Effect of Transactions on Accounting Equation :
Illustration
If the capital of a business is Rs.3,00,000 and other liabilities are Rs.2,00,000, calculate the total assets of the business.
Solution
Assets = Capital + Liabilities
Capital + Liabilities = Assets
Rs. 3,00,000 + Rs.2,00,000 = Rs.5,00,000
Illustration
If the total assets of a business are Rs.3,60,000 and capital is Rs.2,00,000, calculate liabilities.
Solution
Assets = Capital + Liabilities
Liabilities = Assets – Capital
Assets – Capital = Liabilities
Rs. 3,60,000 – Rs. 2,00,000 = Rs. 1,60,000
Illustration
If the total assets of a business are Rs.4,50,000 and outside liabilities are Rs.2,50,000, calculate the capital.
Solution:
Capital = Assets – Liabilities
Assets – Liabilities = Capital
Rs. 4,50,000 – Rs. 2,50,000 = Rs.2,00,000
Illustration –
Transaction 1: Murugan started business with Rs.50,000 as capital. The business unit has received assets totalling Rs.50,000 in the form of cash and the claims against the firm are also Rs.50,000 in the form of capital. The transaction can be expressed in the form of an accounting equation as follows:
Assets = Capital + Liabilities
Cash = Capital + Liabilities
Rs. 50,000 = Rs. 50,000 + 0
Transaction 2: Murugan purchased furniture for cash Rs.5,000. The cash is reduced by Rs,5,000 but a new asset (furniture) of the same amount has been acquired. This transaction decreases one asset (cash) and at the same time increases the other asset (furniture) with the same amount, leaving the total of the assets of the business unchanged. The accounting equation now is as follows:
| Assets = | Capital | + | Liabilities | ||
| Cash + | Furniture = | Capital | + | Liabilities | |
| Transaction 1 | 50,000 + | 0 = | 50,000 | + | 0 |
| Transaction 2 | (–) 5,000 + | 5000 = | 0 | + | 0 |
| Equation | 45,000 + | 5,000 = | 50,000 | + | 0 |
Transaction 3: He purchased goods for cash Rs.30,000. As a result, cash balance is reduced by the goods purchased, leaving the total of the assets unchanged.
| Assets | = | Capital | + | Liabilities | |||||
| Cash | + | Furniture | + |
Stock (Goods) |
= | Capital | + | Liabilities | |
| Transaction 1&2 | 45,000 | + | 5,000 | + | 0 | = | 50,000 | + | 0 |
| Transaction 3 | (–) 30,000 | + | 0 | + | 30,000 | = | 0 | + | 0 |
| Equation | 15,000 + | 5,000 | + | 30,000 | = | 50,000 | + | 0 |
Transaction 4: He purchased goods on credit for Rs.20,000. The above transaction will increase the value of stock on the assets side and will create a liability in the form of creditors.
| Assets | = | Capital | + | Liabilities | |||||
| Cash | + | Furniture | + | Stock | = | Capital | + | Liabilities | |
| Transaction 1-3 | 15,000 | + | 5,000 | + | 30,000 | = | 50,000 | + | 0 |
| Transaction4 | 0 | + | 0 + | + | 20,000 | = | 0 | + | 20,000 |
| Equation | 15,000 | + | 5,000 | + | 50,000 | = | 50,000 | + | 20,000 |
Transaction 5: Goods costing Rs.25,000 sold on credit for Rs.35,000. The above transaction will give rise to a new asset in the form of Debtors to the extent of Rs.35,000. But the stock of goods will be reduced by Rs.25,000 i.e., the cost of goods sold. The net increase of Rs.10,000 is the amount of revenue which will be added to the capital
| Assets | = | Capital | + | Liabilities | |||||||
| Cash | + | Furniture | + | Stock | + | Debtors | = | Capital+
Revenue |
+ | Liabilities | |
| Transaction 1-4 | 15,000 | + | 5,000 | + | 50,000 | + | 0 | = | 50,000 | + | 20,000 |
| Transaction 5 | 0 | + | 0 | + | (-)25,000 + | 35,000 | = | 10,000 | + | 0 | |
| Equation | 15,000 | + | 5,000 | + | 25,000 | 35,000 | = | 60,000 | + | 20,000 | |
Transaction 6: Rent paid Rs.3,000.
It reduces cash and the rent is an expense, it results in a loss which decreases the capital.
| Assets | = | Capital | + | Liabilities | |||||||
| Cash | + | Furniture | + | Stock | + | Debtors | = | Capital | + | Creditors | |
| Transaction 1-5 | 15,000 | + | 5,000 | + | 25,000 | + | 35,000 | = | 60,000 | 20,000 | |
| Transaction 6 | – 3,000 | + | 0 | + | 0 | + | 0 | = | –3,000 | + | 0 |
| Equation | 12,000 | + | 5,000 | + | 25,000 | + | 35,000 | = | 57,000 | + | 20,000 |
| 77,000 | 77,000 |
From the above transactions, it may be concluded that every transaction has a double effect and in each case – Assets = Capital + Liabilities, i.e., ‘Accounting equation is true in all cases’. The last equation appearing in the books of Mr.Murugan may also be presented in the form of a statement called Balance Sheet. It will appear as below:
Balance Sheet of Mr. Murugan
as on . . . . . . . . . . . . . .
| Liabilities . Rs. | Rs | Assets | Rs |
| Capital | 57,000 | Cash | 12,000 |
| Creditors | 20,000 | Stock | 25,000 |
| Debtors | 35,000 | ||
| _________ | Furniture | __5,000 | |
| 77,000 | 77,000 | ||
Note : Increase in one asset will be automatically either decrease in another asset or increase in liability or increase in capital. Likewise decrease in asset by way of either in increase in another asset or decrease in liability or capital.
Illustration
Show the Accounting Equation on the basis of the following transactions and prepare a Balance Sheet on the basis of the last equation.
| Rs. | |
| 1. Maharajan commenced business with cash | 1,00,000 |
| 2. Purchased goods for cash | 70,000 |
| 3. Purchased goods on credit | 80,000 |
| 4. Purchased furniture for cash | 3,000 |
| 5. Paid rent | 2,000 |
| 6. Sold goods for cash costing Rs.45,000 | 60,000 |
| 7. Paid to creditors | 20,000 |
| 8. Withdrew cash for private use | 10,000 |
| 9. Paid salaries | 5,000 |
| 10. Sold goods on credit (cost price Rs.60,000) | 80,000 |
Solution :
Accounting Equation
| S.No. | Transactions | Accounts Affected | |
| 1 | Capital brought in |
Cash increases (comes in) |
Capital increases (created) |
| 2 | Cash purchases | Stock increases
Cash decreases |
–– |
| 3 | Credit purchases |
Stock increases |
Creditors increase |
| 4 | Furniture bought |
Cash decreases |
–– |
| 5 | Rent paid | Cash decreases | Capital decreases (Rent is an expenses it results in a loss) |
| 6 | Cash Sales |
Cash increases Stock decreases |
–– |
| 7 | Payment to creditors | Cash decreases | Creditors decrease |
| 8 | Withdrawal of cash forprivate use (Drawings) | Cash decreases | Capital decreases |
| 9 | Salaries paid | Cash decreases | Capital decreases (Salary is an expense – Loss) |
| 10 | Credit Sales | Stock decreases Debtors increase |
–– |
Balance Sheet of Mr.Maharajan
as on ……………………….
| Capital & Liabilities | Rs. | Assets | Rs. |
| Capital | 1,18,000 | Cash | 50,000 |
| Creditors | 60,000 | Stock | 45,000 |
| Furniture | 3,000 | ||
| ___________ | Debtors | 80,000 | |
| 1,78,000 | 1,78,000 |