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Chapter 5 Accounting Equation Shri Krishna Education visit us at www. accountsshikshak. com 2

Meaning of Accounting Equation An Accounting Equation is a statement of equality between assets and the claims against these assets. In other words, an accounting equation is a formula of accounting which shows the assets and liabilities of a firm as equal. Shri Krishna Education visit us at www. accountsshikshak. com 3

Equation Assets = Liabilities + Capital or Liabilities = Assets An Amount own by firm to outsiders. - Capital Any thing which can be converted into Cash Shri Krishna Education visit us at www. accountsshikshak. com An amount invested by owner 4

The above relationship is known as the Accounting Equation or the Balance Sheet Equation. This Accounting Equation is the basis for Double entry system of Accounting. Let’s take few examples to see the effect of transaction on Accounting Equation: 1) Started business with Cash of `. 30, 000. Solution Two elements in the transaction were Shri Krishna Education visit us at www. accountsshikshak. com 5

Cash Asset Capital Owner’s equity Transaction will be expressed if the following way Assets Cash 30, 000 = = = Liabilities 0 + + Capital 30, 000 Shri Krishna Education visit us at www. accountsshikshak. com 6

2) Purchase goods for Cash for `. 10, 000. (-) N. E Cash Goods Decreased Increased Assets = Liabilities Cash + Goods 30, 000 10, 000 + 10, 000 = = = 0 + 30, 000 20, 000 + 10, 000 = 0 + 30, 000 Shri Krishna Education visit us at www. accountsshikshak. com + Capital 7

3) Purchase furniture for `. 5, 000 Two elements Cash Furniture Decreased Increased Cash + Goods + furniture 20, 000 + 10, 000 = 5, 000 + + 5, 000 15, 000 + 10, 000 + 5, 000 = = = Liabilities 0 0 + + + Capital 30, 000 0 + 30, 000 Shri Krishna Education visit us at www. accountsshikshak. com 8

(4) Sold goods for Cash Cost `. 5, 000 for Rs. 6, 000 Three Elements Cash Goods Profit Increased decreased Increased Assets = Cash + Goods + furniture 15, 000 +10, 000 + 5, 000 6, 000 - 5, 000 21, 000 + 5, 000 Liabilities + Capital = = = 0 + + 30, 000 1, 000 = 0 + 31, 000 Shri Krishna Education visit us at www. accountsshikshak. com 9

5) Sold goods to Mr. X for `. 4, 000 Two Element Mr. X Goods Debtor / Assets decreased = Liabilities + Cash + Goods + furniture + Debtor = 21, 000 + 5, 000 = - 4, 000 + 4, 000 = 0 + + 31, 000 0 21, 000 + 5, 000 0 + 31, 000 + 4, 000 = Capital Shri Krishna Education visit us at www. accountsshikshak. com 10

Note : A) Goods are sold at no profit or no loss basis B) Goods are sold on credit, since the name of customer is given Shri Krishna Education visit us at www. accountsshikshak. com 11

6) Purchased Goods from Mr. Y on Credit for `. 30, 000 Two Elements Mr. Y Goods Creditor / Liability Assets Increased = Liabilities + Capital Cash + Goods + furniture + Debtor = 21, 000 + 5, 000 + 4, 000 = + 30, 000 = Creditor 0 30, 000 + + 31, 000 0 21, 000 + 31, 000 + 5, 000 + 4, 000 30, 000 + 31, 000 = Shri Krishna Education visit us at www. accountsshikshak. com 12

7) Cash of `. 3, 700 received from Mr. X in full & final settlement. Cash Increased Mr. X Value decreased Assets = Discount allowed Expense + Capital Cash + Goods + furniture + Debtor = 21, 000 + 5, 000 + 4, 000 = +3, 700 + 0 - 4, 000 = Creditor 30, 000 + 300 31, 000 24, 700 + 31, 000 + 5, 000 + 0 30, 000 30, 700 = Liabilities + Shri Krishna Education visit us at www. accountsshikshak. com 0 13

8) Paid `. 10, 000 to Mr. Y on account Two Elements Mr. Y Cash Creditor / Liability Assets Decreased = Liabilities + Capital Cash + Goods + furniture + Debtor = 24, 700 + 31, 000 + 5, 000 + 0 = 10, 000 + 0 = Creditor 30, 000 10, 000 + - 30, 700 0 14, 700 + 31, 000 + 5, 000 + 0 20, 000 = + 30, 700 Note On Account means the discount is not received from Supplier Mr. Y Shri Krishna Education visit us at www. accountsshikshak. com 14

9) Paid Rent for `. 5, 000. Two Element Rent Cash Expenses Decreased Assets = Liabilities Cash + Goods + furniture + Debtor = 14, 700 + 31, 000 + 5, 000 + 0 = (-) 5, 000 = Creditor 20, 000 9, 700 + 31, 000 + 5, 000 20, 000 = + Capital + - 30, 700 5, 000 + 25, 700 Shri Krishna Education visit us at www. accountsshikshak. com 15

10) Paid Rent for `. 3, 000 in Advance. Two Element Prepaid Rent Cash Reduced Assets = Liabilities + Capital Cash + Goods + furniture + Prep Rent = 9, 700 + 31, 000 + 5, 000 + 0 = (-) 3, 000 + 3, 000 = Creditor 20, 000 0 + + 25, 700 0 6, 700 + 31, 000 + 5, 000 + 3, 000 20, 000 + 25, 700 = Shri Krishna Education visit us at www. accountsshikshak. com 16

Note: Since “Prepaid Rent” is an Asset and not an Expense that is why it will be shown on Assets side and not to be deducted from Capital Points to Remember 1) a) Prepaid Expenses Assets b) Outstanding Expenses Liability c) Perceived/Unearned Income Liability d) Outstanding/ Accrued income Asset Shri Krishna Education visit us at www. accountsshikshak. com 17

2) The following items will be Adjusted in Capital a/c while preparing Accounting Equations. a. All Expenses To be deducted from Capital A/c b. All Income/Gain Profit To be Add in Capital A/c c. Interest on Capital (+) & (-) from Capital A/c d. Interest on Drawings (+) & (-) from Capital A/c Shri Krishna Education visit us at www. accountsshikshak. com 18

11) Interest on Capital allowed by `. 500 Two Elements Capital Interest on Capital Increased Expense Assets = Liabilities Cash + Goods + furniture + Prepaid Exp = 6, 700 + 31, 000 + 5, 000 + 3, 000 = Creditor 20, 000 6, 700 + 31, 000 + 5, 000 + 3, 000 20, 000 = Shri Krishna Education visit us at www. accountsshikshak. com + Capital + 25, 700 + 500 + 25, 700 19

12) Goods worth `. 4, 000 were used by proprietor for his personal used. Two Elements Goods Drawings Reduces Capital Reduced Assets = Liabilities Cash + Goods + furniture + Prepaid Exp = 6, 700 + 31, 000 + 5, 000 + 3, 000 = - 4, 000 Creditor 20, 000 6, 700 + 27, 000 + 5, 000 + 3, 000 20, 000 = Shri Krishna Education visit us at www. accountsshikshak. com + Capital + - 25, 700 4, 000 + 21, 700 20

13) Salary of `. 5, 000 were due but not paid Two Elements Salary Outstanding Expense Liability Increased Assets = Cash + Goods + furniture + Prepaid Exp = 6, 700 + 27, 000 + 5, 000 + 3, 000 = Liabilities + Capital Creditor 20, 000 5, 000 + 21, 700 + 5, 000 25, 000 Shri Krishna Education visit us at www. accountsshikshak. com - + 16, 700 21

14) Interest on Drawing changed for `. 200 Two Elements Interest on Drawings Reduces Capital Income for firm Assets = Liabilities + Cash + Goods + furniture + Prepaid Exp = 6, 700 + 27, 000 + 5, 000 + 3, 000 = Creditor 25, 000 + 6, 700 + 27, 000 + 5, 000 + 3, 000 25, 000 = Shri Krishna Education visit us at www. accountsshikshak. com Capital 16, 700 + 200 - 200 + 16, 700 22

Balance Sheet Liabilities Capital Creditor Total Assets 16, 700 Cash 25, 000 Goods (Stock) Prepaid Expenses Furniture 41, 700 total Shri Krishna Education visit us at www. accountsshikshak. com 6, 700 27, 000 3, 000 5, 000 41, 700 23