What is Accounting Equation | Example

Accounting Equation Feature Image

What is the Accounting Equation:

Accounting Equation is the basis of the double-entry system of accounting. The double-entry system means every business transaction has two aspects one is the Debit and another is the Credit. Example: – If we want to buy something like coke, pizza or burger we have to pay cash for these items, So in this transaction, we are receiving food and paying cash which means we are doing two jobs, that is why it is called double-entry system.

In the double-entry system, every Debit amount should be equal to Credit amount Because :
The Business can receive cash or assets from two sources, one from an owner and another is the third party. When it received from an owner this is called Capital and when receiving from third parties then it is called liabilities.

So, in Accounting Equation, Cash or Assets always Equal to Capital and Liabilities of the business.

Assets = Liabilities + Capital

The amount received from the owner is called Capital in the sole proprietorship but it is called shareholder’s funds in the limited company.

Assets = Liabilities + Shareholder’s funds

Performa of Accounting Equation shown below: –

S. No.  Transaction  Assets  Capital  Liabilities 
 Name of Assets  Name of Liabilities
1.  1st Transaction Amount Amount Amount
Total Amount  Total  Total  Total 
2. 2nd Transaction Amount Amount Amount
Total Amount  Total  Total  Total 
and So On…..

Illustration: –

We are dividing the transaction of accounting equation transaction into the following categories: –

1st: – Capital to Asset 

When an owner investing something into the business in cash or other assets, then its treatment follows:

add the total amount of investment in Capital Column and also in Asset Column.

Example: Mrs Ramanjit started the business with cash Rs 10,00,000/- and land & building Rs 50,00,000/-

2nd: – Liabilities to Asset 

When taking a loan from the financial institution then its treatment is as follows:

add the total amount of loan in Liability Column and also in Assets Column.

Example: Loan Taken from HDFC Bank Ltd of Rs 20,00,000/- for the purchase of various assets.

3rd: – Assets to Asset 

When we have purchased an asset for cash(cash is also an asset) then treatment is:

add the total value of an asset purchased in the assets column with another name of assets and deduct from the cash (from assets side)

Example: Furniture purchase for Rs 5,00,000/- and  Stock of Rs 15,00,000 cash paid.

4th: – Payment of Expenses

When we have to pay expenses then treatment is:

The amount of expense will be subtracted from cash and also from the capital.

Example: – Salary of Rs 50,000/- paid to employees

5th: – Receipt of Income

When we have received the amount of income then treatment is:

The amount of income will be added to cash or an asset and also add to the capital.

Example: – Commission received for Rs 40,000/-

6th: – Profit or Loss 

When we get profit or loss from the sale of goods then its treatment is:

The total sale price of goods or assets will be added in cash if payment received from debtors or sold on a credit basis.

and the total cost price of goods or any other assets will be subtracted from the stock or particular asset’s account.

and after that profit or loss will be added or subtracted from the capital.

Example: – Sold goods of Rs 50,000/- for Rs 60,000/- for cash. (in this transaction sale price less costing = Profit/loss(income/loss))

S. No. 

Transaction 

Assets

Capital 

Liabilities 

Cash +Land & Building+Funiture + Stock  Bank Loan
1. Mrs Ramanjit started the business with cash Rs 10,00,000/- and land & building Rs 50,00,000/- 10,00,000 + 50,00,000 60,00,000
Total 10,00,000 + 50,00,000 60,00,000
2. Loan Taken from HDFC Bank Ltd of Rs 20,00,000/- for the purchase of various assets. +20,00,000 +    – 20,00,000
Total 30,00,000 + 50,00,000 60,00,000 20,00,000
3. Furniture purchase for Rs 5,00,000/- and  Stock of Rs 15,00,000 cash paid.  -20,00,000+         –         + 5,00,000 + 15,00,000  –  –
Total 10,00,000 + 50,00,000  + 5,00,000 + 15,00,000 60,00,000 20,00,000
4. Salary of Rs 50,000/- paid to employees     -50,000  +         –         +         –      +        –    – 50,000         –
Total    9,50,000 +50,00,000  + 5,00,000 + 15,00,000 59.50,000 20,00,000
5. The commission received for Rs 40,000/-   +  40,000 +         –         +         –      +        –   + 40,000
Total    9,90,000 +50,00,000  + 5,00,000 + 15,00,000 59.90,000 20,00,000
6. Sold goods of Rs 50,000/- for Rs 60,000/- for cash.     +60,000 +         –         +        –        –      50,000    +10,000         –
Total  10,50,000  +50,00,000  + 5,00,000 + 14,50,000 60,00,000 20,00,000

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