Rent is an expenses it results in a loss) 6. Cash Sales Cash increases Stock decreases __ 7. Payment to creditors Cash decreases Creditors decrease
8. Withdrawal of cash for private use (Drawings)
Cash decreases Capital decreases
9. Salaries paid Cash decreases Capital decreases (Salary is an expense - Loss) 10. Credit Sales Stock decreases Debtors increase __ Balance Sheet of Mr.Maharajan as on ............................ Capital & Liabilities Rs. Assets Rs. Capital 1,18,000 Cash 50,000 Creditors 60,000 Stock 45,000 Furniture 3,000 Debtors 80,000 1,78,000 1,78,000

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