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Accounting Equation

Introduction:
The entire financial accounting system is based on the accounting equation. As
we know that for operating a business unit we need the economic resources and
this is being supplied by some one. These economic resources which are
possessed by the business is known as assets. Is is obvious that some amount is
contributed by the proprietor of the business and some amount is contributed by
the out siders.. The amount contributed by the proprietor is known as capital and
the amount which owed by the business to the outsiders is known as liability. If
the total contribution is made by the proprietor, then the total assets equal to
equity or capital. However if the amount is contributed includes outsiders
amount in that case the total assets will be equal to capital and liability.
The two sides of equation will always be equal. On the one side total
resources possessed and on the other side it will represent from where all these
resources are obtained. The equity of two sides will always be true, no matter
how many transactions are entered in to. The actual assets, capital and liability
may change but the equality of the assets with that of total capital and liabilities
will always hold true.
Accounting Equation
The equation based on the principle that accounting deals with property and
rights to property and the sum of properties owned is equal to the sum of the
rights to the properties. The properties owned by a business are called assets
and the rights to properties are known as liabilities or equities to the business.
Equities may be divided in to equities of creditors representing debts of the
business known as liabilities and the equity of owner known as capital. Taking
this in to account, the accounting equation may be as below:
Assets = Liabilities +Capital
Or
Capital =Assets Liabilities
Or
Liabilities = Assets Capital
Assets: Assets are the economic resources of the organization. It includes both
tangible and intangible items. For example tangible assets include land, building,
furniture, machinery, goods, stock equipments etc. Similarly intangible assets
includes goodwill, copy right, patent, trademark etc.
Liabilities: It the amount of obligation of the organization to pay out siders. It
includes creditors, bills payable, bank overdraft, bank loan, outstanding
expenses, income received in advance etc.

Capital: It the amount contributed by the proprietor to start a business. It is the


initial capital brought in to the business.

Example to various situations

Decrease in asset and decrease in owners capital - Cash withdrawn for


private use.
Decrease in asset and decrease in liabilities Amount paid to creditors.
Increase in one asset and decrease in another asset Purchased furniture.
Increase in asset and increase in owners capital Cash brought in to
business as capital.
Increase in asset and increase in liability Goods purchased on credit.
Increase in one liability, decrease in another liability - Bills payable issued
to the creditor.
Increase in capital and decrease in liability creditor becomes partner or
contributor of business.
Decrease in capital and increase in liability When capital amount
transferred to loan.
Decrease in liability, increase in capital and decrease in assets Discharge
of liability at discount.
Decrease in asset, increase in another asset followed by decrease capital
Amount received from debtor after allowing some discount.
Example-1
Prepare accounting equation and also prepare balance sheet.
Particulars

Amount

Started business with capital

10,000

Purchased goods for credit Rs2,000 and for cash

3,000

Sold goods cost price Rs5,000 for

6,000

Rent paid
Commission received

100
500

Bank loan taken

2,000

Paid to the creditors in full settlement of account

1,900

Example-2
Prepare accounting equation and balance sheet
Particulars

Amount

Commenced business with goods Rs6,000 and for cash

14,000

Purchased goods on credit from Mr.X

2,000

Goods withdrawn for private use

500

Interest on capital due

300

Cash withdrawn from bank for private use

500

Example -3
Prepare accounting equation and balance sheet
Particulars

Amount

Commenced business with bank balance

25,000

Purchased furniture

1,000

Purchased goods for Rs3,000 and on credit

7,000

Sold goods to Y cost price Rs3,000 for

4,000

Rent received

1,000

SUGGESTED ANSWERS FOR ASSIGNMENT OF

ACCOUNTING EQUATIONS

It is important before starting the problem that the number of accounts


Involved in the given transaction in the question. This will help you to
Open name of accounts to be opened.

1. Accounting equation of.. as on .


Transactions

cash

Started
business with
capital

10,000

goods

liability

10,000

(-)3,000

5,000

2,000

New equation

7,000

5,000

2,000

Sold goods

6,000

(-) 5,000

Purchased
goods

capital

10,000
1,000

New equation

13,000

Nil

2,000

(-) 1,000
Rent paid

Commission
received
Bank
taken

(-)1,000

12,000

New equation

Nil

2,000

500

10,000
500

12,500

Nil

2,000

2,000

loan

11,000

10,500

2,000

14,500

Nil

4,000

10,500

(-)2,000

100

2,000

10,600

New equation
Paid
creditors

to

(-) 1,900
12,600

Nil

New equation
Balance Sheet as on
Liabilities and capital

Amount

Assets

Amount

Capital

10,600

Cash

12,600

Creditors

2,000
12,600

12,600

2. Accounting equation of ..as on..


Transactions

Goods

Cash

Commenced
business

6,000

14,000

Purchased
goods
on
credit

2,000

New equation

8,000

Goods drawn
for
private
use

(-)500

New equation

7,500

Cash
withdrawn for
private use
New equation

7,500

20,000

14,000

2,000

20,000

(-)500
14,000

14,000

2,000

19,500

300

(-)300

2,300

19,200

(-) 500
7,500

Capital

2,000

Int.on capital
New equation

Liability

13,500

(-) 500
2,300

18,700

Balance Sheet as on
Liability and capital

Amount

Assets

Amount

Capital

18,700

Goods

7,500

Creditors

2,000

Interest due

Cash

13,500

300
21,000

21,000

3. Accounting equation of .. as on
Transactio
n

Bank

Commenc
ed
business

25,000

Furniture
purchase
d
New
equation

1,000

24,000

1,000

(-)3,000

New
equation

21,000

1,000

to
21,000

Goods

Debtor(Y)

Liability

Capital
25,000

(-)1,000

Purchase
d goods

Sold
goods
Y

FF

1,000

25,000

10,000

7,000

10,000

7,000

(-)3,000

4,000

7,000

4,000

25,000

1,000
7,000

26,000

New
equation
Rent
received
New
equation

1,000
1,000
22,000

1,000

7,000

4,000

7,000

27,000

Balance Sheet as on .
Liabilities and capital

Amount

Assets

Amount

Capital

27,000

Bank

22,000

Creditor for goods

7,000

Furniture

1,000

Goods

7,000

Debtors (Y)

4,000

34,000

34,000

Accounting:
It is process of recording the financial transactions in a systematic manner, with
the help of accepted and recognized principles laid down for this purpose; for
arranging,analyzing,summarizing,Classifying,Interpreting,and
providing
the
information to the interested parties.
Parties interested in accounting information:
Internal users

External users

Owners / Share holders

Creditors

Management

Government

Employees

Consumers
General public
Other parties

Basis of Accounting System:


1. Cash or receipt basis: It is the method of recording under which revenues,
costs, assets and liabilities are reflected in accounts in the period in which actual
receipts or actual payments are, made. Receipts and payments A/C in case of
clubs societes; hospitals etc. are the examples of cash basis of accounting.
2. Accrual or Mercantile basis: It is the method or recording transactions by
which revenues, costs, assets and liabilities are reflected in accounts in the
period in which they accrue. This basis includes considerations relating to
outstanding, prepaid, accrued and received in advance.
3. Mixed basis: It is the combination of both the cash as well as mercantile
basis. Incomes are recorded on cash basis and expenses are recorded on
mercantile basis.
Transaction
Any exchange of goods or services for money or moneys worth by the business
with any other business or person is called transaction. It is an economic activity
of the business that changes its financial position.
Mode of
involved

payment

Cash transaction
Credit transaction

Mode
of
involved

entity

Mode of exchange
involved

External transaction
Internal transaction

Exchange transaction
Non-exchange transaction

Determinants of cash and credit transactions:


The transactions, where the terms on
cash or on cheques, by cash or by
cheques, for cash or for cheques are
used
are
identified
as
cash
transactions.

Goods sold for cash Rs1,000


Rent paid by cash Rs 500
Salary paid by cheque Rs
2,000
Good are purchased for cash
Rs 6000

The transactions where in the terms


paid,
received,
settled,
cleared,
deposited, withdrawn etc is used are
identified as cash transactions.

Charges paid Rs200


Shilpi settled her account of
Rs1,000
Rs2,000
bank

deposited

in

the

Mr. Anirban cleared his


account or Rs500 by paying
Rs450
The transactions where in personal
names or name of a firm is mentioned
are identified as credit transactions.

Goods
sold
Rs1,000

to

Sravani

Good
returned
Sreemoti Rs5,000

from

Goods returned
Rs1,000

The transactions where both cash and


personal names are mentioned are
termed as cash transactions

to

Sivani

Goods
purchased
Suman Rs6,000

from

Goods sold to Sravani for Cash


Rs1,000
Goods purchased from Suman
for cash Rs6,000

Account:
An account is summarized record of relevant transactions relating to same
activity or particular head that has taken place during a given period. Separate
individual accounts are opened for every head of expenses, revenue, asset,
liability and capital. The accounts are maintained in ledger formats as shown
below which is discussed in chapter 5 in detail.
Dr
Dat
e

Cr
Particulars

J.F

Amount

Dat
e

Particulars

J.F

Amount

Total brought forward and carried forward or casting:


When the page of journal /ledger is filled up, the total of that page is to be
carried forward (CF) to the next page. It is written as carry forward (CF) on the
same page brought forward (B/F) on the next page. At the end of the question,
the grand total of both the sides are also made. The process of brought forward
(B/F) of totals of each page and making grand total of the amount columns of the
journal is called Casting.

Assignment: Accounting Equation


Prepare Accounting equation and Balance Sheet to the following.
1.
Particulars

Amount

Mohan commenced business with cash

50,000

Purchased goods for cash

30,000

Purchased goods on credit

20,000

Sold goods(cost Rs10,000) for

12,000

Bought furniture on credit

2,000

Paid cash to a creditor

15,000

Answer:
Cash

Goods

Furniture

Capital

Liabilities

17,000

40,000

2,000

52,000

7,000

Balance sheet total Rs59,000


2.
Particulars

Amount

Ram started business with

25,000

Purchased goods on credit

10,000

Sold goods to Ravi on credit costing Rs1,500 for

1,800

Answer:
Cash

Goods

Debtors

Capital

Liabilities

25,000

8,500

1,800

25,300

10,000

Balance sheet total Rs35,300


3.
Particulars

Amount

Raj started business with cash

1,00,000

Purchased furniture for cash

12,500

Purchased goods on credit from Manish worth

27,500

Sold goods to Rupak on credit if costing Rs20,000 for

25,000

Paid rent

1,500

Depreciation to be charged on furniture

1,250

Withdrew cash for personal use

6,000

Answer:
Cash

Furniture

Debtors

Goods

Capital

Liabilities

80,000

11,250

25,000

7,500

96,250

27,500

Balance sheet total- Rs1,23,750


4.
X started business with cash Rs10,000
Purchased furniture for cash Rs1,000
Paid Rent Rs 100
Purchased goods on credit Rs3,000
Sold goods (cost price Rs2,000) for cash Rs5,000
Answer:
Cash

Furniture

Goods

Capital

Liabilities

13,900

1,000

1,000

12,900

3,000

Balance sheet total- Rs15,900


5.

Commenced business with cash Rs30,000


Rent paid in advance Rs500
Purchased goods for cash Rs15,000 and for credit Rs10,000
Sold goods for cash Rs15,000 , costing Rs10,000
Paid salary Rs500 and salary outstanding Rs100
Bought Hero Honda for personal use Rs5000
Answer:
Cash

Pre-paid
rent

Goods

Capital

Liabilities

24,000

500

15,000

29,400

10,100

Balance sheet total- Rs39,500


6.
Invested Rs15,000 in cash in business
Purchased investment Rs7,000
Purchased a residence for personal use paying cash Rs4,000 and loan
Rs10,000
Sold investment costing Rs1,000 for Rs1,400
Purchased an old scooter for Rs2,800 cash. For personal use
Received salary Rs 3,600
Paid cash Rs500 for loan andRs300 for interest
Drawings Rs300
Received dividend Rs200
Answer:
Cash

Investment

Capital

Liabilities

5,300

6,000

1,800

9,500

Balance sheet total- Rs11,300


7.
Commenced business with cash Rs50,000
Purchase good for cash Rs20,000 and credit Rs30,000
Sold goods for cash Rs30,000 costing Rs25,000
Insurance paid Rs500
General expenses outstanding Rs100
Bought furniture Rs4,000 on credit

Bought T.V for personal use Rs 5,000


Purchased building for cash Rs20,000
Interest received Rs300
Answer:
Cash

Goods

Furniture

Building

Capital

Liabilities

34,800

25,000

4,000

20,000

49,700

34,100

Balance sheet total Rs83,800


8.
Started business with cash Rs50,000
Purchased goods for cash Rs5,000 and Rs20,000 on credit from Jitu
Sold goods for cash Rs25,000(cost price Rs15,000)
Paid rent in advance Rs1,000 and other expenses Rs1,500
Purchased scooter for personal use Rs5,000
Paid to Jitu Rs10,000
Answer:
Cash

Goods

Prepaid
rent

Capital

Liabilities

52,500

10,000

1,000

53,500

10,000

Balance sheet total- Rs63,500


9
Ram commenced business with Rs35,000
Withdrew for private use Rs850
Purchased goods on credit Rs7,000
Purchased goods for cash Rs5,000
Paid wages Rs150
Paid for creditors Rs5,000
Sold goods on credit for Rs7,500
Sold goods for cash Rs2,000 (cost price Rs1,500)
Answer:
Cash

Goods

Debtors

Capital

Liabilities

26,000

3,000

7,500

34,500

2,000

Balance sheet total Rs36,500

10.
Started business with Cash Rs9,000
Paid rent in advance Rs200
Purchased goods for cash Rs2,500 and on credit Rs1,000
Sold goods for cash Rs2,000 (costing Rs1,200)
Rent paid Rs500 and rent outstanding Rs100
Bought motor cycle for personal use Rs4,000
Purchased equipment for cash Rs250
Paid to creditors Rs300
Depreciation on equipments Rs25
Business expenses Rs200
Answer:
Cash

Goods

Advance
rent

Equipmen
ts

Capital

Liabilities

3,050

2,300

200

225

4,975

800

Balance sheet total- Rs5,775


11.
Rajesh started business with cash Rs9,000
Purchased equipments for cash Rs7,400
Purchased goods on credit Rs2,650
Paid Rs300 to creditors
Sold goods for cash Rs1,500 ,cost price Rs1,200
Business expenses Rs700
Goods worth Rs400 taken for personal use
Depreciation on equipments Rs200
Purchased goods for cash Rs1,000
Rent outstanding Rs200
Answer:
Cash

Goods

Equipments

Capital

Liabilities

1,100

2,050

7,200

7,800

2,550

Balance sheet total- Rs10,350


12.
Particulars

Amount

Dr .Dhoni commenced business with

70,000

Purchased goods on credit

14,000

Withdrew for private use

1,700

Purchased goods for cash

10,000

Paid wages

300

Paid to creditors

10,000

Sold goods on credit

15,000

Sold goods for cash (cost price Rs3,000)

4,000

Purchased furniture

500

Answer:
Cash

Goods

Debtors

Furniture

Capital

Liabilities

51,500

6,000

15,000

500

69,000

4,000

Balance sheet total Rs73,000


13.
Particulars

Amount

Started business with cash

15,000

Purchased goods on credit

7,000

Purchased furniture for cash

500

Deposited in to bank

2,000

Sold goods to S on credit costing Rs4,000 for

6,000

Withdrawn for private use

200

Paid for salaries

300

Answer:
Cash

Goods

Furnitur
e

Bank

Debtors

Capital

Liabiliti
es

12,000

3,000

500

2,000

6,000

16,500

7,000

Balance sheet total Rs23,500


14.
Particulars

Amount

Started business with cash

50,000

Purchased goods on credit

4,000

Purchased goods for cash

1,000

Furniture purchased

500

Withdrew for private use

700

Paid rent

200

Received interest

100

Sold goods on credit, costing Rs500 for

700

Paid to creditors

400

Paid salaries

200

Answer:
Cash

Goods

Furniture

Debtors

Capital

Liabilities

47,100

4,500

500

700

49,200

3,600

Balance sheet total- Rs52,800


15.
Sl

Transactions

Accounts involved

Started business with capital of Rs10,000

Cash(A) and capital

Purchased goods for cash Rs3,000 and on


credit Rs2,000

Cash (A,
creditor(L)

goods(A)

and

Sold goods
Rs4,000

Cash (A), goods(A)


profit(Capital)

and

Rent paid Rs1,000

Cash (A),Rent(Capital)

Commission received Rs500

Cash(A),Comm.(Capital)

bank loan taken Rs2,000

Cash (A) ,Bank loan(L)

for

cash

Rs6,000

costing

Answer:
Cash

Goods

Capital

Liabilities

14,500

1,000

11,500

4,000

Balance sheet total- Rs15,500


16.
Sl

Transactions

Accounts involved

Commenced business with goods Rs6,000


and cash Rs14,000

Cash(A),Goods(A),Capital

Purchased goods on credit from X for


Rs2,000

Goods(A), X(L)

Goods withdrawn for private use Rs500

Goods(A),Drawings(Cap)

Interest on capital due Rs300

Int(Cap), liabilities

Cash deposited in to bank Rs1,000

Cash (A),Bank(A)

Cash withdrawn from bank for private use


Rs500

Bank(A),Drawings(Cap)

Answer:
Cash

Goods

Bank

Capital

Liabilities

13,000

7,500

500

18,700

2,300

Balance sheet total- Rs21,000


17.
Sl

Transactions

Accounts involved

Commenced business with bank balance


Rs15,000 and cash Rs10,000

Capital, Bank (A), Cash


(A)

Purchased furniture for Rs1,000

Furniture(A), Cash(A)

Purchased goods for Rs3,000 and on credit


for Rs7,000

Cash(A),Goods(A),Cred
itors
(L)

Sold goods
Rs3,000

to

for

Rs4,000,costing

Y
(A),Goods(A),Profit(Ca
p)

Rent received Rs1,000

Rent(Capital) ,Cash (A)

Salary Paid Rs600

Salary
,Cash(A)

(Capital)

Answer:
Goods

Cash

Bank

Furnitur
e

Debtors
(Y)

Capital

Liabiliti
es

7,000

6,400

15,000

1,000

4,000

26,400

7,000

Balance sheet total- Rs33,400


18.
Started business with Rs40,000
Purchased goods worth Rs10,000
Purchased goods for cash Rs5,000
Purchased goods from Laxmi for cash Rs2,000
Purchased good from Bijaya laxmi Rs1,000 and for cash Rs500
Purchased good from Ambika Rs800

Sold goods cost price Rs5,000 for Rs7,000


Sold goods to Manoj Rs4,000, cost price Rs2,500
Sold goods goods for cash to Rabindra cost price Rs6,000 for Rs5,000
Answer:
Debtor

Cash

Goods

Capital

Liabilities

4,000

34,500

5,800

42,500

1,800

Balance sheet total- Rs44,300


19. Commenced business with Rs30,000
Rent paid Rs500
Rent received Rs700
Rent receivable Rs250
Rent due/arrear/payable/ outstanding /to be paid Rs400
Rent paid in advance Rs600
Rent received in advance Rs200
Rent paid on behalf of Anupama Rs300
Rent received on behalf of Indrani Rs600
Rent paid Rs100 and rent outstanding Rs200
Rent paid Rs400 and rent prepaid Rs500
Answer:
Cash

Rent
receivabl
e

Prepaid
rent

Debtors

Capital

Liabilities

29,100

250

1,100

300

29,350

1,400

Balance sheet total- Rs30,750


20.
Commenced business with Rs20,000
Purchased goods for Rs10,000
Goods withdrawn for private use Rs1,000
Cash withdrawn for private use Rs500
Goods given as sample/advertisement Rs500
Goods given as charity/donation Rs300
Goods lost by fire Rs200
Goods lost by fire Rs1,000 and insurance claim received Rs500

Goods lost by fire Rs2,000 and insurance claim admitted Rs1,200


Answer:
Cash

Goods

claim

Capital

Liabilities

10,000

5,000

1,200

16,200

Balance sheet total- Rs16,200


21.
Started business with Rs 15,000
Purchased furniture Rs5,000
Depreciation on furniture Rs300
Repairs to furniture Rs50
Furniture cost price Rs200 sold for 250
Furniture cost price Rs100 sold for Rs75
Furniture taken for personal use Rs500
Answer:
Cash

Furniture

Capital

Liabilities

10,275

3,900

14,175

Balance sheet total Rs14,175


Important tips:

Whether expenses paid or outstanding in both the cases the


amount will be reduced from capital. And also if paid the amount
will reduced from cash and if outstanding it will increase the
liability side.
If income received in advance it will increase the liability and
increase the cash
If any expense paid in advance then a separate prepaid expenses
column will be opened and amount will be shown in the prepaid
expenses and will reduce the cash column in the asset side.
Rent receivable is an asset a separate column will be opened in
assets and added to capital as accrued income