Unit 05. Accounting Equation

What is Accounting Equation?When Transaction happened in a Business, it makes some changes in the values of Assets, Liabilities, Equity, Income and Expenses. Those changes can be derived by an equation. That equation is called Accounting Equation.

Basic Accounting Equation

Assets = Equity + Liabilities

Factors that impact for the changes in Equity• Additional Capital (Increase Equity)• Drawings (Decrease Equity)• Income (Increase Equity)• Expenses (Decrease Equity)

Impact of Transactions on Basic Accounting Equation.

1. Investment of Capital at the Beginning of the Business.Eg: 01.01.2018Nimal Started a Business by investing Rs 500,000 cash and Rs 200,000 worth machine owned by him to the business.

When investing any kind of resource to the business at the beginning of a year, after the investment that becomes under the control of the business, it become an Asset from one side, and since the ownership of those resources invested is upon the owner it become an Equity from the other side.( Since, we learned that Assets which belong to owner called Equity/Capital). In Sole Tradership Business, Capital is same as the Equity.

Cash (Assets) Increase Machines (Assets) Increase Capital (Equity) Increases

Since, there is only Assets and Equity at the beginning of the Business, Accounting Equation shows only the composition of Assets and Equity.

Assets = Equity01.01. +500,000 (Cash) = + 700,000(Capital)

+200,000(Machine)

2. Obtaining a Bank LoanEg: 05.01.2018, Nimal Obtained a Bank Loan Rs 150,000Cash (Assets) Increase Bank Loan (Liability) Increase

Assets = Equity + Liabilities05.01. + 150,000(Cash) = + 150,000(Bank Loan)

3. Investing additional capitalEg: 08.01.2018. Nimal Invested another Rs 25,000 for the BusinessCash (Assets) Increase Capital (Equity) Increase

Assets = Equity + Liabilities08.01. + 25,000 (Cash) = + 25,000(Capital)

4. Owners withdrawing Money or any Goods for the personal use from the Business. (Cash drawings and Goodsdrawings)Eg: 10.01.2018. Nimal has taken Rs 2,500 money and Rs 5,000 worth stock for his personal use.

Assets = Equity + Liabilities10.01. +2,500 (Cash) = + 7,500 (Drawings)

+ 5,000 (Stock)

5. Transaction of Expenses (Except cost of sales)Eg: 11.01.2018. Paid electricity bill of Rs 5,000 for the month of January.

12.01.2018. Paid the Bank Loan Interest Rs 2,500Cash (Assets) Decrease Equity reduce as Electricity Expenses (Since, Increase of expense leads to reduction of EquityCash (Assets) Decrease Equity Reduce as Bank Loan Interest

Assets = Equity + Liabilities11.01. – 5,000 (Cash) = - 5,000 (Electricity) 12.01. – 2,500 (Cash) = -2,500 (Bank Loan Interest)

6. Transaction of Income (Except Sales Income)Eg: 15.01.2018. Received commission income of Rs 12,000

Cash (Assets) Increase Income (Equity) Increase (Income leads to Increase Equity)

Assets = Equity + Liabilities15.01. +12,000 (Cash) = + 12,000 (Commission)

7. Transactions regards to Purchasing and Selling

Cash PurchaseEg1: 16.01.2018Purchased Goods on Cash Rs 5,000 (Cash Sales Rs 5,000)

Cash (Assets) Decreases Stocks (Assets) Increases

Assets = Equity + Liability16.01 + 5,000 (Stocks)

- 5,000 (Cash)

Eg2: 16.01.Purchased Goods on cash Rs 12,000 from john for resale purpose.

Assets = Equity + Liability16.01 + 12,000 (Stocks)

- 12,000 (Cash)

Credit Purchase

Eg : 1.17.01. Purchased Rs 5,000 Stocks on credit.

Assets = Equity + Liability17.01 + 5,000 (Stocks) = + 5,000 (Creditors)

Eg 2 :18.01 Purchased Rs 20,000 Stocks from Kapila on credit for resale purpose .

Assets = Equity + Liability18.01 +20,000 (Stocks) = + 20,000 (Kapila)

Eg 3 : 20.01. Purchased Rs 12,000 stocks from Ananda for resale purpose.

Assets = Equity + Liability20.01 + 12,000 (Stocks) = + 12,000 (Ananda)

(Though they haven’t mentioned the whether this is on credit or not, since they have mentioned the name of the supplier and said , purchased from him, we considered it as a Credit purchase).

Cash Sales and Credit SalesWhen they have given only the sales income the Transaction,

Eg 1: Sold Good on Cash Rs 20,000. (Cash Sales Rs 20,000)Cash (Assets) Increase Sales (Income) Increase

Assets = Equity + Liability+ 20,000 (Cash) = + 20,000 (Sales)

Eg 2 : Sold Goods on Credit Rs 25,000. (Credit Sales Rs 25,000)

Debtors (Assets) Increase Sales (Income) Increase

Assets = Equity + Liability+25,000 (Debtors) = + 25,000 (Sales)

Eg 3: Sold Goods to Kamal on Credit Rs 18,000 (Sold Goods to Kamal Rs 18,000)Debtor Kamal(Assets) Increase Sales (Income) Increase

Assets = Equity + Liability+18,000 (Kamal) = + 18,000 (Sales)

When they have given both cost and the sales price in the transaction.

Eg 1 : 21.01.Sold Rs 15,000 stocks for Rs 25,000 on cash.

WorkingsProfit = Income (Sales Price) – Expenses (Cost of the Goods/ Purchasing Price)

Rs 25,000 - Rs 15,000= Rs 10,000

Cash (Assets) Increases Stocks (Assets) Decreases Profit (Equity) Increases

Assets = Equity + Liability21.01 +25,000 (Cash) = +10,000 (profit)

- 15,000(Stock)

Eg 2 : 22.01. Sold Rs 10,000 stocks for Rs 15,000 on credit.

Debtors(Assets) Increases Stocks (Assets) Decreases Profit (Equity) Increases

Assets = Equity + Liability22.01 +15,000 (Debtors) = +5,000 (profit)

- 10,000(Stock)

Eg 2 : 23.01.Sold Rs 10,000 stocks for Rs 15,000 on credit to Amarapala

Debtors(Assets) Increases Stocks (Assets) Decreases Profit (Equity) Increases

Assets = Equity + Liability23.01 +15,000 (Amarapala) = +5,000 (profit)

- 10,000(Stock)

8. Receiving Cash from DebtorsEg:24.01. Cash Received from Debtor Rs 5,000

Cash received from debtor Amal Rs 15,000

Assets = Equity + Liability23.01 + 5,000 (Cash) =

- 5,000 (Debtors)

+15,000 (Cash) = - 15,000 (Amal)

09. Cash paid to CreditorsEg: 28.01. Paid to Creditors Rs 15,000

Paid to Kamal Rs 20,000

Assets = Equity + Liability28.01. – 15,000 (Cash) = - 15,000 (Creditors)

- 20,000 (Cash) = - 20,000(Kamal)

10. Repaying the Bank LoanEg: 31.01. Settled the part of the Bank Loan Rs 50,000

Assets = Equity + Liability31.01. – 50,000 (Cash) = - 50,000 (Bank Loan)

Accounting Equation When Investing In an Fixed DepositEg : Invested Rs. 50,000 in a Fixed Deposit.Cash (Assets) Decreases Fixed Deposits / Investments (Assets) Increases

Assets = Equity + Liability+ 50,000 (Fixed Deposits)- 50,000 (Cash)

Accounting Equation when Purchasing Non current Assets (Fixed Assets).Eg : Purchased Rs 50,000 worth machine on cash. (Cash Basis)

Purchases Rs 30, 000 worth furnitures on credit from kusuma. (Credit Basis)

Assets = Equity + Liability+ 50,000 (Machine)- 50,000 (Cash)

+ 30,000 (Furnitures) = + 30,000 (Kusuma)

Activity 01

Nehara started a Business which repairs computers. The Following Transactions belong to the first month of the Business.

1. Invested Rs 500,000 as the capital.2. Obtained a Bank Loan of Rs 200,000.3. Deposited Rs 100,000 in a fixed deposits.4. Earned a cash income Rs 60,000 from computer repairs.5. Paid Rs 10,000 as the monthly rent of the business.6. Nehara withdrew Rs 20,000 from the business for personal use.7. Purchased equipment Rs 100,0008. Paid Rs 5,000 as the telephone bill of the month.9. Nehara invested an additional capital of Rs 50,000.10. Setteled Rs 20,000 of the bank loan.

Apply the above Transactions in the Accounting Equation.

Activity 02

Following Transactions Belongs to Thisanka’s Business for the month of January 2019.

01/01 Invested Rs 300,000 as capital.01/04 Purchased goods at Rs 50,000.01/09 Paid Rs 10,000 as Building rent.01/13 Sold Goods which cost Rs 40,000 at Rs 60,000.01/19 Obtained a Bank Loan Rs 300,000.01/21 Paid Rs 10,000 from the Business for the Telephone bill of Thushari’s house.01/28 Received Rs 30,000 from debtors.01/30 Paid the Bank Loan interest of Rs 5,000.01/31 Paid electricity bill of Rs 5,000.

Apply the above transactions in the basic accounting equation. (Assets = Equity + Liabilities)

Activity 03Following transactions belong to Jack’s Business for the month of January 2018.

1. Invested Capital Rs 250,000.2. Invested Rs 30,000 Computer owned by jack to the business.3. Purchased a machine Rs 20,000.4. Cash purchase Rs 45,000.5. Cash Sales Rs 20,000.6. Credit purchase Rs 15,000.7. Credit sales Rs 10,000.8. Rent income received Rs 5,000.9. Paid electricity expenses Rs 4,000.10. Owner took Rs 4,500 for personal use.

Apply the above transactions in the Accounting Equation.

Activity 04

Samantha started a Business in Moratuwa. Transactions of the first month of the Business are given below.

1. Started the Business by investing Rs 500,0002. Obtained a Bank Loan Rs 200,000.3. Invested Rs 100,000 in a Fixed Deposit.4. Purchased Goods from Amara for Rs 15,000 on Credit.5. Paid Building rents of Rs 12,000.6. Purchased goods on cash Rs 45,000.7. Purchased goods on credit Rs 30,000.8. Purchased an Equipment of Rs 100,000.9. Paid Telephone bill of Rs 5,00010. Settling the Bank Loan Rs 20,000.

Apply the above Transactions in the Basic Accounting Equation

Activity 05

Following information belongs to Sandamini’s Business as at 2014.08.01

Furniture Rs 300,000 Bank Loan Rs 300,000Stock (Inventory) Rs 200,000 Creditors Rs 100,000Debtors (Trade Receivables) Rs 100,000Cash Rs 200,000Following Transactions happened during the Month of August 2014.1. Purchased Rs 100,000 stock for resale.2. Sold Rs 100,000 worth stock for Rs 125,000 on cash.3. Settled a part of the Bank Loan Rs 50,000.4. Paid Rs 10,000 as Salary5. Sandamini has taken Rs 20,000 worth stock for her personal use.6. Purchased Rs 50,000 of Furniture for office use.7. Purchased Rs 200,000 on stock for resale on credit.8. Sold Rs 60,000 worth stock for Rs 100,000 on credit.9. Received Rs 80,000 from debtors.10. Paid Rs 50,000 Creditors.

Required:1.Calculate the Capital as at 01.012. Apply the above transactions in the following Equation.Furniture + Stocks + Debtors + Cash = Equity + Bank Loans + Creditors

Activity 06Following Balances belongs to Salmal’s Business as at 01st of July 2018.

Following Transactions happened during the month of July,1. Owner invested additional capital of Rs 200,000.2. Paid the Bank Loan installment Rs 20,000 which included Rs 2,000 of interest on it.3. Purchased Rs 100,000 worth stock on credit.4. Paid to Creditors Rs 50,0005. Invested Rs 200,000 worth machine which is owned by the owner to the Business.6. Sold Rs 100,000 worth stocks for Rs 150,000 on credit.7. Paid insurance premium Rs 10,0008. Received Rs 70,000 from debtors9. Paid Owner’s personal electricity bills by using cash of the Business Rs 5,000.10. Received Rs 10,000 of Sales commission income.

Apply the Above Transactions in the Accounting Equation.

Motor Vehicles Rs 500,000Trade Goods Rs 200,000Cash Rs 100,000

Bank Loans Rs 200,000Creditors Rs 100,000Capital Rs 500,000

Activity 06Given below are some transactions happened in Aloka’s Business in the form of Accounting Equation.

Assume that Owner haven’t done any drawing within the monthDescribe each transaction that could possibly happened within the Month

Date Assets =

Equity+

Liabilities

Lands and + Buildings

Stocks +

Debtors +

Cash =

Equity Bank Loan Creditors

01/01Balance

1000,000 300,000 200,000 300,000 1,200,000 500,000 100,000

1/3 - +200,000 - -100,000 +100,000

1/7 -20,000 -20,000

1/10 -60,000 -10,000 -50,000

1/14 -200,000 +300,000 - +100,000

1/18 +300,000 +300,000

1/21 -100,000 -100,000

1/25 -400,000 +400,000

Activity 07Given below are some transactions happened within Jayantha’s Business for the month of April in the form of Accounting Equation.

Assume the only transaction in 23rd is a drawing.Describe the above transations

Date

Assets Equity Liabilities

Motor Vehicle + Stock + Debtors + Cash = Capital + Creditors

1-Apr 500,000 200,000 - 200,000 700,000 200,000

3-Apr (+)300,000 (+)300,000

5-Apr (+)100,000 (+)100,000

8-Apr (-)50,000 (-)50,000

10-Apr (-)10,000 (-)10,000

11-Apr (-)60,000 (+)100,000 (+)40,000

17-Apr (+)200,000 (+)200,000

19-Apr (-)20,000 (-)20,000

23-Apr (-)20,000 (+)20,000

28-Apr (-)5,000 (-)5,000

30-Apr (+)50,000 (-)50,000

Activity 08Following transactions belongs to Thisuri’s Business for the month of January 2018.1. Invested Rs 300,000 as Capital2. Purchased stocks Rs 50,000. 3. Paid Rs 10,000 as monthly building rent.4. Sold Rs 40,000 worth stock for Rs 60,000 on cash.5. Obtained a Bank Loan Rs 300,000.6. Paid Thisuri’s Personal electricity bill by Cash of the Business. 7. Cash received from debtors Rs 30,000.8. Paid the Bank Loan interest Rs 5,000.9. Paid Electricity bill Rs 5,000.10. Received Commission Income Rs 12,000.

Activity 09

Assets as at 01.01.2019 Rs 120,000Assets as at 31.12.2019 Rs 135,000

During the year Equity of the Business increased by 20% and Liability of the Business decreased by 10%.

Required:1. Calculate the Capital and Liability as at 01.01.20192. Calculate the Capital and Liability as at 31.12.2019

Activity 10Given below are some impacts Transactions on the accounting equation.

Describe two transactions for each incident that could possibly happened.

Date Assets = Equity + Liability

June 1 IncreaseDecrease

June 2 Decrease Decrease

June 3 Increase Increase

June 4 Increase Increase

June 5 Decrease Decrease