CHAPTER eee LEARNING OBJECTIVES The Study of this Chapter would enable you to understand; Q Meaning of an Accounting Equation : ‘Usefulness of Accounting Equation O Effect of Transactions on Accounting Equation | MEANING OF AN ACCOUNTING EQUATION An Accounting Equation is a mathematical expression which shows that the a _ qual As : i issets and liabilities of a J ie eas a al : n oe Equation is based on the Dual Aspect Concept of accounting. It | = . sd ‘ansaction ‘as dual aspect or two sides—debit and credit. It holds that for every } debit aa is a credit of equal amount and vice versa. It means, total liabilities, ie., claims (those q of outsiders and of the proprietors) will always be equal to the total assets of the firm. The liabilities or claims, also known as Equities, are of two types: i 1. Owner's Equity or Capital and 2. Liabilities or amounts due to outsiders (., Outsiders’ Equity). We can express it mathematically as follows: Assets = Equities (Total Claims) Or Assets = Total Liabilities, j.e., Outside Liabilities + Owner's Equity or Capital Or Assets = Liabilities 4 Capital Or Liabilities = Assets — Capital Or Capital = Assets — Liabilities USEFULNESS OF ACCOUNTING EQUATION Accounting Equation is the basis for double entry system of accounting. Total assets of a firm are financed by the creditors, lenders and owners. Therefore, at any point of time, total assets of a firm are equal to its total liabilities. An Accounting Equation always holds true with every change due to a transaction because it is based on the Dual Aspect Concept of accounting. Dual Aspect Concept holds that for every debit ' there is a credit of equal amount. Similarly, for every credit there is a debit of equal amount.A pouble Ent Book KEPINg— Igo, ¢ amount or mount, OF es mn se bY jecreases and capital incre, into two, i, ba tions which are those transactions which af 286 ons affect opposite sides ice ait purchase increases a Similarly bank Joan increases ps creditor decrease, f capital by the proprietor decreases liability tions such as cast purchase of goois rd Cash of Bank, respectively) and tor by issue of Billo le ses another liability (Bill of Exchange). actions affect more than two items sale is made in cash for or example, when @ oods & 25,000) reduces asse! ‘capital increases by the profit @: 5,000) lement of credit that profit increas process of Preparing Accounting Equation ‘The process to prepare an Accounting Equation 1. Analyse the transection in terms ‘of such variables as As ‘and Expenses. 2 Decide the’ in 1 above. 4, Record te effect on the relevant side ofthe equation and ensure that th aides always equal tothe total of left hand side. Let us take a few transactions to understand the accounting equation. actions are Suppose, Rakesh starts business and the following successive tran 1 pes his business with % 20,000 as Capital. 4; It means that the firm has assets totalling 20,000 in against the i firm are also ® 20,000 in the form of capital, The equation stands a5 ——— ssets, Liabilities, Capital, Revenv® e total of right har" entered into the form of cash and dais followsSe G 63 ‘Accounting Equation ‘assets ®) = Liabilities (@) + Capital (®) Rakeshis Gash 7 er copitalitroduced ___20000 = 2, Purchased furniture for ® 500 in cash. es sffect: It means an asset (cash) is reduced by ® 500 but a new asset (furniture) of the same rount is purchased. Thus, total of assets remains unchanged. The equation will now appear as follows: Assets () = Liabilities (@) + —_Capital(®) Cash = + Furniture Rakesh’s old Balance 20000 + 0 0 + 20000 New Transaction -500 + 500 0 4 New Balance 19,500 + 500 0 + 20,000 Tt may be noted that the total assets remain equal to liabilities plus capital. 3, Purchased goods for % 1,000 in cash. Effect: It means an asset (cash) is reduced by % 1,000 and another asset, i.e., stock has come into existence but the total of assets remains unchanged. The equation now will be as follows: Assets () = Labilities(@) + —_Capital(®) Cash + Furniture + Stock Rakesh old Balance 19500 + 500 + 0 0 + 20,000 New Transaction =1000 + 0 + ‘1,000 + 0 New Balance 18,500 + 500 + 1,000 + 20,000 4, Purchased goods for & 2,000 on credit. Effect: It means the stock has increased by % 2,000 making the total assets % 22,000. A liability of €2,000 to the supplier of the goods (creditor) has arisen. The equation now will be as follows: Assets (%) = Liabilities) + Capital (2) Cash + Furniture + Stock Creditors = + —-Rakeshs Old Balance 18500 + 500 + 1,000 0 + 20,000 New Transaction o+ 0 + 2,000 2000 + 0 ‘New Balance. 18,500 + 500 + 3,000 = 2,000 + 20,000 5. Sold goods costing % 2,500 on credit for ® 4,000. Effect: It means a debtor has come into existence for & 4,000. The stock is reduced by % 2,500, being the cost of goods sold. The net increase in assets (profit), % 1,500, i., % 4,000 - ¥ 2,500 will be added to the capital. The equation now will be as follows: Assets (2) = Liabilities (2) + Capital(?) Cash + Furniture + Stock + Debtors = Creditors = + ~—-Rakesh’s Old Balance 18500 + 500 + 3,000 + 0 2 2000 + 20,000 New Transaction 0 + 0 - 2500 + 4,000 = o + 1,500 ‘New Balance 18500 + S00 + 500 + 4,000 = 2000 + 21,500Double Entry Book Keeping ~I5¢ 64 6. Paid & 1,000 for rent and 25,000 for salaries. Effect: It means cash has reduced by & 6,000, these are expenses and no asset comeg Assets (2) Liabili @) oa ~ —_ ‘ i Cash + Fumiture + Stock + Debtors = Creditors 4 Par Old Balance yasoo + «6S00 + 500 + 4,000 = 2,000 + 25 (New Transaction -6000 + Oo + o+ 0 ~ 0 aia 5 ‘New Balance 72500 4 500 + 500 + 4000 2 2000 4 s5e 7. Rakesh withdraws @ 2,000 for his personal use. 7 Effect: Itmmeans cash is reduced by & 2,000 and ca will be as follows: pital will also reduce by the same amu, The new Accounting Equation v Assets (2) + Furniture + Stock + Debtors = Creditors + Rata, Liabities 2) + Capiayy Gash Old Balance 12500 + 500 + 500 + 4,000 = 2,000 + 15509 ‘New Transaction -2000 + o+ o+ 0 = 0 = 2000 New Balance 70500 + 500 + 500 + 4,000 = 2,000 + 1350) Itwillbe observed from above that the total of assets will always be equal to the total of liabiliti and capital. The last equation stated above can also be presented in the form of a statement, je, Balance Sheet. It is given below: BALANCE SHEET OF RAKESH asat.. abies z | Assets z Creditors 2,000 | Cash 10.500 Capital 15,500 Stock st Less: Drawings 13,500. | Debtors Furniture 15,500 ‘The Balance Sheet shows the sources from which funds have been obtained—the left hand se or Liabilities side does that; in the above case, & 2,000 have been obtained from outsiders and 213,500 have been contributed by the proprietor. The other side known as Assets side show* how the funds stand invested. A conclusion apparent from the transactions given above is that every transaction has too sided eft In other words, the Dual Aspect Concept will aways hold good. A decrease or inerease in an asset have a corresponding effect on liabilities or capital. This is because of the rule that every receiver 6! = giver and every giver is a receiver.. 65 Accounting Equation uasteation sve the Accounting Equation on the basis of the following: : 1, Sachin. started business of trading in furniture and introduced capital & 1,00,000 in cash. 4, Purchased goods in cash 50,000. > purchased from M/s Samrat Furnitures € 20,000. 1 sold goods costing € 25,000 for & 35,000. Paid to M/s Samrat Furnitures in cash. solution: ‘No| Transactions Assets = Liabilities = + Capital z z z J sachin started business with cash 7,00,000 o + 1,00,000 2. | Purchased goods in cash +50,000 | _-s0000 New Equation 700,000 = 0 + 100,000 3, | Purchased goods from M/s Samrat Furnitures + 20,000 = 20,000 ik 9 New Equation | 120000 = 20900 + ~—~—~100,000 4, | Sold goods costing ® 25,000 25,000 for 35,000 (Note) 4350002 = oy ee 10,000 New Equation 7,30,000 20000—~«+ 1,10,000 5, | Paid to M/s Samrat Furnitures in cash ~ 20,000 20000 + ° New Equation 17,10,000 = 0 + ‘1.10000 Note: Sale of goods has resulted in a profit of € 10,000. t has been added to capital because net profit at the year end is transferred to Capital Account. Illustration 2. Prepare the Accounting Equation on the basis of the following: 1. Started business with cash % 70,000. 2. Credit purchases of goods % 18,000. 3, Payment made to creditors in full settlement & 17,500. 4, Purchase of machinery for cash € 20,000. Solution: No.] Transactions ‘Assets Liabilities + Capital Cash + Stock + Machinery = Creditors + Capital z z x e z 1.] Started business with cash 270,000 70,000 + o + o = i. + 70,000 2.| Credit purchases of goods 718,000 0 + 18000 + oO = New Equation 70,000 + 18000 + oO = 3.| Payment made to creditors in full settlement % 17,500 i o = New Equation 18,000 + 0 4.| Purchase of machinery for cash 0+ 20000 New Equation 18,000 + = «20,000 =66 Double Entry Book Keeping 1s, Adjustment Transactions i i bi i + 1. Outstanding Expenses are the expenses which have been incurred but not paid during y current accounting period Treatment in Accounting Equation: Subtract from Capital as it is an expe ¢ Liabilities si ase for the current accounting period. * Make a new column on the ide in the name of ‘Outstanding Expenses’, the amount is yet to be paid. advance, ic, they a penses which have been paid in . Prepaid Expenses refer to those ex not yet due but paid, Treatment in Accounting Equation: «Subtract from Cash as there is an out = Make a new column on the Assets side in the name of is yet in advance. ‘Accrued Income refers to th: current accounting period. Treatment in Accounting Equation: + Add in Capital as it is an income ea new column on the Assets si flow of cash. “prepaid Expenses’ as the amoy, at income which has been earned but not received during i for the current accounting period. . de in the name of ‘Accrued Income’ as the amour is yet to be received. 4, Uneamed Income or Income Received in Advance re received but not eared during the current accounting period. Treatment in Accounting Equation: + Add in Cash as there is inflow of cash. « Make a new column on the Liabilities side in the nat amount is received in advance. fers to that income which has bee. me of ‘Unearned Income’ as th Illustration 3. How are the following items dealt with in Accounting Equation? (i) Interest due but not received 500. (ii) Rent received in advance @ 1,000. (iii) Insurance premium paid in advance F 1,500. (iv) Salaries due but not paid & 2,000. Solution: (i) Accrued interest shall be added to assets on one side and to the capital on other side. (i) Hew ncrease cash onthe assets side and increase the liabilities. (ii) It will decrease one asset (cash) and increase another asset (Prepaid insurance). (iv) Salary being an ex ill . roibuibeg ‘pense will be deducted from the capital and being unpaid will be addetaccounting Equation nustration 4. ‘anil had the following transactions: 1, Commenced business with cash % 50,000. we 9, Cash withdrawn for personal use & 10,000, Use Accounting Equation to show the effect of the above transactions on his assets, liabil and capital and also show his Balance Sheet. Purchased goods for cash % 20,000 and credit € 30,000. Sold goods for cash & 40,000, costing % 30,000, Rent paid % 500, Salaries 5,000, Rent outstanding € 100, Salaries Outstanding 1,000. Bought furniture for % 5,000 on credit. Bought refrigerator for personal use % 5,000, paid cash. Purchased computer for cash % 20,000. 67 Solution: Wa. | Transactions Assets Liabilities + — Capital Cash + Stock + Furniture + Computer = Creditors" + Expenses + Capital Outstanding x z x z z z z 7. | Rea Correnced business wit cash 50,000 509000. + o + oF 0 o+ 0 + 50900 2.| Purchased goods for «ash 20000and xed 30,000 -20000 + 0000 ee 3000 + 0 0 New Equation 30,000 + 50,000 +O x00 + 0 50,000 3. | Sold goods for cash {40000 costing 330000 40000-30000 + 0 + 0 o+ 0 10,000 New Equation 7oo0 +2000 ~+~~=~OC~O SSC 3000 + OO 60,000 4 | Rentpaid 500 + 0 o+ 0 o+ 0 500 Salaries Paid -5,000 : 500 New Equation aso + woo + 0 + 0 sono + «OSCR 5, | Rent Outstanding + 10 - 100 Salaries Oustanding o + o + + o + 1000 - 3,000 New Equation 4500+ 20000 + + 30000 + 1,100 + 33,400 6.| Bought furniture for 25 0000ncredit 0 ° 5000 + som + 0 + 0 ‘New Equation 4500+ 20000 + «5000 + 300 + 1100+ «83.400 2. | Bought refrigerator for personal use 35,000, cash 5000+ Ce ee) oe 0 - 57000 New Equation 39500 + 20000 + 500 + 0 3500 + 1100+ 4800 8. | Purchased computer forcash¥ 20,000 -20900 + o + 0 + 2000 o+ 0 0 New Equation 39500 + 20000 + 5000 + 20000 3500 +1100 8400 3. | cash withdrawn for personal use 10000 + o + oF 0 o+ 0 - 10000 New Equation 29500 + 20000 ++ 5000 + 70000 35000 + 1100 + ~—_38400 “Including vendor for furniture & 5,000.a 68 Double Entry Book Keepin, Iso, BALANCE SHEET OF ANIL as at. abilities T__ | Assets Creditors 35,000 | Cashin ‘Hand {including vendor for furniture’ 5,000) Stock Expenses Outstanding 1100 | Furniture Capital 38400 | Computer 74,500, Objective Type Questions 1. Which of the following equations is correct? (Assets + Capital = Liabil (ii) Assets + Liabilities = Capital 2. Which of the following is correct? Capital Assets ~ Liabilitie: iv) None of the above. Assets Liabilities Capital @ %7,85,000 %1,25,000 & 6,60,000 i) %8,20,000 % 2,80,000 %11,00,000 Gil). €9,55,000 %1,15,000 % 8,20,000 (iv) %5,42,000 % 654,000 & 1,12,000 3, Determine the missing amounts on the basis of the Accounting Equation: ‘Assets = Liabilities + Capital (@ %20000 = 15000 + ? @ 2 = % 5000 + 710,000 (ii) T1000 = =? + % 8,000 4, Select the correct alternative: The liabilities of a firm are & 3,000; the capital of the proprietor is € 7,000. The total assets are: ( % 7,000; (ii) & 10,000 and (ii) € 4,000. 5, The assets of a business on 31st March, 2020 are % 50,000 and its capital is © 35,000. Its liabilities on the date shall be & ..& 85,000/ T 15,000/% 35,000). 6. ‘X commenced business on 1st April, 2019 with a capital of & 6,00,000. On 31st March, 2020 his assets wer worth & 8,00,000 and liabilities 50,000, Find out his closing capital. ( %7,50,000 (i) %2,00,000 (iii) 5,50,000 (iv) None of the above. ‘Short Answer Type Questions 1. Explain in short the meaning of an Accounting Equation. 2. “Accounting Equation (A = L + C) always holds good under all circumstances.” Explain with the help two examples. 3, Describe the fundamental accounting equation. How are revenue and expense accounts related tot” |. What is owner's equity? Give an equation for calculating owner's equity. Give two examples at least 5, From the following information find the capital of Vijay: Total Assets & 5,00,000; Creditors & 1,00,000:1% from Bank @ 1,50,000. a 5 6. If the Capital is € 2,60,000 and Assets are % 5,00,000, what is the amount of Liabilities? 7. If the Capital is & 1,00,000 and Outside Liabilities are € 2,50,000, find the Total Assets. =~~ accounting Equation 69 a. Ram started business on 1st April, 2019 with a Capital of & 25,000 and a loan of & 12,500. On 31st March, 2020, is assets were ¥ 50,000. Find his capital as on 31st March, 2020 and the profit earned during the year. 9, Calculate total assets if Capital is€ 2,00,000; Creditors ® 50,000; Revenue during the year & 5,00,000;and Expenses during the year % 4,00,000. Pry outer adel) 1, What will be effect of the following on the Accounting Equation? z {@) Started business with cash 45,000 (i) Opened a Bank Account with a deposit of 4,500 Bought goods from M/s Sun & Co. for 11,200 2. Show the Accounting Equation on the basis of the following transactions: = (0 Gopinath started business with Cash 25,000 (i) Purchased goods from Shyam 10,000 (iii), Sold goods to Sohan costing % 1,800 1,500 {iv) Gopinath withdrew from business 5,000 3, Show the effect of the following transactions on the Accounting Equation: z (@ Started business with cash 50,000 (i Salaries paid 2,000 Wages outstanding 200 (jv) Interest due but not paid 100 (v) Rent paid in advance 150 4, What will be the effect of the following on the Accounting Equation? ie (0 Harish started business with cash 18,000 (i) Purchased goods for cash % 5,000 and on credit € 2,000 Sold goods for cash costing & 2,400 for 4,000 (iv) Rent paid & 1,000 and rent outstanding % 200 5. Prepare Accounting Equation from the following: () Started business with cash X 1,00,000 and Goods ¥ 20,000. Sold goods of € 10,000 for cash & 12,000. (ii) Purchased furniture on credit for & 30,000. 6. Prepare an Accounting Equation and Balance Sheet on the following basis: : z (0) Ajeet started business with cash 20,000 (i) He purchased furniture for 2,000 ) He paid rent of 200 (iv) He purchased goods on credit 3,000 (V) He sold goods (cost price & 2,000) for cash 5,000 7. Prepare an Accounting Equation from the following: (i) Started business with cash T 1,00,000. (ii) Purchased goods for cash & 20,000 and on credit € 30,000. Sold goods for cash costing % 10,000 and on credit costing & 15,000 both at a profit of 20%. 8. Prove that the Accounting Equation is satisfied in all the following transactions of Suresh. Also prepare a Balance Sheet. z () Commenced business with cash 60,000 Paid rent in advance 500 Purchased goods for cash € 30,000 and credit & 20,000. Sold goods for cash % 30,000 costing % 20,000. Paid salary % 500 and salary outstanding being & 100. Bought motorcycle for personal use 5,000NAW Ue Double Entry Book Keepin, Iso, etc ot WS tthe Se Ate aH W Neate follows owing transa ee alance Sheet 'Sactions on assets, liabilities and capital using the Accountin, Meet business with ‘SE quay » Rent received ‘ WO Accrue ww ash : at interes est 2 Commission fed in advance eceived i advanc Amount withdrawn : I) Scan QR Code for Additional Practical Problems GUIDE TO ANSWERS 5. £15,000; 6. (i) &7,50,000, Objective Type Questions 1. Gi; 2 -(; 3. @ F5,000; (i) F 15,000; (i) F 2,000; 4. ‘Short Answer Type Questions 5. Capital— 2,50,000. 6. Liabilities—% 2,40,000. 7. Total Assets— 3,50,000. 8. Capital—% 37,500; Profit—t 12,500. 9. Total Assets—X 3,50,000. Practical Problems 1. Assets—Cash % 40,500 + Bank & 4,500 + Stock % 11,200 = 56,200; Liabilities—Creditors = 11,200 + Capital 7 45,000 = 7 56,200. 2. Assets—Cash % 20,000 + Stock % 8,200 + Debtors € 1,500 = % 29,700; Liabilities—Creditors @ 10,000 + Capital € 19,700 = & 29,700. 3. Assets—Cash & 47,850 + Rent Paid in Advance & 150 = % 48,000; Liabilities—Outstanding Wages € 200 + Outstanding Interest = 100 + Capital t 47,700 = = 48,000. 4, Assets—Cash f 16,000 + Stock % 4,600 = 20,600; Liabilities—Capital % 18,400 + Creditors % 2,000 + Outstanding Rent & 200 = & 20,600. 5. Assets—Cash € 1,12,000 + Stock % 10,000 + Furniture % 30,000 = & 1,52,000; Liabilities—Vendors for Furniture & 30,000 + Capital € 1,22,000 = € 1,52,000. 6. Assets—Cash % 22,800 + Furniture € 2,000 + Stock & 1,000 = € 25,800; Liabilities Creditors Z 3,000 + Capital € 22,800 = & 25,800. 7. Assets—Cash % 92,000 + Stock % 25,000 + Debtors € 18,000 = 1,35,000; Liabilities Creditors € 30,000 + Capital & 1,05,000 = @ 1,35,000. 8. Assets—Cash % 54,000 + Advance Rent € 500 + Stock € 30,000 = % 84,500; Liabilities Creditors € 20,000 + Outstanding Salary & 100 + Capital & 64,400 = 84,500. 9. Assets—Cash % 58,000 + Accrued Interest % 500 = % 58,500; Liabilities—Commission received in advance ¥ 1,000 + Capital & 57,500 = % 58,500. [Hint: Capital = Opening Capital & 60,000 + Rent Received ® 2,000 + Accrued Interest € 500 - Drawings = 757,500] 50 one Scan QR Code for Key Terms and Chapter Summary —