PRINCIPLES OF

ACCOUNTING

Accounting Equation

Narmada Balasuriya
B.Sc. Accounting (Special) – USJ, CIMA (UK)
Department of Accounting and Finance
Faculty of Business
What are the elements in accounting?

• Assets
Basic Accounting
• Liabilities Equation
Expanded
• Equity/Capital Accounting
Equation

• Income

• Expenses

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What are the elements in accounting?
Assets Assets are the resources which are used by the business for its business activities (e.g. property,
equipment and cash).
Assets can be used to earn future economic benefits.
Current assets vs. Non-current assets

Liabilities Liabilities represent the debts of the business – i.e. what is owed by the business to others.
These may be short-term debts which are to be repaid soon (current liabilities) or long-term
debts (non-current liabilities) which may take many years to settle.

Capital/Equity Resources supplied to the business by the owner(s) of the (or equity) business. This capital
could be in the form of money or as other assets. Profits earned from the business and losses
incurred will belong to the owners adjusted to capital or equity.
Income Earnings from goods sold or services provided by the business to customers (E.g. sales revenue
and service income)
Also includes other incomes and gains earned from transactions other than normal business
activities. These may include interest income, rent income, discounts received and other
income.

Expenses Expenses represent the benefits consumed by the business.

E.g.: rent, electricity, insurance, salaries and wages, purchases, stationary etc.
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Let’s talk a bit more about capital/equity

• Equity refers to the ownership of the owners. Or the value of the owner’s interest in the entity.

• Equity increases when the owner invests more in the business.

• When the business earns incomes- equity increases.

• Equity decreases when the owner takes away funds or goods for personal use (drawings)

• Equity decreases when it has to bear expenses.

• Equity is calculated as follows.

• 100,000 +50,000 -10,000+100,000-80,000 =160,000

Equity = Opening Capital + Additional Capital – Drawings + Revenue – Expenses

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Let’s talk a bit more about capital/equity

• Diana is the owner of DB Decors. She invested Rs.700,000 in her business and started business activities.

During the first year she again invested 200,000 more in the business. She took away Rs.20,000 worth goods

for personal use. At the end of the year, Diana identified that the business has recorded a profit of Rs.50,000.

What is the value of equity at the end of the accounting period?

Equity = Opening Capital + Additional Capital – Drawings + Revenue – Expenses

700,000+200,000-20,000+50,000 =930,000
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Let’s talk a bit more about capital/equity

• Bimal is the owner of B Bakers. He invested Rs.800,000 in his business and started business activities. During

the first year he again invested 50,000 more in the business. He took away Rs.35,000 worth funds for personal

use. At the end of the year, Bimal identified that the equity at the end of the year was Rs.550,000. What is the

profit or loss for the accounting period?

Equity = Opening Capital + Additional Capital – Drawings + Revenue – Expenses

800,000+50,000-35,000+Profit(Loss) = 550,000
265,000 loss 6
Accounting Equation

Principle of Duality or Dual Aspect Concept

• Accounting transactions can be considered from two different perspectives.

Accounting Equation
• The accounting equation can be used to show principle of duality.
• The basic accounting equation shows 3 elements – Assets, Liabilities and Capital

Assets = Capital + Liabilities

What the business owns or

Who provided them
controls
(Financial side of the
business)

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Basic Accounting Equation

Assets = Capital + Liabilities

Option 1 = +

Option 2 = +

Option 3 = +

Option 4 = +

What are the other possible options?

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Basic Accounting Equation

The equation must always be in balance  totals of both sides should be balanced.

The accounting equation provides the foundation for the statement of financial position of the
business. Balance Sheet Equation

Can you guess the missing items?

Assets = Capital + Liabilities

1. 5400 4,100 1,300
2. 3,870 1,190 2,680
3. 9,875 1,195 8,680
4. 1,180 543 637
5. 6,767 1,107 5,660
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“Life is like accounting, everything must be balanced”
Basic Accounting Equation
Can you show the impact of the following transactions on the items in basic accounting equation?
• Owner invested Rs.500,000 in cash and started a business.
• The business purchased 60,000 rupees worth machines.
• The owner invested further Rs.20,000 worth office furniture.
• The business obtained a loan of Rs. 1,000,000. This was directly transferred to the newly opened bank
account.
• This money was then used to buy a motor vehicle worth Rs.900,000.
• Bought goods for sale worth Rs.80,000 on credit basis from Nimal Traders.
• Sold goods worth Rs.80,000 for the same amount and collected cash.
• The owner took away Rs.20,000 for his personal use.
• Assets = Equity + Liabilities
• -20,000 (Cash in hand) = -20,000 (Drawings)
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 -60,000 (Cash in hand)
+60,000 (Office furniture)
Basic Accounting
-1,000,000 (Cash in hand) Equation +1,500,000
+2,500,000 (Motor Vehicle)
+800,000 (Cash in hand) +800,000 (Additional capital)
Can you show the impact of the following transactions on the items in basic accounting equation?
+70,000 (Inventory) +70,000 (Trade Creditors)
• Owner invested Rs.2,800,000 and started a flower décor business.
-20,000 (Cash in hand)
• +20,000
Owner(Cash
asked one of his friends to lend some money to the business. The friend gave Rs.1,000,000 as a loan to
at bank)
-70,000 (Inventory)
the business. +50,000 (profit)
+120,000 (Cash)
• The business purchased 60,000 rupees worth office furniture.
• The first delivery vehicle was bought by paying Rs.1,000,000 in cash and the balance 1,500,000 is payable.
• Owner further invested Rs. 800,000 in cash.
• The business purchased its first stock of inventory worth Rs. 70,000 on credit basis.
• The business opened a bank account for its business purpose by depositing Rs.20,000 (taken out from the
drawer)
• Business made its first sale by selling flower decors for Rs.120,000 to a client (for cash). The cost of inventory
here is Rs. 70,000. 12
 Assets + Expenses = Liabilities + Owner’s Capital + Income
Expanded Accounting Equation +2,800,000 (Capital
+2,800,000 (cash)
investment)
+1,000,000 (Cash in hand) +1,000,000
(Creditors)
-60,000 (Cash in hand)
+60,000 (Office furniture)
-1,000,000 (Cash in hand) +1,500,000
+2,500,000 (Motor (Creditor)
Vehicle)
+800,000 (Cash) +800,000 (Additional
Capital)
+70,000 (Inventory) +70,000 (Trade
creditors/ Payables)
-20,000 (Cash in hand)
+20,000 (Cash at bank)
-70,000 (Inventory) +70,000 (Cost +120,000 (Sales
+120,000 (cash in hand) of sales) income)

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Basic Accounting Equation

• Describe the following transactions that occurred in Jina’s Business for the month of July.

  Cash Stocks Machine = Equity Liabilities

1 +500,000     +500,000  

2     +200,000 +200,000  

3 +50,000 -50,000      

4     -2,000 -2,000  

5 -25,000   +325,000   +300,000

6   -1,000   -1,000  

7 -25,000       -25,000

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Expanded Accounting Equation
• Sometimes we expand the accounting equation to show all the equity components.
• This is called the expanded accounting equation.

Assets = Liabilities + Equity

Assets = Liabilities + Owners Capital + Profit
Assets = Liabilities + Owners Capital + Profit
Assets = Liabilities + Owners Capital + (Income – Expenses)
Assets = Liabilities+ Owner’s Capital + Income ─ Expenses

Profit = Revenue – Expenses

We rewrite this equation to:

Assets + Expenses = Liabilities+ Owner’s Capital + Income

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Expanded Accounting Equation

Show the impact of following transactions on expanded accounting equation.

1. Owner invested Rs.1,000,000 cash and Rs.1,500,000 worth motor vehicles in a business.
2. The business purchased 30,000 rupees worth office furniture.
3. The business opened a bank account for its business purpose by depositing Rs.100,000 (taken out from the
drawer)
4. Obtained a loan of Rs.500,000 from a bank.
5. The business purchased its first stock of inventory worth Rs. 50,000 on credit basis.
6. Business made its first sale for Rs.70,000 on credit basis to Jaliya Ltd. The original cost of the inventory is
Rs.50,000.
7. Jaliya Ltd returned goods with a sales value of Rs.10,000. The original cost of these goods were Rs.7,000.
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Expanded Accounting Equation
Assets + Expenses = Liabilities + Owner’s Capital + Income
+1,000,000 (Cash in hand) +1,000,000 (Capital inv.)
+1,500,000 (M/V) +1,500,000 (Capital inv.)
+30,000 (Office Furniture)
-30,000 (Cash in hand)
-100,000 (Cash in hand)
+100,000 (Cash at bank)
+500,000 (Cash at bank) +500,000 (Bank
Loan)
+50,000 (Trade
+50,000 (Inventory)
Creditors)
-50,000 (Inventory) +50,000 (Cost +70,000 (Sales
+70,000 (Trade Debtor- of sales) income)
Jaliya Ltd)
+7,000 (Inventory) -7,000 (Cost of -10,000 (Sales
-10,000 (Trade Debtor- sales) income)
Jaliya Ltd)

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