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ACCOUNTING EQUATION Class 11
An accounting equation represents the mathematical relationship between a business enterprise’s assets, liabilities, and owner’s equity(Capital).
Or
The accounting equation is a fundamental principle in accounting that represents the relationship between a company’s assets, liabilities, and owner’s equity (or shareholder’s equity).
The recording of business transactions in the books of account is based on a fundamental equation called the Accounting Equation.
Total Assets of a business enterprise are equal to the sum of its liabilities and capital (Total Liabilities).
An Accounting equation is based on the dual aspect concept of accounting, according to which, every transaction has two aspects namely Debit and Credit.
It means that every transaction in accounting affects both the Debit (DR.) and Credit (Cr.) sides equally.
The fundamental accounting equation is also called the balance sheet equation.
It is the foundation for the double-entry book-keeping system.
This equation must always balance, meaning that the total value of assets must be equal to the total of liabilities and owner’s equity.
- Assets vs. Liabilities & Equity:
- Assets: Resources with economic value owned by the business.
- Liabilities: Debts or financial obligations owed to outsiders.
- Equity (Capital): Owner’s investment in the business and its retained earnings.
- Formula: Assets = Liabilities + Owner’s Equity Or Capital
Accounting Equation Formula-
Total Assets = Total Liabilities
Or
Total Assets = Internal Liabilities + External Liabilities
Or
Assets = Capital + Liabilities (A = C+L)
Or
Assets = Equities
Or
Capital = Assets – Liabilities (C = A–L)
Liabilities = Assets – Capital (L = A–C)
Following are the nine basic transactions —
1. Increase in assets with a corresponding capital increase.
2. Increase in assets with a corresponding increase in liabilities.
3. Decrease in assets with corresponding decrease in capital.
4. Decrease in assets with a corresponding decrease in liabilities.
5. Increase and decrease in assets.
6. Increase and decrease in liabilities
7. Increase and decrease in capital
8. Increase in liabilities and decrease in capital
9. Increase in capital and decrease in liabilities.
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1. Increase in assets with a corresponding increase in capital-
1.Mr. Mohit started Business with cash Rs. 9,00,000.
Cash Account (Assets Account)
Owner’s Account (Capital Account)
Assets Increase in the form of Cash
Capital Increase in form investment by the owner
Accounting equation
Assets = Capital + Liabilities
Cash = Capital + Liabilities
9,00,000 = 9,00,000 + 0
2. Increase in assets with a corresponding increase in liabilities-
2. Machinery Purchased on credit from Bharat Machinery house Rs. 2,00,000.
Machinery Account (Assets Account)
Creditors Account (Liabilities Account)
Assets Increase in form of Machinery
Liabilities Increase in form creditors for machinery
Accounting equation
Assets = Capital + Liabilities
Cash + Machinery = Capital + Creditors (B.M.H)
Old Equation 9,00,000 + 0 = 9,00,000 + 0
Transaction 0 + 2,00,000 = 0 + 2,00,000
New Equation 9,00,000 + 2,00,000 = 9,00,000 + 2,00,000
3. Decrease in assets with corresponding decrease in capital-
3.Mr. Mohit withdrawn cash Rs.50,000 for personal use.
Cach Account (Assets Account)
Drawing Account (Capital Account)
Assets Decrease in form of cash
Capital Decrease in form of personal use
Accounting equation-
Assets = Capital + Liabilities
Cash + Machinery = Capital + Creditors for Machinery
Old Equation 9,00,000 + 2,00,000 = 9,00,000 + 2,00,000
Transaction (-) 50,000 + 0 = (-) 50,000 + 0
New Equation 8,50,000 + 2,00,000 = 8,50,000 + 2,00,000
4.Decrease in assets with corresponding decrease in Liabilities-
4.Cash Paid to Bharat Machinery House Rs.1,50,000.
Cach Account (Assets Account)
Creditors Account (Liabilities Account)
Assets Decrease in form of cash
Liabilities Decrease in form of creditors
Accounting equation –
Assets = Capital + Liabilities
Cash + Machinery = Capital + Creditors for Machinery
Old Equation 8,50,000 + 2,00,000 = 8,50,000 + 2,00,000
Transaction (-)1, 50,000 + 0 = + (-)1, 50,000
New Equation 7,00,000 + 2,00,000 = 8,50,000 + 50,000
5.Increase and Decrease in assets-
5.Furniture Purchased for cash Rs.20,000.
Cach Account (Aeets Account)
Furniture Account (Assets Account)
Assets Decrease in form of cash
Assets Increase in form of Furniture
Accounting equation-
Assets = Capital + Liabilities
Cash + Machinery + Furniture = Capital + Creditors for Machinery
Old Equation 7,00,000 + 2,00,000 + 0 = 8,50,000 + 50,000
Transaction (-) 50,000 + 0 + 50,000 = 0 + 0
New Equation 6,50,000 + 2,00,000 + 50,000 = 8,50,000 + 50,000
6.Increase and decrease in liabilities-
6.Acceptance given to Bharat Machinery House Rs.20,000.
Bharat Machinery House Account (Creditors) (Liabilities Account)
Bills Payable Account (Liabilities Account)
Liabilities Decrease in form of Creditors
Liabilities Increase in form of Bills payable
Accounting equation-
Assets = Capital + Liabilities
Cash + Machinery + Furniture = Capital + Creditors for Machinery + Bills Payable
Old Equation 6,50,000 + 2,00,000 + 50,000 = 8,50,000 + 50,000 + 0
Transaction 0 + 0 + 0 = 0 + (-20,000) + 20,000
New Equation 6,50,000 + 2,00,000 + 50,000 = 8,50,000 + 30,000 + 20,000
7.Increase and decrease in capital-
7.Interest allowed on capital Rs. 8,500.
Interest on capital Account (Expenses Account)
Capital Account (Capital Account)
As interest on capital is the Expense of business it should be shown or deducted in the capital as well as interest of capital is the amount which is to be given to the owner as capital is the amount which is invested by the owner, therefore it is to be added back to Capital.
Accounting equation-
Assets = Capital + Liabilities
Cash + Machinery + Furniture = Capital + Creditors for Machinery + Bills Payable
Old Equation 6,50,000 + 2,00,000 + 50,000 = 8,50,000 + 30,000 + 20,000
Transaction 0 + 0 + 0 = – 8,500 + 0 + 0
+ 8,500
New Equation 6,50,000 + 2,00,000 + 50,000 = 8,50,000 + 30,000 + 20,000
8.Increase in Liabilities and decrease in capital-
8.Out standing salaries Rs.10,000.
Salareies Account (Expenses Account)
Outstanding Salaries Account (Liabilities Account)
As Expense not paid yet or Outstanding but belong to current financial year so it is deducted from Capital & business has to pay it in near future so it is the liability of the firm.
Accounting equation-
Assets = Capital + Liabilities
Cash + Machinery + Furniture = Capital + Creditors for Machinery + Bills Payable + Out Standing Exp.
Old Equation 6,50,000 + 2,00,000 + 50,000 = 8,50,000 + 30,000 + 20,000 + 0
Transaction 0 + 0 + 0 = – 10,000 + 0 + 0 + 10,000
New Equation 6,50,000 + 2,00,000 + 50,000 = 8,40,000 + 30,000 + 20,000 + 10,000
9. Increase in capital and decrease in liabilities-
Important points-
Transaction related to Expenses
Expenses paid in cash .The transaction will affect both sides as cash (Assets) has been paid so it(Assets) is to be reduced as well as Capital is to be reduced because expense is to be born by the owner.
Transaction related to Income
Income or Profit is the reward for taking risk, as risk is taken by the owner so it is to be added in Capital.
The transaction will affect both sides as cash has been received so it is to be added back in cash as well as in Capital.
Transaction related to Interest on Capital
As interest on capital is the Expense of business it should be shown or deducted in the capital as well as interest of capital is the amount which is to be given to the owner as capital is the amount which is invested by the owner, therefore it is to be added back to Capital.
The transaction will affect Liability side as Interest of Capital should be added back & deducted from Capital as both of them belong to the owner.
Transaction related to interest on Drawing
As interest on Drawing is the Income of business it should be shown or added back in the capital as well as interest of Drawing is the amount which is to be given by the owner to the business so it is treated as drawing and deducted from the Capital.
The transaction will effect Liability side as Interest of Drawing should be added back & deducted from Capital as both of them belong to the owner.
Transaction related to outstanding Expense
As Expense not paid yet or Outstanding but belong to current financial year so it is deducted from Capital & business has to pay it in near future so it is the liability of the firm.
The transaction will affect Liability side as outstanding expense is a Liability should be shown in the Liability side & Expense should be deducted from Capital.
Transaction related to Prepaid or Advance Expense
As Expense paid in advance so it is not belong to current financial year, so it can not be deducted from Capital.
It as an amount which is paid by the business firm for the future course of activity till the activity not happened it is the Assets of the business.
The transaction will affect both sides as Prepaid expense is a Asset should be shown in the Assets side & Cash paid by the business should be deducted from Cash column of assets side.
Transaction related to Advance Income
As Income received in advance so it is not belong to current financial year, so it can not be added back to the Capital.
It as an amount which is received by the business firm for the future course of activity till the activity not happened it is the Liability of the business.
The transaction will effect both sides as Advance Income is a Liability should be shown in the Liability side & Cash received by the business should be added back to the Cash column of assets side.
Transaction related to Accrued Income
Income is to be added back into the capital but as it is not received should be shown in the Assets Side as accrued Income because it meant to be received in this financial year.
The transaction will effect both sides as Accrued Income has been added back to the capital & as it is not received so it is to be shown in the assets side as an asset.
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Accounting Equation Class 11
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