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ACCOUNTING
EQUATION
CHAPTER 1
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2 LEARNING OUTCOMES

• Explain the meaning of assets, liabilities and owner’s equity

• Explain and apply the accounting equation.
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3 ASSETS

• An asset is a resource controlled by the business as a result of a Past transaction

and from which future economic benefits are expected to flow in to the
business.
E.g.: Furniture
Stocks/ Inventory
Debtors/ Trade Receivables
Cash
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4 LIABILITIES

• The economic value of an obligation or debt that is payable by the

enterprise to other establishment or individual is referred to as liability.
• E.g.: Trade Payables / Creditors
Bank Loans
Bank Overdrafts / Short term loans
Accrued Expenses
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5 OWNER’S EQUITY

• The value of owners assets is called Equity.

• Owner's equity represents the owner's investment in the business minus
the owner's draws or withdrawals from the business plus the net
income (or minus the net loss) since the business began.
• Owner's equity is viewed as a residual claim on the business assets
because liabilities have a higher claim. Owner's equity can also be viewed
(along with liabilities) as a source of the business assets.
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6 ACCOUNTING EQUATION
Introduction – Definition
• Accounting Equation shows the relationship between Assets and the
Ownership of those Assets
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7 CONSTRUCTING THE ACCOUNTING EQUATION –

WITH EXAMPLES
• At the inception of a business the Accounting Equation consists of Only Two elements:
Assets and Equity.The reason is, at the beginning, all Assets are financed by the Owner.
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• When the business starts to expand, the resources invested by the owner won’t be
8 sufficient to run the business. A sole proprietor can raise capital by taking out loans to
support the business. He can either bring additional capital by himself or he can obtain a
loan from a third party.
• If the owner approaches a third party (A Financial Institution or a Lender) and obtained a
loan, a Liability would arise in the business. This liability is also called Debt Capital. When
the business obtains a loan to finance the business’s Assets, the Accounting Equation
expands as follows,
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9 THEREFORE THE BASIC ACCOUNTING EQUATION

IS,

A=L+E
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10 ACCOUNTING EQUATION AND TRANSACTION

ANALYSIS

• Andrew started a business to repair computers. The following transactions are given to
you for the first month of the business.
1. Invested $5 000 as the capital.
2. Obtained a bank loan of $2 000.
3. Deposited $1 000 in the bank.
4. Earned a cash income $60 from computer repairs.
5. Paid $100 as the monthly rent of the business
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11 1. Invested $5 000 as capital.

Capital  Cash $ 5 000

Assets purchased
All the assets in the computer repair business = Owner’s money + Any Liabilities
A=E+L
$ 5000 (Cash) = $ 5 000 (Equity) + 0
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All the assets in the computer repair business = Owner’s money + Any Liabilities

A =E +L

1. $ 5000 (Cash) = $ 5 000 (Equity) 0

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2. Obtained a bank loan of $2 000.

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Goes to the bank and gets a loan

Gets $2 000 (cash)

The total
assets would
Invests it into now increase
the business to ?
All the assets in the computer repair business = Owner’s money + Any Liabilities
A=E+L
$ 5000 (Cash) = $ 5 000 (Equity) + 0
$ 2 000 (Cash) = 0 + $ 2 000 (Bank Loan)
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All the assets in the computer repair business = Owner’s money + Any Liabilities

A =E +L

1. $ 5000 (Cash) = $ 5 000 (Equity) 0

2. $ 2 000 (Cash) =0 $ 2 000 (Bank Loan)
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3. Deposited $1 000 in the bank.

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Goes and deposits in the bank

Takes cash
from the
business

What would happen to

the cash reserves in
the business now?
Increase or decrease?
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All the assets in the computer repair business = Owner’s money + Any Liabilities

A =E +L

1. + $ 5000 (Cash) = + $ 5 000 (Equity) 0

2. + $ 2 000 (Cash) =0 + $ 2 000 (Bank Loan)
3. - $ 1 000 (Cash)
+ $ 1 000 (Bank)
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4. Earned a cash income $60 from computer repairs.

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Provides
services for a
fee

Boosts profits 
Increases Owners Earns an
Equity income

Equity increases Cash Asset increases

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All the assets in the computer repair business = Owner’s money + Any Liabilities

A =E +L

1. + $ 5000 (Cash) = + $ 5 000 (Equity) 0

2. + $ 2 000 (Cash) =0 + $ 2 000 (Bank Loan)
3. - $ 1 000 (Cash)
+ $ 1 000 (Bank)
4. + $ 60 (Cash) = + $60 (Income)
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5. Paid $100 as the monthly rent of the business

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A =E +L
1. + $ 5000 (Cash) = + $ 5 000 (Equity) 0
2. + $ 2 000 (Cash) =0 + $ 2 000 (Bank Loan)
3. - $ 1 000 (Cash)
+ $ 1 000 (Bank)
4. + $ 60 (Cash) = + $60 (Income)
5. - $100 (Cash) = - $100 (Rent expense)
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20 PRACTICE QUESTION
• The following balances were shown as at 01.07.2019 of John’s business.
1. Owner invested $ 2 000 as capital
2. Obtained a bank loan for $ 1 000 from Lloyds Bank
3. Purchased goods at Rs. 100 000 on credit
4. Paid Rs. 50 000 to creditors
5.Received Rs. 70 000 from debtors
6. Paid Rs. 5 000 from business for the electricity bill
7. Paid $300 bank loan installment including $10 as the interest expense.
8. Received sales commission income of Rs. 10 000
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21 REQUIRED,
• Indicate the transactions in the basic Accounting Equation.
• State whether each transaction has increased/decreased/no change in the
accounting elements of the equation. Use the format given below.
Transaction Assets Equity Liabilities
Number
1
2
3
4
5
6
7
8
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22 SITUATIONS THAT CHANGE THE EQUITY

• By studying the above facts, you may have understood the transactions that affect to
increase or decrease the owner's equity. The following transactions affect to change the
equity of the business.
1. Introduction of additional capital
2. Drawings
3. Income
4. Expenses
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23 DRAWINGS

• Drawings means, the owner taking cash or stocks/goods of the company

for his personal use.
• Drawings are of 2 types,
Cash Drawings
Goods Drawings
• Drawings reduces the owner’s Equity. Drawings is not considered as an
expense to the business. It only reduces the Equity and Assets.
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24 PAST PAPER QUESTIONS