LEARNING OBJECTIVES > Todiscuss the Accounting Equation. > To know the rules of Accounting Equation. > To Know the Effects of Business Transactions on Accountirg Equation and Balance Sheet. Introduction ee The whole of financial accounting is based on the accounting equation. For a firm to operate resources are required and these resources are to be supplied to the firm by someone, The resources possessed by the firm are known as assets and obviously some of the resources will have to be supplied to the firm by the owner of the business. The total amount supplied by him is known as his capital. If he was the only one who had supplied the assets then capital must be equal to assets On the other hand, some of the assets will normally have been provided by someone other than the owner. The indebtness of the firm for these resources is known as liabilities. The capital must be equal to assets minus liabilities. The two sides of equation are, therefore,equal. On the one side are the resources possessed and on the other side are the sources from which these resources w obtained. The equity of the two sides will always be true, no matter how many transactions are entered into. The actual assets, capital and liabilities may change but the equality of the assets with that of the total of capital and liabilities will always hold true. Capital is often called the owner's equity or net worth. Accounting Equation American accountants have derived the rules of de! accounting equation which is given below : Assets = Eq) it and credit through2 i ACCOUNTING EQuAToy ‘The equation is based on the principle that accounting deals with property and yj ii d is equal to the sum of the rights t, te property and the sum of the PrePrr business are called assets and the rights! )perties. The properties owned Lb eer fare known as liabilities or equities of the business. one ee Equities may be divided into equities of creditors representing debts of the busines, known as liabilities and equity of the owner known as capital. Keeping in view the ty, types of equities the equation given above can be stated as usd a ‘Assets = Liabilities + Capital ; or Capital = Assets — Liabilities ; or Liabilities = Assets _ Capital Rules of Accounting Equation 1 Regarding assets ; fue in assets are debits and decreases in assets are credits. 2. Regarding Liabilities Bor ; Increases in liabilities are credits and decreases in liabilities are debits, 3. Regarding Capital Increases in capital are credits and decreases in capital are debits 4. Regarding Expenses Increases in expenses are debits and decreases in expenses are credits. 5. Regarding Incomes or Profits Increases in incomes or profits are credits and decreases in incomes or profits are debits. ISTRATION 1 You are required to complete the gaps in the following table : Assets Liabilities Capital z z z @ 25,000 3,600 ? ) 56,000 9,800 2 © 33,600 ? , ? 25,000 @ 39,200 2 32 an 0) 2 12,600 38,400 ” 2 23,300 79,500 SOLUTION : With the help of Accounting Equation ie. Capital + Liabilities = Assets or Capital = Assets — Liabilities or = Assets ~ Capital The table in the illustration is completed : Assets = Liabilities * Capital z z z if pee 3,600 21,400 x 9,800 (9) 33,600 8,600 ea 25,000If sll Me re i ie 1, Hitesh started business 6. Paid rent 3,000 swiabieash 2,50,000 7. Received interest 1,000 2, Purchased goods on credit 24,000 8. Sold goods on credit 3, Purchased goods for cash 4,000 (cost & 1,500) 1,700 4, Purchased furniture for cash 1,500 9. Paid to creditors 4,000 5, Withdrew for private use 1,000 10. Paid salaries 2,000 Transactions __ Hitesh starts business with cash % 2,50,000 2.| Purchases goods on credit for = 24,000 New Equation 3.| Purchases goods for cash for ® 4,000 New Equation 4.| Purchases furniture, for cash for € 1,500 New Equation 5.| Withdraws cash for private use € 1,000 New Equation 6.| Pays rent ¢ 3,000 New Equation 7.| Receives interest = 1,000 New Equation B.| Sells goods costing ® 1,500 for ® 1,700 on credit New Equation 9.} Paid to creditors € 4,000 New Equation 10.| Pays salaries % 2,000 New Equation ILLUSTRATION 3 how the Arvind had the following transactions : Use acco on his assets, liabilities and capital : (a) Started business with ¥ 15,000. ‘Accounting Equation : Assets = Liabilities + Capital 2,50,000 24,000 2,74,000 (+) 4,000 () 4,000 2,74,000 (+) 1,500 (-) 1,500 2,74,000 (1,000 2,73,000 (3,000 2,70,000 (+) 1,000 2,71,000 (-) 1,500 (+) 1,700 2,71,200 (-) 4,000 ” 2,67,200 (-) 2,000 2,65,200 ‘Assets = Liabilities + Capital uunting equation te 2,50,000 2,50,000 o + 0 2,50,000 24,000 + o + 0 24,000 + o + 2,46,000 o + (+) 200 (Profit) 24000 + 247,200 ()4,000_+ __0 20,000 + 2,47,200 On + 7 )2,000 30,000 2,45,200(6) © @ () (a) Purchased securities for cash € 7,500. Purchased a building for & 15,000 giving % 5,000 in cash and the balance aloan. Sold securities costing = 1,000 for = 1,500. Purchased an old car for & 2,800 cash. Received cash % 3,600 as salary. Paid Cash % 500 for loan and % 300 for interest. Paid cash for household expenses % 300. Received cash for dividend on securities % 200. ACCOUNTING EQUATION Assets = Started business with 7 15,000 Purchased securities for cash = 7,500 New Equation Purchased a building for & 15,000 giving 5,000 in cash and the balance through aloan New Equation Sold securities costing 7 1,000 for = 1,500 New Equation Purchased an old car for 7 2,800 cash New Equation Received cash as salary New Equation Paid cash 500 for loan and = 300 for interest. New Equation Paid cash for household expenses ¢ 300 New Equation Received cash for dividend on securities ¢ 200 New Equation z 15,000 = 7,500 = 7,500 = (+) 15,000 = ©) (+) © 15,000 = 5,000 = 25,000 = 1,500 = 1,000 = “roa (+) © 25,500 2,800 = 2,800 = 25,500 =AVak a EQUATION oo aye 1] 1, 2021 Rajesh started a business and deposited © 50,000 in Bank Account first Recounting Equation will be as follows The Assets Cash at Bank % 60,000 Capital Rajesh’s Capital © 60,000 I Balance-sheet of the business would appear as under : ‘The initial BALANCE-SHEET OF MR. RAJESH as on April 1, 2021 Liabilities c Assets T : Rajesh’s Capital 50,000 | Cash at Bank | 50,000 purchase of an Asset by Cheque (On Srd April, 2021 Rajesh buys a building for * 30,000. The effect of this tran js that the Cash at Bank is decreased and a new asset building appears. The Account Equation will be as follows Liabilities + Capital = Assets Rajesh’s Capital € 50,000 = Cash at Bank * 20,000 + Building * 30,00¢ After the transaction the Balance Sheet will appear as under BALANCE SHEET OF RAJESH as on 3rd April, 2021 Liabilities | ue Assets c Rajesh’s Capital 50,000 | Cash at Bank 0 Building On 6th April, 2021, Rajesh buys some goods for % 5,000 from Dass ani pa them sometime within next two months. The effect of this is that a new 8 stock goods, is acquired and a liability for the goods is created. The Accounting Equation : Liabilities + Capital Creditors + Rajesh’s capita ash at Bank + Building + Stock of 5,000 + % 50,000 = & 20,000 + & 30,000 + & 5,000 After this transaction, the Balance Sheet will be as under : BALANCE SHEET OF MR, RAJESH as on 6th April, 2021 ______ Dabiities t Assets e Creditors Cash at Bank 20,000 Aajest’® Capital 50,000 | Stock of Goods S000 Building 30,000 55,000 $5,000. Hitesh for thy 00 were sold to © Sam, Ont = ich had cost & 1,000 were | tock of good: amount; a4 era a : paid Eine effect is a reduction in the stock of goods ang the creation of a new asset. The Accounting Equation : Liabilities + Capital = Assets. Creditors + Rajesh’s Capital = Cash at Bank + Building + Stock of Goods + Debian — rs + Rajesh’s = = 1,000 5 % 5,000 + € 50,000 = ¢ 20,000 + & 30,000 + © 4,000 . _ g After this transaction, the Balance Sheet will be as f° F ‘SH NCE-SHEET OF mA. RAJE! aes as on April 10, 2021 r Liabilities z| Assets a: 5,000 | Cash at Bank 20,009 Rajesh Captal 50,000 | Stock of Goods ‘aa , ; Debtors 1000 ! Building | soon F 55,000 | Sale of an Asset for Immediate Payment On 13th April, 2021 goods which had cost € 500 were sold to Dalal for the same amount; Dalal paying for them immediately by cheque. Here one asset stock of goodsis reduced, while another asset, cash at bank is increased. The Accounting Equation : Liabilities + Capital = Assets (Creditors + Rajesh’s Capital = Cash at Bank + Stock of Goods + Buildings + Debtors 5,000 + £50,000 = 20,500 + € 3,500 + 30,000 + % 1,000 After this transaction the Balance Sheet will appear as under : BALANCE-SHEET OF MR. RAJESH as on 13th April , 2021 Liabilities Assets i Creditors Cash at Bank 20,500 Rajesh's Capital Stock of Goods 3,500 Debtors. 1,000 Building 30,000 [55,000 | Sm Payment of a Liability _ On 15th April, 2021, Rajesh Bave a cheque for & 2,000 to D. amount owing, The asset of bank is, therefore, reduced and th, ass in part payment of the e liability of the creditor ©oR] 8/8883]. / AS een ee ee yy uation —— s+ Capital = Assets =Cash at Bank + Stock of goods + Debtors + Building + (® 1,000) + (& 30,000) inbilitie wap ‘s Rajesh’s Capital oreo) + (50,000) = (® 18,500) + (% 3,600) is transaction the Balance Sheet will appear as under : BALANCE-SHEET OF MR. RAJESH 18 on 15th April, 2021 After thi ——awe || Assets z en 9) | 3,000| Cash at Bank 18,500 Ca Cophal 50,000 | Stock of Goods 3,500 Rajesh Debtors 1,000 Building 30,000 53,000 on 30 Hitesh who owed Rajesh % 1,000 makes a part payment of ® 750 by cheque April, 2021. The effect is to reduce one asset, debtor, and to increase another a at bank. ‘Accounting Equation SS Liabilities + Capital = Assets Creditors + Rajesh’s Capits (© 3,000) + (% 50,000) After this transaction, the Balance Sheet will be as under: BALANCE-SHEET OF MR. RAJESH as on 30th April, 2021 sh at Bank + Stock of Goods + Deb (% 19,250) + (® 3,500) Liabilities HE z Assets | Creditors 3,000 | Cash at Bank | 19.25 Rajesh’s Capital 50,000 | Stock of Goods | Debtors. |_| Building 53,000 tems. Tt can be seen that every transaction has affected two changed two assets by reducing one and increasing the other. Other tim differently. a UL de ee s it has reacted Show the Accounting Equatior transactions 1 on the basis of the following ¢ 10,000 Paid ‘o creditors (i) Mohan commenced business (vi) 9 with 70,000 (vii) Sold goods on credit for 15,000 (ii) Withdrew for private use 1,700 (viii) Sold goods for cash 7, (iii) Purchased goods on credit 14,000 (Cost price was © 3,000) fon fiv) Purchased goods for cash 10,000 (wx) Purchased furniture for 5 300 (v) Paid wagesACCOUNTING EQUATION Assets [Stock of Goods | Debtors Cash 15,000 15,000 Show the Accounting 2021 (a) Started business with cash (6) Paid rent in advance & 400, (c) Purchased goods for cash 7 and on credit & 2,000. (d) Sold goods for cash ® 4,000 (costing % 2,400). (e) Rent paid ® 1,000 and rent outstanding @ 200, 15,006 Equation for the following tr 73,000 insactions of Hitesh for the year €18,000. (Bought motor-cycle for personal u 7 8,000. (@) Purchased equipments for cash ¢ 500 (h) Paid to creditors % 600. (Depreciation on equipment & 25 Business expenses & 400 5,000200 1,400 9.975 400 4,600 otal 200 + 1,400 + 9,975 = 11,575 6,100 + 400 + 4,600 + 475 = Sometimes, it is required to find out the profit or loss by comparing the two capital palances i.e. at the beginning and the closing. Suppose, if capital at the beginning is % 10,000 and capital at the end is 7 15,000. Then if there are no other transactions the difference in capital & 5,000 (i.e. 15,000 - = 10,000) is to be treated as profit for the period. But if there are other transactions, for example some loan has been taken by the firm, some amount has been withdrawn by the proprietor for his personal use or some more amount of capital has been introduced, in that case the following procedure is to be adopted : Closing Capital = Closing assets — Closing liabilities Profit = Closing Capital — Opening Capital (if no other transactions are there) or Profit = Closing Capital + Drawings — Additional Capital — Opening Capital or Opening Capital = Closing Capital + Drawings — Additional Capital — Profit This will be more clear from the following illustrations ILLUSTRATION 6 Z 1,00,000 and a loan of ¢ 50,000 Ram started a business on 1-4-2020 with capital of a f borrowed from Shyam. On 31-83-2021 his assets were % 4,00,000. Find out his Capital as on 1-3-2021 and profit made or loss incurred during the 1 SOLUTION Closing Capital year is — Closing external liabilities = Closing asset: Joan trom Shyam) = % 4,00,000 — 2 50,000 (i.e, Profit = Closing Capital - Opening Capital = @ 3,50,000 - % 1,00,000 = € 2,0,000 = © 3,50,000[tee id Ram started a business an 1-4-2020 with a Capital of = 1,00,000 ang al £50,000 borrowed from Shyam. During 2020-21, he has introduced additional Qgpi¢ ses. On 31-3-2021 }, tal y ithdrawn % 20,000 for personal expense: c lag ace Ear out his Capital as on 31-3-2021 and profit made or loss incu during the year 2020-21. SOLUTION it it it - bilities Closing Capital = Closing assets - Closing external lial i % 4,00,000 - ¥ 50,000 =% 3,50,000. Closing Capital + Drawings — Additional Capital - Opening Capital %3,50,000 + % 20,000 - % 40,000 - @ 1,00,000 =% 2,30,000 Profit ILLUSTRATION 8 On 31-3-2021, the total assets and external liabilities were = 4,00,000 and & 20,00) respectively. During the year, the proprietor had introduced additional capital € 40g and withdrawn 7 15,000 for personal use. He made a profit of ¢ 20,000 during the yea, Calculate capital on 1-4-2020. SOLUTION Closing Capital = Closing Assets - Closing external liabilities = 4,00,000 - 2 20,000 = % 3,80,000 it i = ic | — Profits Opening Capital = Closing Capital + Drawings — Additional Capital = % 3,80,000 + % 15,000 - % 40,000 - @ 20,000= ¢ 3,35,000 ILLUSTRATION Give one example for each of the following types of transactions. (®) Increase is one asset, decrease in another asset. (i) Increase in asset, increase in liability (ii) Increase in asset, increase in owner's capital (i) Decrease in asset, decrease in liability (v) Decrease in asset, decrease in owner's SOLUTION capital. () Machinery purchased for cash : Increase in machinery and decre, Machinery purchased on credit : Increase in machinery and incre Capital introduced by the proprietor : Increase in cash and increa: Payment to creditors by cash : Decrease in cash and decrease ir Cash withdrawn by the proprietor : Decrease in cash and decrea ase in cash ase in liability se in owner's capital. n creditors. se in owner's capital. QUESTIONS (ES meaning of Accounting fundamental accounting Ww 1, Explain in short the 2. Describe the related to it ? quation, equation. How are revenue and expense account| Me Le aa B cyleolone] poof eS. AS 3 of of : qrnat is owner's equity ? Give an equation for calculating owner's equity? Give two amples at least. {You are required to complete the gaps in the following table nets Liabilities Capital z © g (@) _1:10,000 33,800 2 © ? 34,400 68,800 @ 72,200 57,000 (@ 239,000 30,800 2 (@ 1,76,000 2 1,24,000 2 98,000 2,20,000 o ? [la) € 76,200 (b) © 1,08,200 (c) © 15,200 (d) @ 2,08,200 (c) & 52,000 (P) 3,18,000). ‘Total assets of A on 31st March 2021 were ® 51,000. His liabilities were : Creditors 2 5,000 Fock Overdraft © 9,000. Bills payable % 7,000 outstanding wages % 2,000. Calculate his capital as on that date. [= 34,000] (a) Astartsa business and invests % 30,000 on 1-4-2020. On 31 March, 2 are ¢ 45,000 and liabilities € 5,000. Find out the amount of capital on 31 find out his profit. (@) In respect of above, if the proprietor had invested ¢ 3,000 as additional capital, what will be your answer for profit ? (©) IfA had withdrawn from his business this case. [(a) = 40,000, = 10,000 ; (6) = 7,000; (e) % 12,000]. (@) Ahad a capital of € 45,000 on 31-3-2021. He had also goods amounting 5,000 for personal use, find out the profit in Z 25,000 which he had purchased on credit and the payment had not been made. Find out the value of the assets. [= 70,000] @ After a period of one month, he came to know that he had suffered a loss of € 2.500 sets of the He withdrew = 1,500 for his personal use. Find out his capital and business. IF 41,000 and ¢ 66,000] (a) Raj started a business on 1-4-2020 with a capital of ¢ 20,000 and he from a friend. He earned a profit of ¢ 10,000 during 2020-21 and withdrew cash 7 5,000 for private use. What is his capital on 31-3-2021? [% 25,000) (©) Mohinder started a business with a capital of € 25,000 on 1-4-2020. During hhe made a profit of % 10,000. He owes € 12,000 to suppliers of goods What of assets in his business on 31-3-2021 ? [? 47,000) Complete the columns to show the effects of the borrowed T the year, he total following transactions Assets Liabilities. Capital t & 5,000. (a) Bought a motor van on credit Singh © (b) Repaid by cash a loan owed to P. 10,000. (c) Bought goods for 7 1,500 paying by cheque. (d) The owner puts a further © 50,000 cash in the business. (©) A debtor returns to us € 800 goods. We agree to make an allowance for them.ACCOUNTING EQUATION (PD _ Bought goods on credit & 2,200. (g) The owner takes out © 1,000 goods for his personal use. (h) We pay a creditor ¥ 1,900 by cheque. Ans. [(@) + Motor Van + Creditors (&) —Cash—Loan (c) + Stock — Bank (d) + Cash + Capital x (©) + Stock — Debtors (P +Stock + Creditors (g) -Stock - Capital (h) — Creditors — Bank). 10. Shyam started a business on 1-4-2020 with a Capital of € 1,5 borrowed from Shyam. On 31-3-2021 has assets were ® 6,00,000. Find out his Capital on $1-8-2021 and profit made or loss incurred during the year 2020-21 Ans. [Closing Capital ¢ 5,25,000, € 3,75,000]. 11, Ram started a business on 1 0,000 and a loan of & 75,000 0 with a Capital of € 4,00,000 and a Ioan of ® 2,00,000 borrowed from Shyam. During the year 2020-21, he has introduced additional Capital Rs, 1,60,000 and has withdrawn © 80,000 for personal expenses. On 31-3-2021 his assets were % 16,00,000. Find out his Capital on 31-3 year 2020-21 Ans. [Closing Capital ¢ 14,00,000, Profit © 9,20,000]. 2021 and profit made or loss incurred during the 12. On 3$1-3-2021, the total assets and external liabilities were & 2,00,000 and % 10,000 respectively. During the year, the proprietor had introduced additional Capital of ® 20,000 and withdrawn 7,500 for personal use. He made a profit of € 10,000 during the year. Calculate Capital on 1-4-2 ‘Ans. [Closing Capital ¢ 1,90,000, Opening Capital ¢ 1,6 001. tions owner's Capital. —\ sset and decrease in liabilitie 1S. Give an example of each of the following types of trans: (@ Decrease in ase in in one asset and decrease in another asset \ (iv) Increase in asset and incre (e) Increase in 3 et and decrease e in owner's Capital. ity sset and increase in liat (ci) Increase in one liability, decrease in another liability Brae aaa usie 1. What is Accounting Equation ? Explain with suitable examples. © “Accounting Equation is true under all circumstances”. Justify this statement with the help of five illustrations. 3. Mention the different ways in which transactions may affect assets, liabilities and owner's funds. Give reasons in support of your answer ? seets and liabilities are claims in favour of and against of a business.” Discuss fully this statement with imaginary figure 5S What is an accounting equation ? Illustrate its mechanism by imaginary figures to prove that the two sides of the equation are always equal (UUM. PRACTICAL PROBLEMS 1. Show the accounting equation on the basis of the following transactions : ted business with % 25,000 ; (ii) Purchased goods from Shyam on credit ) Sold goods to Sohan (costing € 1,500) for €1,800 on creditoe 0 EQUATION 2, Prepare accounting equation on the basis of the following (Rahim started business with cash 7 20,000. (i) Rahim purchased furniture for cash ¥ 2,000. (iii) Rahim paid rent ® 200. (iv) Rahim purchased goods on credit ® 3,000. (v) Rahim sold goods (cost price % 2,000) for 7 3,000 on cash ‘Ans. [% 23,800]. ; me 3. Prove that the Accounting Equation is satisfied in all the following transactions of Suresh (i) Commenced business with cash ® 60,000. DS (ii) Rent paid in advance & 500. (iii) Purchased goods for cash % 30,000 and credit ? (iv) Sold goods for cash % 30,000 costing @ Ay na (v) Paid salary 500 and salary outstanding % 100. (vi) Bought motor-cycle for personal use 2 6,000. Ans. [84,000]. 4. Calculate total equity if— (@) Owner's equity is 60,000; (ii) Equity of creditors is 7 50,000; (iii) Revenue during the period is 7 70,000; (iv) Expenses during the same period are 7 Also calculate revised owners’ equity. Ans. [% 1,10,000 ; Revised Owner's Equity * 65,000 ; Revised Total Equity 7 1,15,000}. 5. Show the Accounting Equation on the basis of the following transactions (® Raj started business with cash 25,000 (vi) Paid salaries ' (ii) He purchased goods on credit 7,000 (vii) Received cash from Rajesh (iii) He sold goods for cash, costing (viii) Withdrew cash for private use 000. % 2,800 3,200 (ix) Received rent from tenants (iv) Purchased furniture for cash (x) Purchased goods from Murli (v) Sold goods to Rajesh on credit for cash 1,50¢ costing 7 300 600 Ans. [% 32,650]. 6 Show the Accounting Equation on the basis of the following transactions (a) Rajesh started business (Pp Business expenses 700. with cash & 9,000. (@) Goods worth € 400 taken from ss pment for business for personal use. ero (h) Depreciation on equipment € 200. (d) Paid % 300 to creditors. Gj) Rent outstanding ® 200. (e) Sold goods for cash ® 2,000 (Cost price 2 1,200). Ans. [® 10,850]. Ai, 7, Bam starts reat sos have been recored (a) Paid three months advance rent for of () Bought office car % 42,000. with a cash investment of € 70,000. Following {fice accommodation € 4,200. % 14,000. Standard Supply Company © 6,000. (c) Purchased office furniture (d) Bought office type-wFi iter fromCag ACCOUNTING EQUATION (©) Sold extra office furniture at Cost to Amar for ® 2,000. Amar paid ? 1,200 in cash ang accepted a bill at three months for the balance. : (P) Amar paid the amount of the bill at maturity and Ram paid half the amount he owned to Standard Supply Company. (@) Collected ® 12,000 as commission. (h) Paid telephone bill amounting to 300. Work out the effect of the foregoing transactions on the equity of Ram through the Accounting Equation [= 84,700) Arvind had the following transactions. Use accounting equation to show their effect on his ‘assets, liabilities and capital. (a) Brought ® 45,000 in cash to start business. (b) Purchased securities for cash % 22,500, (©) Purchased an office building for % 45,000 giving ¥ 15,000 in cash and the balance through a loan, (d) Sold securities costing ¢ 3,000 for & 4,500 (e) Purchased an old car for * 8,400 cash. D Received cash for rent 10,800, (@) Paid cash € 1,500 for loan and ® 900 for interest (h) Paid cash for office building expenses ® 900 (@ Received cash for dividend on securities € 600. [F 84,6001.