Accounting Equation

Dual aspect may be stated as "for every debit, there is a credit. Every transaction should have twofold effect to the extent of the same amount. This concept has resulted in accounting equation which states that at any point of time the assets of any entity must be equal (in monetary terms) to the total of equities.

Basic accounting equation

Assets = Liabilities + Capital (Shareholder s or Owner s Equity) or Assets - Liabilities = Capital (Shareholder s or Owner s Equity)

Example- Accounting Equation

Transaction 1: Mr. XYZ commences his business with cash $50,000. This is an example of investment of asset in the business by the owner. The effect of this transaction on the accounting equation is that cash asset is increased by $50,000 and the proprietorship (XYZ's capital) is also increased by the same amount such as: Assets (Cash) + 50,000 = ---= Liabilities + Owner XYZ s Capital + 50,000

Transaction

2:

Purchased

furniture

on

cash

$10,000.

This

transaction effected accounting equation as the increase in one new asset furniture and decreases in assets cash with the same amount. Thus : Assets Cash + 50,000 - 10,000 + 10,000 Furniture = ---= Liabilities + Proprietorship XYZ, Capital + 50,000

40,000

+ 10,000 =

50,000

Transaction 3: Purchased merchandise for cash $10,000. This transaction will introduce a new element (merchandise) on the assets side and decrease the cash by $10,000.

Assets Cash -10,000 Furniture Merchandise + 40,000 + 10,000 -+ 10,000

= =

Liabilities ----

Proprietorship XYZ, Capital + 50,000

30,000

+10,000

+ 10,000

50,000

 Transaction 4
Purchased merchandise on account (on credit) $5,000.
Cash + 30,000 Assets Furniture + 10,000 = Merchandise + 10,000 + 5,000 + 15,000 = + 5,000 = + 5,000 + 50,000 Liabilities Creditors + Proprietorship XYZ, Capital + 50,000

30,000

+10,000

Transaction 5:
Sold merchandise for cash $2,000 cost of these merchandise were $1,500
Assets Cash + 30,000 + 2,000 Furniture Merchandise + 10,000 + 15,000 - 1,500 = = Liabilities Creditors + 5,000 + Proprietorship XYZ, Capital + 50,000 + 500 (Profit)

+ 32,000

+10,000

+ 13,500

+ 5,000

+ 50,500

Transaction 6:Sold merchandise on credit for $4,000 costing $3,000.

Assets Merchan Furniture Debtors dise + + 10,000 13,500 - 3,000 + 4,000 +10,000 + 10,500 + 4000 = Liabilities Creditors = + 5,000 + Proprietorship XYZ, Capital + 50,500 + 1,000 = + 5,000 + 51,500

Cash + 32,000

32,000

Transaction 7: Paid $1,000 to creditors for merchandise purchased.

Assets Mercha Furniture Debtors ndise + + 10,000 + 4,000 10,500 = Liabilities Creditors = + 5,000 - 1,000 + 10,500 + Proprietorship XYZ, Capital + 51,500

Cash + 32,000 - 1,000

31,000

+10,000

+ 4000

+ 4,000

+ 51,500

Transaction 8: Received cash from a debtor $ 1,000 whom a sale on credit was made earlier. This is an example of collection from debtors. This transaction is an exchange of one asset for another. the effect is on one side of the equation, i.e., asset side. Thus:
Assets Cash + 31,000 + 1,000 + 10,500 Furniture + 10,000 Merchan Debtors dise + 10,500 + 4,000 - 1,000 = = Liabilities Creditors + 4,000 + Proprietorship XYZ, Capital + 51,500

32,000

+10,000

+ 3000

+ 4,000

+ 51,500

Transaction 9: Paid salaries $1,000 in cash. This transaction affected the equation by decrease in a cash asset and decrease in proprietorship (i.e., capital). Thus:
Assets Merchandi Debtors se + 10,500 + 4,000 = = Liabilities + Proprietorship

Cash

Furniture

Creditors + 4,000

XYZ, Capital + 51,500 - 1,000

+ 32,000 + 10,000 - 1,000

31,000

+10,000

+ 10,500

+ 3000

+ 4,000

+ 50,500

Effects of all the transactions explained above are presented in the following table:
Cash + 50,000 50,000 - 10,000 40,000 - 10,000 30,000 30,000 + 2,000 32,000
Assets + Furniture +Merchandise = + Debtors Liabilities Creditors + Proprietorship + XYZs Capital +50,000 = + 10,000 10,000 + 10,000 10,000 10,000 10,000 10,000 + 5,000 15,000 - 1,500 13,500 - 3,000 + 4,000 4,000 = 5,000 - 1,000 10,000 10,500 4,000 1,000 + 10,000 10,000 + 10,500 10,500 + 3,000 3,000 = 4,000 4,000 + + 51,500 1,000 50,500 = 4,000 + 51,500 + = 5,000 + = = + 5,000 5,000 + 50,000 + 500 (Profit) 50,500 + 1,000 (Profit) 51,500 + 50,000 = + 50,000 + 50,000

3 4 5 6

32,000 - 1,000 31,000 +1,000 32,000 1,000 31,000

10,000

10,500

 The elements of the equation of Mr. XYZ that is,

Cash + Furniture 10,000 + Merchandise + Debtors = + 10,500 + 3,000 = Creditors + 4,000 + Capital 50,500 31,000 +

This may also be stated in vertical form as shown below:

EQUITIES Creditors Capital $4,000 $50,500 ASSETS Cash Debtors Merchandise Furniture $31,000 3,000 10,500 10,000 $54,500

$54,500

CLASSES OF ACCOUNTS:
Accounts

PERSONAL

REAL

NOMINAL

Natural

Artificial

Represe ntative

Tangible

Intangible

Expanses & Losses

Incomes & Gains

Examples of types of accounts

Types Sub-Types Personal Account Natural Explanation Example Natural Persons means the Amit s account, Aisha s Account etc., persons who are creation of God. These include the accounts of Accounts of Companies, Cocorporate bodies or institutions operative society, Club, which are recognized as persons Government, Bank Account by law These are the accounts which represent a certain person or group of persons Outstanding Rent account Outstanding Salaries A/C Interest Outstanding A/C Prepaid insurance A/C Drawings A/C, Bank Overdraft A/c, Capital A/C, Drawings A/C Cash A/C, Building A/C, Furniture A/C, Stock A/Purchase A/C, Sales A/C, Purchase A/C, Sales A/C, Purchase returns & Sales Returns Patents A/C, Copyright A/c Goodwill A/C, Trademark A/c Rent A/c, Interest A/c, Salary A/c, Insurance a/c, Commission A/C, Discount A/c, Bad Debts A/C, and Reserve for discount on Creditors, Cash Discount A/C Artificial

Representative

Real account

Tangible

Tangible real accounts are those accounts which relate to such things which can be touched, felt, measured etc. These accounts represent such things which cannot be touched. These accounts deal with expanses, incomes, profits and losses. These accounts are opened in the books to simply explain the nature of transactions.

Intangible

Nominal

Expanses & Losses Incomes & Gains

RULES OF DEBIT & CREDIT

PERSONAL ACCOUNT DEBIT the receiver CREDIT the giver

REAL ACCOUNT

DEBIT what comes in and CREDIT what goes out

NOMINAL ACCOUNT

DEBIT all expanses and losses CREDIT all gains & incomes

Accounts Balances

Figure 2: Effect of Debit & Credit Assets, expanses and dividends

Figure 3: Effect of Debit & Credit on Liabilities, Revenue & Equity