Accounting Equation

ACCOUNTING EQUATION

An accounting equation is a formula of accounting which shows that the assets of a business are always equal to the total of Capital and Liabilities. A business transaction will result in the change in either of the assets, liabilities or capital of the firm. After the change, assets will be again equal to the total of capital and liabilities. Therefore,

ASSETS = LIABILITIES + CAPITAL

OR

LIABILITIES = ASSETS - CAPITAL

OR

CAPITAL = ASSETS - LIABILITIES

We can understand it by an example.

Example: Show the Accounting Equation on the basis of the following transactions and prepare a Balance Sheet on the basis of last new equation:-

                                                                                                                             ₹          

1. A started business with cash                                         90,000
2.  Purchased goods for cash                                              30,000
3.  Purchased goods on credit                                            20,000
4.  Purchased furniture for cash                                           6,000
5.  Paid rent                                                                              5,000
6. Received commission                                                        1,000
7.  Withdrew cash for private use                                         3,000
8. Sold goods on credit (cost price ₹20,000)                    30,000
9. Paid to creditors                                                                10,000

 Solution:

 

S. No.	Transaction	Assets                                              = Liabilities + Capital  Cash+Stock+Furniture+Debtors=Creditors+Capital
1.	A started busi-ness with cash ₹90,000	90,000 + 0 + 0 + 0                               = 0 + 90,000
2.	Equation Purchased goods for cash ₹30,000	90,000 + 0 + 0 + 0                               = 0 + 90,000   (-)30,000 + 30,000 + 0 + 0                 = 0 + 0
3.	Equation Purchased goods on credit ₹20,000	60,000 + 30,000 + 0 + 0                     = 0 + 90,000    0 + 20,000 +0 +0                                 = 20,000 + 90,000
4.	Equation Purchased furni-ture for cash ₹6,000	60,000 + 50,000 + 0 + 0                     = 20,000 + 90,000     (-)6,000 + 0 + 6,000 + 0                      = 0 + 0
5.	Equation Paid rent ₹5,000	54,000 + 50,000 + 6,000 + 0             = 20,000 + 90,000   (-)5,000 + 0 + 0 + 0                             = 0+ (-)5,000
6.	Equation Received commi-ssion ₹1,000	49,000 + 50,000 + 6,000 + 0             = 20,000 + 85,000   1,000 + 0 + 0 + 0                                 = 0 + 1,000
7.	Equation Withdrew cash for private use ₹3,000	50,000 + 50,000 +6,000 + 0              = 20,000 + 86,000     (-)3,000 + 0 + 0 + 0                             = 0 + (-)3,000
8.	Equation Sold goods on credit ₹30,000  (cost price ₹20,000)	47,000 + 50,000 + 6,000 + 0             = 20,000 + 83,000     0 – 20,000 + 0 + 30,000                     = 0 + 10,000
9.	Equation Paid to creditors ₹10,000	47,000 + 30,000 + 6,000 + 30,000   = 20,000 + 93,000   (-)10,000 + 0 + 0 + 0                           = (-)10,000 + 0
	Final Equation	37,000 + 30,000 + 6,000 + 30,000   = 10,000 + 93,000

 

EXPLANATION

Serial No.	Transactions	Accounts Affected
		Assets	Liabilities & Capital
1	Capital brought in	Cash increases	Capital increases
2	Purchased goods for cash	Stock increases Cash decreases
3	Purchased goods on credit	Stock increases	Creditors increase
4	Purchased furniture for cash	Cash decreases Furniture increases
5	Paid rent	Cash decreases	Rent = Expenses Capital decreases
6	Received Commission	Cash increases	Commission = Income Capital increases
7	Withdrew cash for private use	Cash decreases	Capital decreases
8	Sold goods on credit for ₹30,000(cost price ₹20,000)	Debtors increase by ₹30,000. Stock decreases by ₹20,000	Capital increases by ₹10,000
9	Paid to creditors	Cash decreases	Creditors decrease

 Balance Sheet of A

As at ---------------

Liabilities + Capital	₹	Assets	₹
Creditors Capital	10,000 93,000	Cash Stock Furniture Debtors	37,000 30,000 6,000 30,000
	1,03,000		1,03,000

 

At any point of time, the total of the both sides of the Balance Sheet is always equal because the assets of a business are purchased either from the Funds (capital) supplied by the proprietor or from the funds provided by the external parties. From the study of above example, it may be concluded that every transaction has a double effect and in each case Assets = Liabilities + Capital. In other words, we can say that ‘Accounting Equation is true in all cases’.

  

Discount

DISCOUNT

It is a rebate or an allowance given by the seller to the buyer. It is of two types:

1.     Trade Discount

2.     Cash Discount

Trade Discount: When discount is allowed by a seller to its customers at a fixed percentage on the list or catalogue price of the goods, it is called trade discount. It is allowed when goods are purchased in bulk i.e. large quantity. It is allowed both on credit as well as cash transactions since it is related to the purchases and not to the payment. Main Features:

·        It is allowed by a wholesaler or manufacturer to the retailers at a fixed percentage on the printed price list.

·        It is allowed to the retailers to enable them to make some profit even if they sell the goods at their catalogue price.

·        It is deducted from the invoice.

·        It is not recorded separately in the books of accounts.

·        It is allowed when goods are purchased in a specific quantity.

·        No separate entry is passed for the trade discount, as it is deducted from the cash memo or invoice of the goods.

·        If the goods sold at trade discount are returned by the customer, the amount of trade discount is again deducted from the list price of returned goods.

Cash Discount: When discount is allowed to the customers for making prompt payment, it is called cash discount. It is allowed only if the customer makes the payment within a fixed period. Such discount motivates the customer to make the payment at the earliest. Main Features:

·        It is allowed if the customer makes the payment immediately or within a fixed period.

·        It is allowed to encourage quick or prompt payment.

·        It is not deducted from the invoice.

·        It is recorded separately in the books of accounts.

·        It is allowed when payment is made on or before a specified date.

·        It is allowed at the time of making payment, so the entry for the cash discount is recorded along with the entry for payment.

·        Discount is a nominal account. So it is debited when it is allowed to a customer and credited when it is received.

 

             Sometimes, a customer is allowed both the discounts, i.e. trade discount as well as cash discount. In such a case, first trade discount is to be deducted from the price of the goods and then, cash discount is to be calculated on the balance of the amount.