Accounting Equation is the basis of financial accounting. This is also known as the balance sheet equation. we have explained this topic in this article thoroughly.
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 a double-entry system.
In the double-entry system, every Debit amount should be equal to the Credit amount Because :
The Business can receive cash or assets from two sources, one from an owner and another is a third party. When it is received from an owner this is called Capital and when received from third parties then it is called liabilities.
The meaning of the Accounting Equation is explained with the help of an Animated Video:
We also explained the meaning of Accounting Equations with the help of an animated video which is available for free of cost on this page as well as on our youtube channel. You can check it out from the below video or by going to our youtube channel.
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So, in Accounting Equation, Cash or Assets are always Equal to the Capital and Liabilities of the business.
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Assets = Liabilities + Capital |
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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 |
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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….. |
||||
Categories of Transactions: –
We have divided all business transactions into the following 6 categories under the accounting equation: –
1st: – Capital to Assets or Assets to Capital
When an owner invests something into the business in cash or in-kind then it will be treated with the help of the capital-to-assets technique. The total amount of investment will be added in two-column of the accounting equation table (format is shown above) i.e. Capital Column and Assets Column.
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Example Capital to Assets:
Mrs. Ramanjit started the business with cash Rs 10,00,000/- and land & building Rs 50,00,000/-
Solution: –
| S. No. | Transaction | Assets = | Capital+ | Liabilities |
| Cash + land & building | ||||
| 1. | Mrs Ramanjit started the business | 10,00,000 + 50,00,000 | 60,00,000 | – |
| 10,00,000 + 50,00,000 | 60,00,000 | |||
Example Assets to Capital:
after one month he withdrew 1000 from the business cash for personal use.
Solution: –
| S. No. | Transaction | Assets = | Capital+ | Liabilities |
| Cash + land & building | ||||
| 1. | Mrs Ramanjit started the business | 10,00,000 + 50,00,000 | 60,00,000 | – |
| 10,00,000 + 50,00,000 | 60,00,000 | |||
| 2. | withdrawal 1000 from the business cash for personal use. | -10,000 | -,10,000 | |
| 9,90,000 + 50,00,000 | 59,90,000 |
2nd: – Liabilities to Assets or Assets to Liabilities
When taking a loan from a financial institution then its treatment is as follows:
add the total amount of the loan in the Liability Column and also in the 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 the 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 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 a business earns profit or loss from the sale of goods or assets then it will be treated as:
The total sale price of goods or assets will be added in cash if payment is received at the time of sale of goods and assets and the total cost price of goods or any other assets will be subtracted from the stock or particular asset’s account.
After that, if a business earned profit then it will be added to the balance of the capital account, or if incurred loos then it will be 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))
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