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 “Politics is for the present
but
an equation is for eternity”

-Albert Einstein

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 Copyright Notice

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Chapter Contents
Particulars Page No.
What is accounting equation? 6
The accounting equation with examples 7-9
Objective Type Questions 10-35

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What is Accounting Equation?

 The equation that is the foundation of double entry accounting

 It shows what a company owns, what a company owes & what stake the
owners have in the business.
 It describes that the total value of assets of a business is always equal to
its external liabilities plus owner’s capital.
 This equation summarizes the essential nature of double entry
accounting systems: Debits always equal Credits, and Assets always
equal the sum of Capital and Liabilities.

The Accounting Equation is as follows:

Assets = Capital + External Liabilities

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Need and Importance of Accounting Equation:

 The accounting equation is the basic accounting equation, represents

the relationship among the liabilities, assets, and owner's equity of a
business.

 Double entry principle indicates that the total debits are equal to the
total credits for any transaction.

 It is also known balance sheet equation.

 The mathematical expression of the accounting equation is: Assets =

Liabilities + Owner’s Equity or A==L+E.

 It is most commonly used to balance sheet, the final financial statement

for a company. It is the systematic form of representing company
status, displaying the total assets of a company is equal to the total
liabilities and shareholder equity.

 The balance sheet is a complex expression of this equation, presenting

the total assets of a company is equal to the total of liabilities and
owner’s equity.
 It is helpful to make use of the accounting equation at the time of
preparing financial statements, as it would not only help you to
maintain the accuracy, but also enable you to track the debits and
credits, so that you can balance the equation accordingly.

 The importance of accounting equation should not be underestimated,

as it's very much helpful to serve as a basis for all the accounting
transactions. Representing the relationship with the components of the
balance sheet, it reveals the financial standing of a business entity.

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Examples of Entries & their effects in the Accounting Equation:

1. Mr. X purchased Furniture for Rs. 50,000

The Accounting Equation is:
Asset (Furniture Comes in)

Asset (Cash Goes Out)

Asset = Capital + External Liabilities

(50,000- 50,000) = 0 + 0
0 = 0 + 0

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 2. Mr. X purchased Goods on Credit Rs.10,000

The Accounting Equation is:

Assets (Goods Come in)

Liabilities (Increase in Creditors)

Asset = Capital + External Liabilities

10,000 = 0 + 10,000

3. Mr. X withdrew Rs. 5,000 for his personal use.

Liabilities (Drawings are deducted from Capital)

Assets (Cash Going Out)

Asset = Capital + External Liabilities

(5,000) = 0 + (5,000)

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 4. Mr. X borrowed Rs. 2,500 from Bank of India.

Assets (Cash Comes In)

Liabilities (Liability to pay bank occurs)

Asset = Capital + External Liabilities

2,500 = 0 + 2,500

5. Mr. X Paid Rs. 8,000 to Creditors.

Assets (Cash Goes Out)

Liabilities (Reduction in amount to be paid to Creditors)

Asset = Capital + External Liabilities

(8,000) = 0 + (8,000)

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 Objective Type Questions

Q.1.Choose Appropriate Answer

1. The Basic Accounting Equation is Assets = External Liabilities +

__________
A. Drawings
B. Capital
C. Net Profit
D. None of the Above

2. The accounting equation should remain in balance because every

transaction affects how many accounts?
A. Only One
B. Only Two
C. Two Or More
D. None of the Above

3. Which of the following will not cause Assets to increase?

A. Owner‟s Drawings
B. Purchase of Goods on Credit
C. Sale of Goods on Cash
D. None of the Above

4. Which of the following will cause Liabilities to decrease?

A. Purchase of Goods on Cash
B. Sale of Goods on Cash
C. Repayment of Bank Loan
D. Purchase goods on Credit

5. Capital is the money borrowed from the

A. Creditor
B. Debtor
C. Supplier
D. Owner

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 Q.2.Tick on the Appropriate Column following the
Accounting Equation
1. The company purchases equipment with its cash.
2. The owner withdraws cash from the business for personal use.
3. The company purchases a significant amount of supplies on credit.
4. The company receives cash as a loan from a bank.
5. The company repays the bank that had lent money to the company.

No. Assets Total Liabilities

Increase Decrease No Effect Increase Decrease No Effect

1.
2.
3.
4.
5.

Q.3. Using the Accounting Equation formula, find the

Missing Figure
No. Assets Capital External
Liabilities
1. 50,000 ? 30,000
2. ? 60,000 10,000
3. 15,000 5,000 ?
4. 7,000 2,000 ?
5. ? 9,500 9,500

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Q.4. Solve the Following
1. Show the effects of Accounting Equation from the following transactions:
A. Mr. Shah started business with cash Rs.50,000
B. Mr. Shah purchased goods on credit Rs.10,000
C. Mr. Shah purchased Machinery on Credit Rs.15,000
D. Paid to Creditor Rs.5, 000.

2. Show the effects of Accounting Equation from the following transactions

A. Mr. Patel commenced business with Rs. 1, 00, 000
B. Mr. Patel bought loose tools of Rs. 20,000
C. Mr. Patel sold goods on Cash 15,000
D. Mr. Patel purchased goods on Cash 10,000

3. Show the effects of Accounting Equation from the following transactions

A. Mr. Mehta started business with Rs.10,000
B. He withdrew Rs.500 for personal use.
C. Paid Salary Rs.5,000
D. Purchased Goods on Credit 10,000

4. Show the effects of Accounting Equation from the following transactions

A. Mr. Parekh started business with 60,000
B. Paid for Repairs Rs. 1,050
C. Loan taken from Bank Rs. 15,000
D. Received interest Rs. 3,500.

5. Show the effects of Accounting Equation from the following transactions

A. Mr. Desai started business with cash Rs. 55,000
B. Purchased goods on credit Rs. 6,500
C. Paid to Creditor Rs. 5,000
D. Additional Capital Introduced in business Rs. 18,000

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 Answers
Q1.
1- B
2- C
3- A
4- C
5- D

Q2.

No. Assets Liabilities Liabilities

External Liabilities Capital
Increase Decrease No Increase Decrease No Increase Decrease No
Effect Effect Effect
1.

2.

3.

4.

5.

Q3.

1. 20,000
2. 70,000
3. 10,000
4. 5,000
5. 19,000

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Q4.

1. The first solution provides the Steps and method to solve the Problem
A. The accounting equation will be
Assets= External Liabilities + Capital
50,000(Cash) = 0 + 50,000

B. The Accounting Equation will be

Assets = External Liabilities+ Capital
50,000+ 10,000(increase in assets -goods) = 10,000(increase in creditors) + 50,000

C. The Accounting Equation will be

Assets = External Liabilities+ Capital
50,000+10,000+15,000(increase in assets-Machinery) = 10,000+ 15,000(increase in
creditors) + 50,000

D. The Accounting Equation will be

Assets = External Liabilities+ Capital
50,000-5,000(cash paid) + 10,000 + 15,000 = 10,000+ 15,000- 5,000(Decrease in
liabilities as paid to creditors) + 50,000

Therefore, The Accounting Equation will be

Assets = External Liabilities+ Capital
70,000= 70,000

Transaction Accounting Equation

Assets = External + Capital

Liabilities

A. Mr. Shah started business with 50,000 0 50,000

cash Rs.50,000

B. Mr. Shah purchased goods on 10,000 10,000 0

credit Rs.10,000

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C. Mr. Shah purchased Machinery 15,000 15,000 0
on Credit Rs.15,000

D. Paid to Creditor Rs.5, 000 (-)10,000 (-)10,000 0

65,000 = 15,000 + 50,000

2.

Transaction Accounting Equation

Assets = External + Capital

Liabilities

A. Mr Patel commenced business 1,00,000 0 1,00,000

with Rs. 1, 00, 000

B. Mr Patel bought loose tools of 20,000 0 0

Rs. 20,000
(-)20,000

C. Mr Patel sold goods on Cash 15,000 0 0

15,000
(-)15,000

D. Mr Patel purchased goods on 10,000 0 0

Cash 10,000
(-)10,000

1,00,000 = 0 + 1,00,000

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3.

Transaction Accounting Equation

Assets = External + Capital

Liabilities

A. Mr. Mehta commenced 10,000 0 10,000

business with Rs. 10,000

B. Withdrew for personal use Rs. (-)500 0 (-)500

500

C. Paid Salary Rs. 5,000 (-)5,000 0 (-)5,000

D. Purchased goods on Credit 10,000 10,000 0

Rs. 10,000

14,500 = 10,000 + 4,500

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4.

Transaction Accounting Equation

Assets = External + Capital
Liabilities
A. Mr Parekh started business with 60,000 0 60,000
60,000
B. Paid for Repairs 1,050 (-)1,050 0 (-)1,050

C. Loan taken from Bank Rs.15,000 15,000 15,000 0

D. Interest Received 3,500 3,500 0 3,500

77,450 = 15,000 + 62,450

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5.

Transaction Accounting Equation

Assets = External + Capital
Liabilities
A. Mr. Desai started business with 55,000 0 55,000
cash Rs. 55,000
B. Purchased goods on credit Rs. 6,500 6,500 0
6,500

C. Paid to Creditor Rs. 5,000 (-)5,000 (-)5,000 0

D. Additional Capital Introduced in 18,000 0 18,000

business Rs. 18,000

74,500 = 1,500 + 73,000

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 Hope you have enjoyed Learning

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