ACCOUNTING EQUATIOn

Meaning of Accounting Equation

Accounting equation is based on the Principle of Duality which states that for every debit, there is a
credit: It shows that resources are equal to the sources of finance of those resources. In other words,
Assets are equal to Liabilites plus Shareholder Equity.

Thus, Assets = Liabilites +_ Sharehodlers Equity

Assets reflects a firm investment decision and the mix of liabilities plus shareholder equity reflects a firm
financing decision. Thus, the aforesaid Accounting Equation may be expressed as follow

Total Assets = Total Equities

Assets = Shareholder Equity + External Equity

Assets = Capital + Liabilities

Assets are economic resource. An asset has the ability or potential to provide future benefit to the
firm. Liabilities are creditors claim on the assets of the company. Shareholder Equity reflects the claim
of the owner on the assets of the enterprise.

Development of Accounting EQYATUIB

1. Determine the variables (assets, Liabilities or capital) involved in the equation

2. Ascertain the effect of transaction on the variables in terms of increase or decrease
3. The effect of transaction is to be shown on the Equation
4. Ensure that at the end of each transition in a better way

Examples 1

Show the accounting equation on the basis of the following transition

1. Commended business with cash Rs. 50000

2. Purchased office equipment for cash Rs. 20000
3. Purchased goods for cash Rs. 5000 and credit Rs. 6000
4. Paid salary Rs. 2000
 5. Sold goods for cash Rs. 10,000
6. Sold goods on credit for Rs. 6000
7. Drew cash for personal use Rs. 2000

JOURNAL, LEDGER AND TRAIL BALANCE

Accounting Cycle

Accounting is the science and art of recording, classifying transactions and events of monetary nature,
summarizing these transaction and events and finally interpretation of results therefore by preparing
and presenting financial statements. Accounting cycle refers to the cycle which starts with recording
of opening entries in the Journal and ends with the preparation of financial statements. The following
steps are included in the accounting cycle.

i. Recording of opening entries in the Journal

ii. Recording of transactions n events in the Journal Proper (Journalization), Preparation of to
her Subsidiary books i.e Purchase Day book, Sale Day book, Purchase Return Book, Sales
Return Book and Cash Book
iii. Posting of Journal Entries in appropriate accounts in the Ledger
iv. Preparation of Trial Balance recording of closing entries to prepare financial statements
v. Preparation of financial statement , Income Statement and Balance Sheet to interpret the
results of financial transactions an events during the accounting period.

Transactions and events are recorded in the Journal in chronological order. Classification of accounts is
done in the ledger by assigning appropriate heads to various accounts. Accounts are balanced
periodically and the summarized balances are shown in “Trial Balance. Closing entries are passed for the
preparation of financial statements. In the last, financial statement s are prepared. Income Statement
is prepared to present the results of the operating activities of the firm for a specific time period.
Balance sheet is prepared to reveal the health of the business at the end of the specific time period.
Thus, the results of various transactions and events flow through the accounting system beginning with
the journalizing and ending with the preparation of financial statements.

Classification of Accounts

An accounts is summary of relevant transactions and events at one place under a particular head. It
records the amount of the transaction and also depict their effect and directions.

Classification of Accounts According to Traditional Approach

 1. Personal Accounts: accounts related to individual banks, financial institutions, firm, companies,
are known as personal accounts. The personal accounts are related to
a. Natural Personal Accounts: Accounts of individual (natural person) such as Ram , Sunil ,
Prasad, Alekya are natural personal accounts
b. Artificial Personal Accounts: Accounts of firms, companies, banks, cooperative societies
financial institutions are artificial personal accounts.
c. Representative Personal Accounts; The accounts related to outstanding expenses , prepaid
expenses, income received in advanced, accrued income are represented personal accounts
2. Real Accounts: Real accounts related to tangible or intangible assets. Tangible assets are one
( which can touched and seen) such as buildings, plant, furniture, cash, et. Intangible assets are
related to objects (which can neither be touched nor seen) and do not have any physical
example good will, trademarks, patents copyrights
3. Nominal Accounts The accounts related to income, expenses, losses and gains are classified as
nominal accounts for example, wages salaries, purchases sales discounts, commissions ets.

Classification of Accounts According to Accounting Equation

1. Assets Accounts: it related to tangible or intangible assets.

2. Liabilities Accounts: these accounts represent the financial obligations of the enterprise
towards outsiders. For example, trade creditors, bills payable, long term loans, bank overdraft.
Etc.
3. Capital Accounts: These accounts relates, to owners of an enterprise for example capital,
Drawings. Capital is the amount due by the enterprise to the owners Drawings relate to
amount withdrawn by the owner out of business resources for personal use.
4. Revenue Accounts: These accounts relate to amount earned by the enterprise by rendering
goods and services. Example sales , discount received , interest received, commission received
etc.,
5. Expenses Accounts: these accounts relate to the amount lost or incurred in the process of
earning revenue. For example Purchase account, discount allowed commission paid, loss by
theft account etc.

RULES OF DEBIT AND CREDIT

Debit refers to entering an amount on the left side of an account and credit means to enter an
amount on the right side of an account. In the abbreviated form. Dr. Stands for debit and Cr stands
for Credit . Both debit and credit represents either an increase or decrease depending upon the
nature of an account. The words Debit and Credit have no another meaning in account. Rules of
debit and Credit is based on Dual Aspects Concept and every accounting transaction would be
expressed by a debit amount and an equal and opposite credit amount.
The Rules for Debit and Credit are given

Person Accounts:

Debit = Debit the Receiver,

Credit = The Giver

Real Accounts

Debit : What comes in

Credit : What goes out

Nominal Accounts

Debit : Debit all expenses and loss

Credit : All incomes and gains.

Meaning and format of Journal

The first book in which the transactions of a business unit are recorded is called in Journal. Here,
business transactions are recorded n chronological order, i.e. in the order in which they occur.
Each record in a journal is called an entry . As a journal is the first book in which entries are
recorded, a journal is also knows as a book of original entry. A journal entry is an analysis of the
effects of a transaction on the accounts, usually accompanied by an explanation (properly called as a
narration). Therefore, a journal is a tools for analysis and describing the impact of various
transactions upon a business unit. Before a journal entry is passed, it is necessary to decide for
each transaction, what are the accounts involved,. It is also necessary, that the accounts to be
debited or credited are identified.

Journal books

1. Journal Proper
2. Cash book
3. Purchase book
4. Sales Day book
5. Purchase Return
6. Sales return
Formant of Journal

Date Particulars LF Debit Credit

Ruling of a Journal

In its usual form, a Journal is divided by vertical lines into five columns in which to enter, in respect of
each transaction

Date: in the date column, date is written on which transaction took place. It should be kept in mind
that journal records transactions in the order in which they occur, i.e chronological order, therefore
transactions must be recorded date wise. The year and month is written once, till they change.

Particulars Column in this column, the names of the accounts to be debited and then the names of the
accounts to be credited is written ‘Narration’ is also written which appear as parenthesis (in bracket). It
is a brief explanation of the transaction to be entered. It is written at the end of each journal entry.

LF( Ledger Folio Column): under this column, the page number of the ledger will be entered on which
the relevant accounts appears.

Debit Amount Column: Under this column, the amounts to be debited is written

Credit Amount Column: Under this column, the amount to be credited is written

Methods of writing up Journal

Step -1: Ascertain the accounts involved in the transaction

Setp -2: Ascertain the nature of the accounts involved

Step -3 Recall the ‘Rules of Debit and Credit’ of the accounts involved.

Step-4 Ascertain as to which accounts is to be debited and which account is to be credited.

Step -5 Record the date of the transaction in the Date Column

Step -6 Wire the name of the accounts to be debited very close to left hand side with the abbreviation
Dr on the same line in the extreme right hand side of Particulars Column. The amount to be debited is
written in the debit column in the same line against the amount debited.
Step -7 Write the name of the account to be credited in the next line. It should be preceded by the
word ‘To which should eb written a few steps towards right in the ‘Particulars column’ amount of the
account to be credited is written in the same line in the ‘Credit amount column against the account
credited.

Step -8 write the narration (brief explanation of the transaction) appearing as parenthesis in the ext
line in the Particulars Column

Step -9 Draw a line across the entire ‘Particulars Column to separate on entry from another. The line
should be drawn only in particular Column.

THE LEDGER

The ledger is the principal book of accounts where similar transaction relating to a particular person or
thing are recorded. The journal is used to record the transactions in the chronological order. The
owner of a business is not interest to know the effect of individual transaction on the financial
statements, what he wants is the accumulated effect of each ‘Chart of Accounts’ Chart of accounts is an
index to all accounts constrained in a double entry system. It allocates to each accounts a number oand
arranges accounts in logical subdivision. For example, if he wants to know the total purchases for an
accounting period, he will only see the Purchase account.

It is not possible to ascertain from the journal the total amount o purchases made. In the journal,
record of purchase made at different dates can be also be against cash or credit. Therefore, similar
transactions should be sorted out and consolidated at one place to ascertain their net effect. This kin d
of processing is possible where different accounts are prepared in the ledger. Again for example to
ascertain the cash position of a business, one is look at the Cash account; one can not know cash
position with the help of a journal Likewise, to ascertain net sales for the accounts period, one is to look
at the Sales Account, which incorporate all information with regard to cash sales, credit sales, and the
like. Therefore, an account represents a detailed record of changes that have occurred in a particular
asset, liability, expense, loss, gain or capital during an accounting period.

Utility of Ledger

i. It provide information about all the accounts in on book

ii. It is easy to ascertain that how much money business owes in his creditors and amount it
has to recover from its debtors form perosnl accounts
iii. It enables to ascertain the kind and value of assets from real accounts
iv. It enables to ascertain the sources of income and the amount spend on various items as
heads of expenses from nominal accounts
v. It facilitates the preparation of financial statements.
Relation ship between Journal and Ledger

Both Journal and ledger are the important books under Dual Entry System of Book keeping. The are
different, yet closed related to each other.

i. The Journal is a book of Prime entry or original entry. The transaction are first recorded in
the journal, then they are posted to the ledger, thus ledger serves as book of secondary
entry or final entry. The journal is the starting point, while ledger is the destination.
ii. Journal records transition on the basis of source documents, while the ledger records
transactions on the basis of journal, thus journal serves as an input for the transaction
posted in the ledger.
iii. Journal records transactions in the chronological manner, while the ledger records
transaction in a classified and analytical manner
iv. The process by which transaction are recorded in the journal is termed as ‘Journalizing
while the process of recording transaction in the ledger is termed as Posting.
v. Journal becomes the basis for ledger which serves as the basis for preparation of final
statements.

FORMAT OF LEDGER ACCOUNT

Name of the Account (Account Title)

Ledger Folio No….

Dr Cr

Date Particular JF Amount Date Particulars JF Amount

To By

Date Column: It records the year, month and day of the transaction
Particulars Column: the source of transaction is indicated by specifying the name of account included
in t Journal. The word ‘To is prefixed to the debit side entries and the word ‘By’ is used before the
credit side entries.

Journal Folio Colum: The page number of the journal from which the entry has been transferred is
written.

Amount Column: the amount mentioned in the journal for a particular accounts is written

POSTING: posting gis the process of transferring the transaction recorded in the books of original entry
to the concerned accounts in the ledger, it is necessary to ensure that the exact names of account used
in the journal should be carried ot the ledger. Posting may be done at any time, however it is better to
posit the transaction without delay. It may be done daily, weekly, fortnightly or months according to
the requirement of the business enterprise.

BALANCING OF AN ACCOUNT

Balancing is the process of equalizing the two sides of the account, by which net balance of the account
after considering the total of both debits and credit of an account, is ascertained. The debit and credit
refer to the debit amount column and credit amount column respectively of an account. Sometimes,
the amount on the debit and credit side will be equal to each other.

When the total of debit side is greater than the total of credit side, it indicated ‘Debit Balance” while
the Credit Balance shows the total of credit side being greater than the total of debit side. IF the sum
of debits equals the sum of credit, it is a closed account and the account is said to have no balance.

The balance is put on the side of the amount which is smaller by giving a reference of balance using
carried forward (c/f or c/d) to the next period. On the other hand, the balance is brought forward and
brought down (b/f or b/d) from the previous period while opening and account in the next period