CHAPTER

5
Accounting Equation
LEARNING OBJECTIVES
This chapter would enable students to understand:
nderstand:

Meaning of an Accounting Equation

O Effect of Transactions on Accounting Equation

Process of Preparing Accounting Equation

Rules for Accounting Equations
Effect of Adjustment Transactions on Accounting Equation

MEANING OF AN ACcOUNTING EQUATION

Accounting Equation is a mathematical expression based on Dual Aspect Concept

of Accounting.
Accounting Equation is based on the Dual Aspect Concept of accounting. It means every
transaction has dual aspect or two aspects debit and credit. It holds that for every
debit there is a credit of equal amount and vice versa. It means, total claims (those of
outsiders and of the proprietors) will always be equal to the total assets of the firm. The
claims, also known as equities, are of two types:
1. Owner's equity or capital and
2. Liabilities or amounts due to outsiders (i.e., Outsiders' Equity).
We can express it mathematically as follows:
Assets Equities(Total Claims) Or Assets= Liabilities +Capital
Or Liabilities= Assets -Capital Or Capital= Assets- Liabilities
The above relationship is known as the Accounting Equation or the Balance
Sheet Equation.
An Accounting Equation always holds true with every change that occurs due to a
transaction entered into. It is because of the reason that it is based on the Dual Aspect
Concept of accounting.
Efect of Transactions on Accounting Equation
A transaction may affect either both sides of the equation by the same amount or one
side of the equatíon only, by both increasing or deereasing it by equal amou
Tra
Transactions from the Accounting Equation viewpoint, can be divided into two, i.e.

.Transactions Affecting Two Items, and

2TransactionsAffecting More Than Two Items.
Let us discuss them in detail.
 1. Transactions Affecting Tuo Items AccountingEquation

As the title suggests, these are those transactions that affect two items of the aceo 5.3
equation or Balance Sheet. The equation stands as follows:
Transactions affecting opposite sides are: Assets
Cash Liabilities + Capital
) Increase in Asset, Increase in Liability
Rakesh's
Transaction such as credit purchases increase asset (stock) and also increase lkat. C a p i t a lI n t r o d u c e d 20,000
(creditor). Similarly, Loan from bank increases asset (cash or bank) and also in +20,000
liability (Bank Loan). ncrea (2) Purchases
furniture for 500 in
sh
(i) Decrease in Liability, Decrease in Asset edfaet-
Tt means cash in hand is reduced
by 7 500 but a
purchased. Thus, total of assets remains (Furniture) of the
new asset
Transaction of payment to a creditor decreases liability (creditor) and also Tod ame amount has been
asset (cash or bank). edue The equation will now appear as follows: unchanged.
(i) Increase in Asset, Increase in Owner's Capital Assets
Introduction of capital by the proprietor increases asset (cash or bank) and also Liabilities+ Capital
(owner's capital).
(iv) Decrease in Owner's
liabilie
liak Cash+ Fumiture
20,000+
Rakesh's
Capital, Decrease in Asset old Balance
20.000
Drawings by the proprietor decrease liability (owner's capital) and also asset (cash or h New Transaction 500+500
Transactions affecting same side but in opposite direction are: banl New Balance 19.500 500
+20.000
It may be noted that the total assets remain
) Increase in Asset, Decrease in Another Asset equal to liabilities plus capital.
Transactions such as cash purchases or receipt from debtors increase one (3) Purchases goods for 1,000 in cash.
asset (o
and cash or bank,
respectively) and decrease another asset (cash or bank and Efect: It means cash in hand is reduced by 1,000 and another
deht has come into existence. However, total of assets remains
asset, i.e., stock
ii) Decrease in Liability, Increase in Another unchanged.
Liability The equation now will be as follows:
Settlement of creditor by issue of Bill of
increases another liability (Bill of
Exchange decreases a liability (creditor
Exchange). at Assets
Liabilities + Capital
2.Transactions Affecting More Than Two Items Cash+Furniture Stock Rakesh's
Some transactions affect more than two
items of the accounting equation or a 19,500+ 500
Sheet. For example, when a sale is
made in cash for 30,000, it is Balan Old Balance
20,000
25,000) plus profit 5,000). Cost of goods R 25,000) reduces asset made at New Transaction -1,000 0 +1,000
cash increases by 30,000 and the (stock of goods New Balance 18,500+ 500 1,000
owner's +20,000
should be noted that profit increases the capital
increases by the profit R
5,000),
owner's capital and loss decreases it. (4) Purchases goods for 2,000 on credit.
Process of Preparing
Accounting Equation Effect: It means the stock has increased by 2,000 increasing the total assets to
The process of 22,000. A liability of R2,000 to the supplier of the goods (creditor) has arisen. The
Accounting Equations begins with:
1.
Ascertaining Assets, Liabilities or Capital effected by a transaction. equation now will be as follows:
2. Deciding the effect (in terms of increase Assets
Liabilities or Capital.
or decrease) of a transaction on Asset Liabilities+ Capital
Cash+Furniture+ Stock Creditors Rakeshs
3. Recording the effect on the relevant side of the equation.
Let us take few transactions to Old Balance 18,500 500 +1,000
understand the accounting equation. New Transaction 0+ 0 2000 20,000
Suppose, Rakesh starts business and the
following successive transactions ar New Balance 18,500 500 + 3,000
2.000
entered into: 2,000 20,000
(1) He commences his business (6) Sold goods costing 2,500 on credit for
with 20,000 as Capital. 4,000.
Effect: It means that the firm has assets Effect: It means a debtor has come into existence to the extent ofR 4,000. The
claims against the firm are also totalling 20,000 in the form of cash a is reduced stock
only by 2,500, being the cost of goods sold. Net increase in assets,
20,000 in the form of capital. 1,500 (i.e., R 4,000-7 2,500) (profit) will be added to the
capital
 Doubie tnUy Doon
nEPgCBS
CBSE X
5.4 AccountingEquation

as follows: 5.5
now will appear
The equation
Illustration 1.
Liabilities
Assets
Capital Show Accounting Equation
ting Ee on the basis of the
+ Furniture+ Stock +Debtors Creditors + Rakesh following transactions:
with cash 1.0000010wing
transactions:
Cash
1. Sunil started business
500 + 3,000+ 2,000 Purchased goods cash
in 50,000.
Old Balance 18,500
2,500 + 4,000 20,000 2.
hased furniture trom M/s Samrat Furnitures
NewIransaction 1,500 cOsting? 25,000 for? 35,000 against cash.20,000.
500+ 500+ 4,000 2,000
New Balance 18,500 21,500 MIs Samrat Furnitures was paid in cash.
(6) Paid 1,000for rent and5,000 for salaries.
Solution
Effiect: It means cash in hand has reduced by ? 6,000; these are expenses and no ase. No. Transactions
comes into existence. Hence, capital will be reduced bythis amount, as shown below Assets Liabilities Capital
Assets Liabilities+ Capital Sunil started business with cash
1,00,000
Cash+ Furniture + Stock + Debtors Creditors +Rakesh Purchased goods in cash 1,00,000
2 +50,000
Old Balance 18,500 + 500 + 500+ 4,000 2,000 -50,000
21,500 New Equation
New Transaction -6,000 + 0 + 0 + 0 0
6,000 1,00,000 1,00,000
Purchased furmiture from M/s Samrat Furnitures (Note 1)
New Balance 12,500 + 500 +500 + 4,000 2,000 +20,000 20,000
15,500 New Equation 1,20,000 20,000 1,00,000
(7) Rakesh withdraws? 2,000 for his personal use. Sold goods costing 25,000
-25,000
for 35,000 (Note 2)
Effect: Cash in hand is reduced by ? 2,000 and capital will also reduce by the same +35,000 10,000
amount. The new Accounting Equation will be as follows: New Equation 1,30,000 20,000
Payment to M/s Samrat Furnitures
1,10,000
5 20,000 20,000 0
Assets Liabilities + Capital New Equation 1,10,000 1,10,000
Cash Furniture+ Stock+Debtors Creditors + Rakesh's
Notes: 1. The transaction with M/s Samrat Furnitures ( 20,000) is a credit
transaction since it is not stated to
cash paymen
Old Balance 12,500+ 500 500+ 4,000 2,000 15,500
New Transaction 2,000+ 2. Sale of goods has resulted in a profit of 10,000. It has been added to
0 2,000 the year end is transferred to Capital Account.
capital because net profit at
New Balance 10,500+ 500 500+ 4,000 2,000 13,500 Illustration 2.
It will be observed from above that the total of assets will always be equal to the total
of liabilities and the capital. The last equation stated above can also be
Prepare the Accounting Equation on the basis of the following:
presented in 1. Started business with cash7 70,000.
the form of a statement, i.e., Balance Sheet as given
below 2. Credit purchases
of 18,000. goods?
3. Payment made to creditors in full settlement
BALANCESHEET OF RAKESH as at.. 4. Purchase of
17,500.
Liabilities Assets
machinery
for cash 20,000. (KVS)
Solution:
Creditors 2,000 Cash
Capital 10,500 No. Transactions Assets
15,500 Stock 500 Liabilities Capital
Less: Orawings 2,000 13,500 Debtors 4,000 Cash+ Stock Machinery Creditors+ Capital
Furniture 00
15,500 15,500
1 Started business with cash
The Balance Sheet shows the sources 70,000 70,000 70,000
from which funds have been obtained Credit Purchases of goods
hand side does that; in the above case, -the let 18,000
2,000 have been obtained from outsiders and 0+18,000+ 18,000
13,500 have been contributed the by
shows how the funds stand invested.
proprietor. The other side known as
assets S1de New Equation 70,000 + 18,000 18,000 + 70,000
Payment made to creditors in
A conclusion full settlement
apparent from the transactions given above is that -17,500 0 -18,000 500
two sided effect. In other every transaction h New Equation
words, the Dual 52,500 18,000 70,500
reduction or increase in an asset will have a Aspect Concept will always hold good. 4. Purchase of machinery for cash -20,000 0 + 20,000
This is because of the rule that corresponding effect on liabilities or capito New Equation 32,500 +18,000 +20,000 70,500
every receiver is a giver and +
every giver is a recebe
 P

8
8 8 o8

. E.
Ele . . ss. . s.
 Double Entry Book Keeping-CBse
5.8
SEX ccounting Equation
5.9
profit by 200. Thus, capital
Notes: Rent being an expense will reduce will be Solution:
reduce cash by 200. O
1. Rent paid will wst due but not received shall be added to assets on one
reduced by 200.
increase Bank Balance. It being an income increase profit by
will increase Drot
on other side. side and to the capital
received from Bank will
2. Interest

R 100. Thus, capital

will be increased. will increase cash on the assets side
and increase the liabilities.
reduced by &500 and Debtors will be
increased by 700. Capital will be increas by 200 ie, l decrease one asset
3. Stock will be (cash) and increase another
700-7 500)being profit asset (Prepaid insurance).
5 Salary being an expense Will be
deducted from the capital and
4. As explained in
Note1.
be added to
liabilities. being unpaid will
Effect of Adjustment Transactions
on Accounting Equation
Ilustration 6.
those expenses which have
been incurred but ha
1. Outstanding Expenses are
nave Anil had the following transactions:
not been paid.
1, Commenced business with cash 50,00o
Treatment in Accounting Equation:
expense and
will reduce profit for the currennt o Purchased goods for cash 20,000 and credit 30,000.
Deduct from Capital as it is an 3. Sold goods for cash R 40,000, costing 30,000.
accounting period.
Liabilities side in the name
of 'Outstandin. 4. Rent paid 500, Salaries 5,000
Make a new column on the

Expenses' as the amount is still

to be paid. 5. Rent outstanding 100, Salaries Outstanding 1,000.
those expenses which have been paid
in advance, thes
i.e., they 6. Bought furniture for 5,000 on credit.
2. Prepaid Expenses are

are not yet due but paid. 7. Bought refrigerator for personal use 5,000.
Treatment in Accounting Equation: 8. Purchased computer for cash 20,000.
.Deduct from Cash as there is an outflow of cash. 9. Cash withdrawn for personal use 10,000.
.Make a new column on the Assets side
in the name of "Prepaid Expenses' as 10. Interest drawings charged 500 and the interest on Capital 1,000.
on

the amount is paid in advance. Use Accounting Equation to show the effect of the above transactions on his
assets,
earned but not received durine liabilities and capital and also show his Balance Sheet.
3. Accrued Income is that income which has been
the current accounting period. Solution: Solution on Page No. 5.10.
Treatment in Accounting Equation: Illustration 7.
the current
Add in Capital as it is an income and will increase profit for Prepare Accounting Equation of the following transactions and also the Balance Sheet:
accounting period.
Make a new column on the Assets side in the name of 'Accrued Income' as the
1. Manu started business with cash.
amount is still to be received. 1,00,000
Opened a Bank Account and transferred 4,00,000 from his
4. Unearned Income or Income Received in Advance is that income which has Savings Account.
been received but not earned during the current accounting period. 2. Purchased a building from Sohan for
12,00,000 paid by
Treatment in Accounting Equation: taking a loan from SBI. 10,00,000
Add in Cash as there is inflow of cash. 3. Paid interest on loan 20,000 and
instalment ofR 1,00,000.
Make a new column on the Liabilities side in the
as the amount is received in advance.
name
of Unearned Incom 4. Purchased goods from Rohan on credit. 1,00,000
5. Goods returned to Rohan costing 20,000
Illustration 5. 6. Sold goods costing 40,000 for 50,000 on credit to Ram.
How are the following items dealt in Accounting Equation? 7. Took goods from business for personal use. 10,000
( Interest due but not received R 5,000 8. Accrued interest.
5,000
() Rent received in advance 10,000 9. Commission received in advance. 20,000
ii) Insurance premium paid in advance 10. Cash received from
15,000 Ram. 10,000
Ge) Salaries due but not paid 20,000 Solution: Solution on Page No. 5.11.
 Double Entry Book Keeping

5.10
Reeping-dBSE A c c o u n t i n gE q u a t i o n
5.11
No. 5.9)
6, Page Liabilities+
Solution:
(Ilustration
Assets
Expenses+ Capital
Transactions Cash Stock +Furniture +Computer =Creditors+ Capita
Outstanding9
No
+
olo
1. Commencedbusines 0 0+ 0 +
with cash 50,000 s0,000
for
2 Purchased goods
cash t 20,000 and
credit t 30.000 -20,000 50,000 030.000 0
NewEquation
30,000 50,000
Sold goods for cash
40,000 costing 0 0
30,000 40,000 30,000

New Equation 70,000+ 20,000 0 30.000 0

+ 600
0 0 0
4. Rent paid -500 + 0

Salaries Paid -5,000

0 30,000+ 0
New Equation 64,500 + 20,000
+ 100
5AS
5. Rent Outstanding 0 1,000
0 0+
Salaries Outstanding
New Equation 64,500+ 20,000 0+ 30,000+1,100 5340
6. Bought furniture for
5,000+ 0
5,000 on credit 0 0+5,000

New Equation 64,500+ 20,000 + 5,000+ 0 35,000+1,100 53A00

7. Bought refrigerator P P

for personal use

0 0+ 0 0 + 5.0
t5,000 -5,000+ +

59,500 + 20,000 +5,000+ 0 35,000 1,100 + 4840

New Equation
Purchased computer
0 0
forcashR 20,000 -20,000+ 0 + 0+20,000
35,000 t 1,100 48400
New Equation 39,500 20,000 +5,000+ 20,000
Cash withdrawn for
personal use -10,000 + 0 + 0+ 0

New Equation 29,500+20,000+5,000 +20,000 35,000+ 1,100 38,400

0 0 0+ 0 0+ 0
10. Interest on drawings

Interest on Capital 1,0

20,000 + 5,000+ 20,000 = 35,000+ 1,100 38,40

New Equation 29,500
Including ereditors for furniture R 5,000.

BALANCESHEET OF ANIL asat..

Liabilities Assets
Creditors Cash in Hand 29,50
35,000
(indluding creditor for furniture 5,000) Stock
20,00

Expenses Outstanding 1,100 Furniture 5.00

Capital 20,00
38,400 Computer
74,500 74S0 L
 Accounting E q u a t i o n
5.12
OF MANU as at... 5.13
BALANCE SHEET
Assets llustration 10.

Liabilities Cash in Hand From the follow mation, caleulate the total assets of the business:
Capital
4,85,000
9,00.000 Cashat Bank
1,80300 00;
Capital 4,00,000; Creditors 3,00,000; Revenue earned
Stock during the period R 7,50,000;
Loan fron SB)
80,000
20,000 Debtors
309 E x p e n sa
es
incurred during the period 2,00,000; Value of unsold stock
s incurred

2,00,000.
Creditors
Commission Received in Advance Accrued Interest AD
S Solution:
Building 12,00 Total Assets = Liabilities (Creditors) Capital+ Profit
14,85,000 1485 0 +

R3,00,000+R4,00,000+75,50,000 (i.e., {7,50,000-2,00,000)

=

=
R12,50,000 (including 72,00,000 Closing Stock).
Illustration 8.
of transactions:
each of the following types Illustration 11.
Give an example for
asset.
decrease in another
1. Inerease in one asset, A commenced his cloth business on 1st
April, 2020 with a capital of 30,000. On
increase in liability. 31st March, 2021 his assets were R 50,000 and liabilities were 10,000. Find out his
2. Increase in asset,
in owner's capital. closing capital and profits earned during the vear.
in asset, increase
3. Increase
decrease in liability.
4. Decrease in asset, Solution:
decrease in owner's capital. Total Assets = Capital + Liabilities
5. Decrease in asset,
increase in owner's capital.
6. Decrease in liabilities, 50,000 Capital + 10,000
decrease in another liability. Closing Capital = 7 50,000 10,000= 40,000
7. Increase in one liability,
decrease in owner's capital. Profit
8. Increase in liabilities, Closing Capital Opening Capital
-

=
740,000-7 30,000 =7 10,000.
Solution:

of furniture for cash-Increase in furniture and decrease in cash. Illustration 12.

1. Purchase
credit-Increase furniture and increase in liability
in Calculate total liability if
2. Purchase of furniture on

cash and increase in capital. 1. Owner's capital in the beginning is 60,000. 2. Creditors at the end is 50,000.
3. Capital introduced by proprietor-Increase in
and decrease in creditors. 3. Revenue during the period is R 70,000. 4. Expenses during the period are ? 65,000.
4. Payment to creditors-Decrease in cash
and decrease in capital. Also calculate amount of owner's capital at the end.
5. Cash withdrawn by proprietor-Decrease in cash
loan into capital-Increase in capital and decrease in loan Solution:
6. Conversion of partner's
7. Bills Payable accepted-Increase in bills payable and decrease in creditors. Total Liability = Owner's Capital at the end + Creditors

8. Outstanding expenses provided -Increase in creditors for outstanding expense =

65,000 +750,000 7 1,15,000.
=

and decrease in capital. Owner's Capital at the end = Owner's Capital in the beginning + Revenue - Expenses

Calculation of Total Assets, Capital and Other Variables

=
60,000+7 70,000 65,000 = 65,000.

Ilustration 9. Illustration 13.

of R 40,000, calculate t X started a business on 1st April, 2020 with a capital of R50,000 and a loan of 725,000
f the capital of a business is 70,000 and liabilities are
taken from Y.During 2020-21, he had introduced additional capital of 7 25,000 and had
total assets.
withdrawnR 15,000 for personal use. On 31st March, 2021 his assets were R 1,50,000.
Solution: Find his capital as on 31st March, 2021 and profit made or loss incurred during the
Total Assets =Capital + Liabilities =
7 70,000+7 40,000 =7 1,10,000. year 2020-21.
 5.14 Double Entry
Keeping-CBSE
Book

Solution:
Closing Capital Closing Assets-Closing Liabilities (i.e.,
=
Y's Loan
*1,50,000- 25,000= 1,25,000.
ont= Closing Capital + Drawings - Additional Capital -
Opening Capital
1,25,000+ 15,000-7 25,000-
50,000 =R65,000
llustration 14.
On 31st March, 2021, the total assets
and external
iabilities w e r e 00 and
1,00,000

S,000 respectively. During the vear. the proprietor had introduced &adatoCapit
made a protit of 10,0
of 10,000 and had withdrawn 6,000 for personal use. He 000
during the year. Caleulate the capital as on 1st April, 2020.
Lzabilhties
Solution: Closing Capital = Closing Assets- Closing External
=R1,00,000- 3,000 =7 97,000.
Additional Capital Prês -

Opening Capital = Closing Capital+ Drawings-

10,000-7 10,000 =? 83,000.
=? 97,000+76,000-7
Illustration 15.
Calculate the amount of External Liabilities as on 31st March, 2021 in each

the following cases:

15,00,000 and R S,50,00
) On 31lst March, 2021, total assets and capital were
respectively.
of R 2,00,000 and a loa
() On 1st April, 2020, Anil started business with capital
a

he earned profit of 50,00

of 50,000 borrowed from a friend. During 2020-21,
On 31st March, 2021, the total assets were 6,00,000.
of T 5,00,000 anda
On 1st April, 2020, Sohan started a business with capital
a
(ian) loan of 2,50,000 borrowed from a friend. During 2020-21, he earned a pro
of 2,50,000, introduced an capital of 3,00,000 and had withdrawa
additional
71,50,000 for his personal use. On 31st March, 2021, the total assets wert
20,00,000.

Solution:
External Liabilities
=
Assets - Capital
= 15,00,000- 8,50,000 = T6,50,000.
(D Closing Capital = Opening Capital + Additional Capital+ Profit - Drawings
= 72,00,000+0+ 50,000-0=72.50,000
External Liabilities
= Assets Closing Capital
-

= 7 6,00,000- 2,50,000= T 3,50,000

Closing Capital = 5,00,000+30.000+ 2.50,000-T 1,50,000 =79.00.0
(i)
External Liabilities =t 20,00,000-R 9,00,000= 00,0 D.

S c a n QR Code for Additional lllustrations