Accounting Equation
Subject: Other
Overview
The accounting equation is based on the principle that assets of a business should always be equal to the total outside liabilities and owner’s equity or capital. This note has information about accounting equation and its principles.Accounting Equation
In accounting, every business transactions involve double effects of equal value. Such double effects of equal value create an equation, which is called accounting equation. Such accounting equation should always be in balance. The accounting equation shows the relationship between the economic resources belonging to the business and the claims against these resources. The next term of economic resources is assets and claims consist of creditor’s claim (liabilities) and owner’s claim (owner’s equity). It can be expressed as follows:
Assets= Liabilities + Owner’s Capital
Principles of Accounting Equation
The accounting equation is based on the principle that assets of a business should always be equal to the total outside liabilities and owner’s equity or capital. Assets are the resources owned by the business firm for future benefits while liabilities and capital are the claims over the assets. Hence, the accounting equation shows the relationship between the economic resources belonging to the business and the claims against those resources. It focuses on the concept of duality i.e. each transaction has a dual effect and affects two components of the balance sheet.
Every transaction of a business, regardless of its complexity, has its effect on the accounting equation. A business transaction may bring a change in all or any of the components of the equation. Whatever may be the change i.e. increase or decrease, the accounting equation remains in balance.
| Items | Increase | Decrease |
| Assets | Capital increases or liability increases or other asset decreases. | Capital decreases or liability decreases or other asset increases. |
| Liabilities | Capital decreases or other liability decreases or asset increases. | Capital increases or other liability increases or asset decreases. |
| Capital | Asset increases. | Asset decreases. |
| Income and gain | Capital and asset increase. | Capital and asset decrease. |
| Expenses and loss | Capital and asset decrease. | Capital and asset increase. |
The process of determining the effect of each transaction in each component of accounting equation i.e. on assets, liabilities and owner’s equity is known as the transaction analysis. This process shows the increase or decrease of each component by the effect of each financial transaction. With the help of such analysis, we can journalize the transactions in the books of original entries or directly post on the debit or credit side of relevant asset or liability on owner’s equity account.
Assets
Anything which is the possession of a business including the amounts due to it from others is called an asset. As asset may be changed from a transaction of a business.
Liabilities
Liabilities are the claims of others against the business. Like an asset, a liability may be changed from transactions of a business.
Capital
Capital refers to the amount invested by the proprietor in the business. It also includes the amount of profit or loss. It may also be changed from a transaction of a business.
Preparation of accounting equation
Accounting equation can be prepared by using the following rules:
- First of all, a format is prepared.
- Description of every transaction is made in the transaction column.
- Each transaction of a business has a two-fold effect – an effect on its assets and another effect on its liabilities or the proprietor’s capital, or an effect on one asset and another effect on another asset, or an effect on a liability and another effect on another liability.
- After showing the effect, the total of each transaction is made. The total of the first transaction is written as ‘Beginning or Starting equation’. After that, the totals of other transactions except final transaction are called ‘New equation’. But the total of the final transaction is called ‘Final or Ending equation’.
- As it has been already stated above that the claim over the assets by the outsiders is first, liabilities appear before the owner’s capital in accounting equation.
Things to remember
- The accounting equation is based on the principle that assets of a business should always be equal to the total outside liabilities and owner’s equity or capital.
- Anything which is the possession of a business including the amounts due to it from others is called an asset.
- Liabilities are the claims of others against the business.
- Capital refers to the amount invested by the proprietor in the business.
- It includes every relationship which established among the people.
- There can be more than one community in a society. Community smaller than society.
- It is a network of social relationships which cannot see or touched.
- common interests and common objectives are not necessary for society.
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Accounting Equation
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Questions and Answers
The following transactions are given:
- Commenced business with cash Rs.50,000
- Goods purchased for cash Rs.20,000
- Goods purchased on credit Rs.30,000
- Goods sold for cash Rs.12,000
- Sold goods on credit Rs.20,000
Required: Accounting Equation
Solution:
Accounting Equation
| S.N. | Transactions | Assets | = | Capital | + | Liabilities |
| a) | Commenced business with goods | + 50,000 | + 50,000 | 0 | ||
| Beginning Equation | 50,000 | = | 50,000 | + | 0 | |
| b) | Goods purchased on cash | + 20,000 | 0 | 0 | ||
| - 20,000 | ||||||
| New Equation | 50,000 | = | 50,000 | + | 0 | |
| c) | Goods purchased on credit | + 30,000 | 0 | + 30,000 (Cr.) | ||
| New Equation | 80,000 | = | 50,000 | 30,000 | ||
| d) | Goods sold on cash | - 12,000 | 0 | 0 | ||
| + 12,000 | ||||||
| New Equation | 80,000 | = | 50,000 | 30,000 | ||
| e) | Goods sold on credit | -20,000 | 0 | 0 | ||
| + 20,000 | ||||||
| Final Equation | 80,000 | = | 50,000 | + | 30,000 |
The following transactions are given:
- Started business with bank balance Rs.75,000
- Goods purchased and paid by cheque Rs.25,000
- Goods costing Rs.18,000 sold on cash Rs.20,000
- Salary paid Rs.5,000
- Commission received Rs.8,000
Required: Accounting Equation
Solution:
Accounting Equation
| S.N. | Transactions | Assets | = | Capital | + | Liabilities |
| a) | Started business with bank balance | + 75,000 | + 75,000 | 0 | ||
| Beginning Equation | 75,000 | = | 75,000 | + | 0 | |
| b) | Goods purchased through cheque | +25,000 | 0 | 0 | ||
| -25,000 | ||||||
| New Equation | 75,000 | = | 75,000 | + | 0 | |
| c) | Goods sold on profit | -18,000 | + 2,000 (profit) | 0 | ||
| + 20,000 | ||||||
| New Equation | 77,000 | = | 77,000 | + | 0 | |
| d) | Salary paid | -5,000 | -5,000 | 0 | ||
| New Equation | 72,000 | = | 72,000 | + | 0 | |
| e) | Commission received | +8,000 | +8,000 | 0 | ||
| Final Equation | 80,000 | = | 80,000 | + | 0 |
The following transactions are given:
- Cash introduced as capital Rs.28,000
- Furniture purchased on cash Rs.7,000
- Goods bought from Roshan Rs.8,400
- Goods sold to Sabita (cost price Rs.5,600) on credit Rs. 7,000
- Paid wages Rs.2,000
Required: Accounting Equation
Solution:
Accounting Equation
| S.N. | Transactions | Assets | = | Capital | + | Liabilities |
| a) | Cash introduced as capital | + 28,000 | + 28,000 | 0 | ||
| Beginning Equation | 28,000 | = | 28,000 | + | 0 | |
| b) | Purchased furniture | + 7,000 | 0 | 0 | ||
| -7,000 | ||||||
| New Equation | 28,000 | = | 28,000 | + | 0 | |
| c) | Goods purchased from Roshan | + 8,400 | 0 | + 8,400 | ||
| New Equation | 36,400 | = | 28,000 | + | 8,400 | |
| d) | Goods sold to Sabita on credit | -5,600 | +1,400 | 0 | ||
| + 7,000 | ||||||
| New Equation | 37,800 | = | 29,400 | + | 8,400 | |
| e) | Paid wages | -2,000 | -2,000 | 0 | ||
| Final Equation | + 28,000 | = | 27,400 | + | 8,400 |
The following data are provided:
- Commencement of business with cash Rs.40,000 and goods Rs.10,000
- Loan taken from Surya Rs.12,000
- Goods lost by fire Rs.4,000 and compensation received from insurance company Rs.3,000
- Repayment of loan to Surya Rs.12,500 including interest on loan Rs.500
- Commission received Rs.4,000 and still receivable Rs.6,000
Required: Accounting Equation
Solution:
Accounting Equation
| S.N. | Transactions | Assets | = | Capital | + | Liabilities |
| a) | Commencement of business with cash and machinery | +4,000 | 50,000 | 0 | ||
| +10,000 | ||||||
| Beginning equation | 50,000 | = | 50,000 | + | 0 | |
| b) | Loan taken from Surya | +12,000 | 0 | + 12,000 | ||
| New Equation | 62,000 | = | 50,000 | + | 12,000 | |
| c) | Goods lost by fire and compensation received from insurance company | -4,000 | -1,000 (loss) | 0 | ||
| +3,000 | ||||||
| New Equation | 61,000 | = | 49,000 | + | 12,000 | |
| d) | Repayment of loan to Surya including interest on loan | -12,500 | -500 | -12,000 | ||
| New Equation | 48,500 | = | 48,500 | + | 0 | |
| e) | Commission received and still received | +4,000 | +10,000 | 0 | ||
| +6,000 | ||||||
| Final Equation | 58,500 | = | 58,500 | + | 0 |
The following transactions are provided:
- Started business with cash Rs.40,000
- Goods purchased (60% on cash and rest 40% on credit) Rs.10,000
- Salary paid Rs.10,000 and still due Rs.2,000
- Commission received Rs.3,000 including advance for next month Rs.1,000
- Paid rent Rs.4,000 including Rs.1,000 advance for next month
Required: Accounting Equation
Solution:
Accounting Equation
| S.N. | Transactions | Assets | = | Capital | + | Liabilities |
| a) | Started business with cash | + 40,000 | +40,000 | 0 | ||
| Beginning Equation | 40,000 | = | 40,000 | + | 0 | |
| b) | Goods purchased | +10,000 | 0 | +4,000 (Cr.) | ||
| -6,000 | ||||||
| New Equation | 44,000 | = | 40,000 | + | 4,000 | |
| c) | Salary paid with due amount | -10,000 | -12,000 | +2,000 | ||
| New Equation | 34,000 | = | 28,000 | + | 6,000 | |
| d) | Commission received including advance | +3,000 | +2,000 | +10,000 (Cr.) | ||
| New Equation | 37,000 | = | 30,000 | + | 7,000 | |
| e) | Paid rent including advance for next month | +1,000 | -3,000 | 0 | ||
| -4,000 | ||||||
| Final Equation | 34,000 | = | 27,000 | + | 7,000 |
What is an accounting equation?
In accounting, every business transactions involve double effects of equal value. The accounting equation shows the relationship between the economic resources belonging to the business and the claims against these resources.
What is transaction analysis?
The process of determining the effect of each transaction in each component of accounting equation i.e. on assets, liabilities and owner’s equity is known as the transaction analysis. This process shows the increase or decrease of each component by the effect of each financial transaction.
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