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Accounting Equation

Dual aspect may be stated as "for every debit,

there is a credit.

Every transaction should have twofold effect tothe 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.

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Basic accounting equation

Assets = Liabilities + Capital (Shareholders or

Owners Equity)

or

Assets - Liabilities = Capital (Shareholders orOwners Equity)

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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 theproprietorship (XYZ's capital) is also increased by the same

amount such as:

Assets = Liabilities + Owner

(Cash) XYZs Capital

+ 50,000 = ---- + 50,000

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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 = Liabilities + Proprietorship

Cash Furniture YZ, Capital

+ 50,000 = ---- + 50,000

- 10,000 + 10,000

40,000 + 10,000 = 50,000

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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 = Liabilities + Proprietorship

Cash Furniture Merchandise XYZ, Capital

+ 40,000 + 10,000 = ---- + 50,000

-10,000 -- + 10,000

30,000 +10,000 + 10,000 = 50,000

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Transaction 4

Purchased merchandise on account (on credit) $5,000.

Transaction 5:

Sold merchandise for cash $2,000 cost of these merchandise were $1,500

Assets = Liabilities + Proprietorship

Cash Furniture Merchandise Creditors XYZ, Capital

+ 30,000 + 10,000 + 10,000 = + 50,000

+ 5,000 + 5,000

30,000 +10,000 + 15,000 = + 5,000 + 50,000

Assets = Liabilities + Proprietorship

Cash Furniture Merchandise Creditors XYZ, Capital+ 30,000 + 10,000 + 15,000 = + 5,000 + 50,000

+ 2,000 - 1,500 + 500 (Profit)

+ 32,000 +10,000 + 13,500 = + 5,000 + 50,500

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

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

Assets = Liabilities + Proprietorship

Cash Furniture Merchandise

Debtors Creditors XYZ, Capital

+ 32,000 + 10,000+

13,500= + 5,000 + 50,500

- 3,000 + 4,000 + 1,000

32,000 +10,000+

10,500

+ 4000 = + 5,000 + 51,500

Assets = Liabilities + Proprietorship

Cash FurnitureMercha

ndise

Debtors Creditors XYZ, Capital

+ 32,000 + 10,000+

10,500+ 4,000 = + 5,000 + 51,500

- 1,000 - 1,000

31,000 +10,000+

10,500+ 4000 = + 4,000 + 51,500

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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 = Liabilities + Proprietorship

Cash Furniture Merchandise

Debtors Creditors XYZ, Capital

+ 31,000 + 10,000+

10,500+ 4,000 = + 4,000 + 51,500

+ 1,000 - 1,000

32,000 +10,000 +10,500

+ 3000 = + 4,000 + 51,500

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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 = Liabilities + Proprietorship

Cash Furniture Merchandise

Debtors Creditors XYZ, Capital

+ 32,000 + 10,000 + 10,500 + 4,000 = + 4,000 + 51,500

- 1,000 - 1,000

31,000 +10,000 + 10,500 + 3000 = + 4,000 + 50,500

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Effects of all the transactions explained above are presented in the following table:

Assets = Liabilities + Proprietorship

Cash + Furniture +Merchandise + Debtors Creditors + XYZs Capital

1 + 50,000 +50,000

50,000 = + 50,000

2 - 10,000 + 10,000

40,000 10,000 = + 50,000

3 - 10,000 + 10,000

30,000 10,000 10,000 = + 50,000

4 + 5,000 + 5,00030,000 10,000 15,000 = 5,000 + 50,000

5 + 2,000 - 1,500 + 500 (Profit)

32,000 10,000 13,500 = 5,000 + 50,500

6 - 3,000 + 4,000 + 1,000 (Profit)

32,000 10,000 10,500 4,000 = 5,000 + 51,500

7 - 1,000 - 1,000

31,000 10,000 10,500 4,000 = 4,000 + 51,500

8 +1,000 1,000

32,000 + 10,000 + 10,500 + 3,000 4,000 + 51,500

9 1,000 1,000

31,000 10,000 10,500 3,000 = 4,000 + 50,500

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

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

Cash + Furniture + Merchandise + Debtors = Creditors + Capital

31,000 + 10,000 + 10,500 + 3,000 = 4,000 + 50,500

EQUITIES ASSETS

Creditors $4,000 Cash $31,000

Capital $50,500 Debtors 3,000

Merchandise 10,500

Furniture 10,000

$54,500 $54,500

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CLASSES OF ACCOUNTS:

Natural Artificial Represe

ntative

Accounts

PERSONAL REAL NOMINAL

Incomes

& Gains

Tangible Intangible Expanses

& Losses

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Examp es o types o accountsTypes Sub-Types Explanation Example

Personal Account Natural Natural Persons means the

persons who are creation of God.

Amits account, Aishas Account etc.,

Artificial These include the accounts of

corporate bodies or institutions

which are recognized as persons

by law

Accounts of Companies, Co-

operative society, Club,

Government, Bank Account

Representative These are the accounts which

represent a certain person or

group of persons

Outstanding Rent account

OutstandingSalaries A/C

Interest Outstanding A/C

Prepaid insurance A/CDrawings A/C, Bank Overdraft A/c,

Capital A/C, Drawings A/C

Real account Tangible Tangible real accounts are those

accounts which relate to such

things which can be touched, felt,

measured etc.

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

Intangible These accounts represent such

things which cannot be touched.

Patents A/C, Copyright A/c

Goodwill A/C, Trademark A/c

Nominal Expanses &

Losses

These accounts deal with

expanses, incomes, profits and

losses. These accounts are opened

in the books to simply explain the

nature of transactions.

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

Incomes & Gains

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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

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Accounts Balances

Figure 2: Effect of Debit& CreditAssets,expansesand dividends

Figure 3: Effectof Debit& CreditonLiabilities, Revenue & Equity