Accounting Equation

• Dual aspect may be stated as "for every debit,

there is a credit.“
• Every transaction should have twofold effect to
the extent of the same amount.
• This concept has resulted in accounting equation
which states that at any point of time the assets
of any entity must be equal (in monetary terms)
to the total of equities.
 Basic accounting equation

Assets = Liabilities + Capital (Shareholder’s or

Owner’s Equity)
or

Assets - Liabilities = Capital (Shareholder’s or

Owner’s Equity)
Example- Accounting Equation
• Transaction 1: Mr. XYZ commences his business with cash
$50,000. This is an example of investment of asset in the business
by the owner. The effect of this transaction on the accounting
equation is that cash asset is increased by $50,000 and the
proprietorship (XYZ's capital) is also increased by the same
amount such as:

Assets = Liabilities + Owner

(Cash)       XYZ’s Capital

+ 50,000 = ----   + 50,000

• Transaction 2: Purchased furniture on cash $10,000. This transaction
effected accounting equation as the increase in one new asset
furniture and decreases in assets cash with the same amount. Thus :

Assets = Liabilities + Proprietorship

Cash Furniture       XYZ, Capital
+ 50,000   = ----   + 50,000
- 10,000 + 10,000        

40,000 + 10,000 =     50,000

• Transaction 3: Purchased merchandise for cash $10,000. This
transaction will introduce a new element (merchandise) on the
assets side and decrease the cash by $10,000.

Assets = Liabilities + Proprietorship

Cash Furniture Merchandise       XYZ, Capital
+ 40,000 + 10,000   = ----   + 50,000
-10,000 -- + 10,000        

30,000 + 10,000 =     50,000

+10,000 
• Transaction 4
Purchased merchandise on account (on credit) $5,000.

Assets = Liabilities + Proprietorship

Cash Furniture Merchandise   Creditors   XYZ, Capital
+ 30,000 + 10,000 + 10,000 =     + 50,000
    + 5,000   + 5,000    

• 30,000+10,000
Transaction + 15,000
5: = + 5,000   + 50,000

Sold merchandise for cash $2,000 cost of these merchandise were $1,500

Assets = Liabilities + Proprietorship

Cash Furniture Merchandise   Creditors   XYZ, Capital
+ 30,000 + 10,000 + 15,000 = + 5,000   + 50,000
+ 2,000   - 1,500       + 500 (Profit)

+ 32,000 +10,000 + 13,500 = + 5,000   + 50,500

Transaction 6:Sold merchandise on credit for $4,000 costing $3,000.

Assets = Liabilities + Proprietorship

Merchan
Cash Furniture Debtors   Creditors   XYZ, Capital
dise
+
+ 32,000 + 10,000   = + 5,000   + 50,500
13,500
    - 3,000 + 4,000       + 1,000

+
32,000 +10,000 + 4000 = + 5,000   + 51,500
10,500
Transaction 7: Paid $1,000 to creditors for merchandise purchased.

Assets = Liabilities + Proprietorship

Mercha
Cash Furniture Debtors   Creditors   XYZ, Capital
ndise
+
+ 32,000 + 10,000 + 4,000 = + 5,000   + 51,500
10,500
- 1,000         - 1,000    

+
31,000 +10,000 + 4000 = + 4,000   + 51,500
10,500
Transaction 8:

Received cash from a debtor $ 1,000 whom a sale on credit was made
earlier. This is an example of collection from debtors. This transaction
is an exchange of one asset for another. the effect is on one side of the
equation, i.e., asset side. Thus:
Assets = Liabilities + Proprietorship
Merchan
Cash Furniture Debtors   Creditors   XYZ, Capital
dise
+
+ 31,000 + 10,000 + 4,000 = + 4,000   + 51,500
10,500
+ 1,000     - 1,000        

+
32,000 +10,000 + 3000 = + 4,000   + 51,500
10,500
• Transaction 9:

Paid salaries $1,000 in cash. This transaction affected the equation by

decrease in a cash asset and decrease in proprietorship (i.e., capital).
Thus:

Assets = Liabilities + Proprietorship

Merchandi
Cash Furniture Debtors   Creditors   XYZ, Capital
se

+ 32,000 + 10,000 + 10,500 + 4,000 = + 4,000   + 51,500

- 1,000             - 1,000

31,000 +10,000 + 10,500 + 3000 = + 4,000   + 50,500

• Effects of all the transactions explained above are presented in the following table:
Assets = Liabilities + Proprietorship
 
Cash + Furniture +Merchandise + Debtors   Creditors   + XYZ’s Capital
1 + 50,000             +50,000

50,000 = + 50,000
2 - 10,000 + 10,000            
 
  40,000  10,000     =   + 50,000
3 - 10,000   + 10,000          
  30,000 10,000 10,000   =   + 50,000
4     + 5,000     + 5,000    
30,000 10,000 15,000 = 5,000 + 50,000
5 + 2,000 - 1,500 + 500 (Profit)
32,000 10,000 13,500 = 5,000 + 50,500
6 - 3,000 + 4,000 + 1,000 (Profit)

32,000 10,000 10,500 4,000 = 5,000 + 51,500

7 - 1,000 - 1,000

31,000 10,000 10,500 4,000 = 4,000 + 51,500

8 +1,000 1,000

32,000 + 10,000 + 10,500 + 3,000 4,000 + 51,500

9 1,000 1,000
31,000 10,000 10,500 3,000 = 4,000 + 50,500
• The elements of the equation of Mr. XYZ that is,
Cash + Furniture + Merchandise + Debtors = Creditors + Capital

31,000 + 10,000 + 10,500 + 3,000 = 4,000 + 50,500

• This may also be stated in vertical form as shown below:

EQUITIES   ASSETS  
Creditors $4,000 Cash $31,000
Capital $50,500 Debtors 3,000
Merchandise 10,500
    Furniture 10,000

  $54,500   $54,500
 CLASSES OF ACCOUNTS:

Accounts

PERSONAL REAL NOMINAL

Natural Artificial Represe Tangible Intangible Expanses Incomes

ntative & Losses & Gains
 Examples of types of accounts
Types Sub-Types Explanation Example
Personal Account Natural Natural Persons means the Amit’s account, Aisha’s Account etc.,
persons who are creation of God.

Artificial These include the accounts of Accounts of Companies, Co-

corporate bodies or institutions operative society, Club,
which are recognized as persons Government, Bank Account
by law
Representative These are the accounts which Outstanding Rent account
represent a certain person or Outstanding Salaries A/C
group of persons Interest Outstanding A/C
Prepaid insurance A/C
Drawings A/C, Bank Overdraft A/c,
Capital A/C, Drawings A/C

Real account Tangible Tangible real accounts are those
accounts which relate to such
things which can be touched, felt,
measured etc.
Intangible These accounts represent such
things which cannot be touched.
Cash A/C, Building A/C, Furniture
A/C, Stock A/Purchase A/C, Sales
A/C, Purchase A/C, Sales A/C,
Purchase returns & Sales Returns
Patents A/C, Copyright A/c
Goodwill A/C, Trademark A/c

Nominal Expanses & These accounts deal with Rent A/c, Interest A/c, Salary A/c,
Losses expanses, incomes, profits and Insurance a/c, Commission A/C,
Incomes & Gains losses. These accounts are opened Discount A/c, Bad Debts A/C, and
in the books to simply explain the Reserve for discount on Creditors,
nature of transactions. Cash Discount A/C
 RULES OF DEBIT & CREDIT
PERSONAL ACCOUNT DEBIT the receiver CREDIT the giver

REAL ACCOUNT DEBIT what comes in and CREDIT what goes out

NOMINAL ACCOUNT DEBIT all expanses and losses CREDIT all gains &
incomes
 Accounts Balances

Figure 2: Effect of Debit & Credit Assets, Figure 3: Effect of Debit & Credit on
expanses and dividends Liabilities, Revenue & Equity