Accounting Equation

 

Accounting Equation is a mathematical expression showing that a firm's assets and liabilities are equal. Show that the assets and liabilities of a firm are equal. 

 

An accounting Equation is based on the dual aspects concepts of accounting meaning, every transaction has two aspects- debits and credits. It holds that for every debit there is a credit of equal amount. It will always equal the total assets of the firm. The claim, also known as equities, are of two types.

 

1. Owner equities (Total Capital).
2. Liabilities or amounts due to outsiders.

We can express it as follows:

* Assets = Equities (Total Claims)
* Assets = Liabilities + Capital
* Capital = Assets - Liabilities
* Liabilities = Capital - Assets

The above relationship is known as the Accounting Equations or the Balance Sheet Equations.

 

*If the capital of a business is 70,000 and liabilities are 40,000, calculate the assets.

Liabilities + Capital = Total Assets 

70,000 + 40,000 = 1,10,000.

 

A transaction may affect either both sides of the equation by the same amount or one side of the equation only, by both increasing or decreasing it by equal amounts.

 

1. Transaction Affecting two sides:

Increasing in assets 

Increasing in liabilities. 

Decreasing in liabilities.

Decreasing in assets.

Decreasing in owner's capital. 

Decreasing in assets. 

increasing in assets.

increasing in owner's equity, etc...

 

2. Transaction Affecting more than two items:

The sale is made in cash for 30000, at a cost of 25000 plus profit.

Cost of goods 25000 reduces asset (stock of goods); cash increasing by 30000 and the owner's capital increases by the profit of 5000 etc...

 

There are some examples for showing the Effect of transactions on the Accounting Equation

1. Ram started the business and introduced capital rs. 1,00,000 in cash.

2. Purchase goods in cash rs. 50,000.

 

Transaction	Assets         =	Labilities        +	Capital
Ram started the business with cash	1,00 000		1,00,000
Purchase of goods in cash 50,000	+50,000     -50,000
	1,00,000		1,00,000

 

3. Furniture purchased from M/S Ritu P Ltd. for Rs. 5.000/-

Transaction	Assets     Furniture         =	Labilities      +	Capital
Purchase of goods in cash 50,000	+50,000  -50,000
	1,00,000		1,00,000
New Equation
Furniture purchased from M/S Ritu P. Ltd	+5,000	+5,000
	1,00,000 +   5,000	5,000	1,00,000