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’.