BASIC

ACCOUNTING
EQUATION
INFORMATION SHEET 1.1-4
BASIC ACCOUNTING EQUATION:

ASSETS = LIABILITIES + CAPITAL (OWNER’S EQUITY)

or

DEBITS = CREDITS
or

ASSETS = LIABILITIES + CAPITAL (-Drawing+Income-Expenses)

BASIC ACCOUNTING EQUATION:

ASSETS = LIABILITIES + CAPITAL (OWNER’S EQUITY)

RESOURCES CLAIMS ON THE RESOURCES

 The resources controlled by a business are referred to as its assets. For a new business those assets
originate from two possible sources:
1. Investors who buy ownership in the business
2. Creditors who extend loans to the business
 Those who contribute assets to a business have legal claims on those assets. Since the total assets of
the business are equal to the sum of the assets contributed by investors and the assets contributed by
creditors, the following relationship holds and is referred to as the accounting equation.
BASIC ACCOUNTING EQUATION:

ASSETS = LIABILITIES + OWNER’S EQUITY

+ Initial Contribution
+ Revenue
- Expenses
+ Gains
- Losses
+ Additional Contribution
- Withdrawals
The Accounting Equation – A Practical Example

Mike Peddler decides to open a bicycle repair shop. To get started he rents some shop
space for business. Here is a listing of the transactions that occurred during the first
month:
Date Transaction
 Sep 1 Owner contributes P7500 in cash to capitalize the business.
 Sep 8 Purchased P2500 in bike parts on account, payable in 30 days.
 Sep 15 Paid first month’s shop rent of P1000.
 Sep 17 Repaired bikes for P1100; collected P400 cash; billed customers for the
P700 balance.
 Sep 18 P275 in bike parts were used.
 Sep 25 Collected P425 from customers’ accounts.
 Sep 28 Paid P500 to supplies for parts purchased earlier in the month.
The Accounting Equation – A Practical Example
      ASSETS     = LIABILITIES + OWNER’S   EQUITY

ACCOUNTS ACCOUNTS PEDDLER REVENUE

  CASH + BIKE PARTS + = + +
RECEIVABLE PAYABLE CAPITAL (EXPENSES)

SEP 1 7500         =     7500    

SEP 8     2500     = 2500        

SEP 15 (1000)         =         (1000)

SEP 17 400       700 =         1100

SEP 18     (275)     =         (275)

SEP 25 425       (425) =          

SEP 28 (500)         = (500)        

Totals 6825 + 2225 + 275 = 2000 + 7500 + (175)

          P9325 = P9325        

Sep 1 Owner contributes P7500 in cash to capitalize the business.

Sep 8 Purchased P2500 in bike parts on account, payable in 30 days.
Sep 15 Paid first month’s shop rent of P1000.
Sep 17 Repaired bikes for P1100; collected P400 cash; billed customers for the P700 balance.
Sep 18 P275 in bike parts were used.
Sep 25 Collected P425 from customers’ accounts.
Sep 28 Paid P500 to supplies for parts purchased earlier in the month.
Note: The sum of entries under the “Assets” heading is equal
to the sum of entries under the “Liabilities + Owner’s Equity”
heading.
9 TYPES OF EFFECTS OF TRANSACTIONS:

 Increase in Assets = Increase in Proprietorship

 Increase in Assets = Increase in Liabilities
 Increase in Some form of Assets = Decrease in other forms of Assets
 Decrease in Assets = Decrease in Liabilities
 Decrease in Assets = Decrease in Liabilities
 Increase in Liabilities = Decrease in Proprietorship
 Increase in Some form of Liabilities = Decrease in other form of Liabilities
 Increase in Proprietorship = Decrease in Liabilities
 Increase in Some form of Proprietorship = Decrease in other form of Proprietorship