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CHAPTER 6- ACCOUNTING EQUATIONS

An Accounting Equation is a mathematical expression which shows that the assets and liabilities of a firm are equal. An
Accounting Equation is based on the Dual Aspect of Concept accounting. It holds that for every debit there is a credit of equal
amount and vice versa. It means, total claims (those of outsiders and of the proprietors) will always be equal to the assets of the
firm. The claims, also known as equities, are of two types:
1. Owner's equity or capital and
2. Liabilities or amounts due to outsiders (i.e., Outsiders' Equity).
We can express it as follows: ASSETS = CAPITAL + LIABILITIES
The above relationship is known as the Accounting Equation or the Balance Sheet Equation.

Effect of Transaction on Accounting Equation:- A transaction may affect either both sides of the equation by the same
amount or one only, by both increasing or decreasing it by equal amounts. Transaction from the Accounting Equation viewpoint,
can be divided into two, i.e.,
1. Transaction Affecting Two Items and
2. Transaction Affecting More Than Two Items.

Process of Preparing Accounting Equation:- The process of Accounting Equations begins with:
1. Analyzing the transaction in terms of variables, i.e., assets, liabilities, capital, revenues and expenses.
2. Decide the effect of the transactions in terms of increase or decrease of variable stated in 1 above.
3. Record the effect on the relevant side of the equation.

Question: 1. Prepare the Accounting Equitation from the following transactions:

1. Sachin started business and introduced capital ₹ 1,00,000 in cash.
2. Purchased goods in cash ₹ 50,000.
3. Purchased furniture form M/s. Samrat Furniture ₹ 20,000.
4. Sold goods costing ₹ 25,000 for ₹ 35,000 against cash.
5. Paid M/s. Samrat Furnitures in cash.

Question: 2. Prepare the Accounting Equitation on the basic of the following:

1. Started business with cash ₹ 70,000.
2. Credit purchases of goods ₹ 18,000.
3. Payment made to creditors in full settlement ₹ 17,500.
4. Purchased of machinery for cash ₹ 20,000.

Question: 3. Prepare the Accounting Equation on the basis of the following:

1. Rakesh commenced business with cash. 1,50,000
2. Furniture purchased for cash. 20,000
3. Purchased goods from Mahesh on credit. 25,000
4. Sold goods (costing ₹ 10,000) to Mohan for cash. 14,000
5. Additional capital introduced. 20,000
6. Commission received in advance. 2,000
7. Paid to creditor (Mahesh) in full settlement. 22,500
8. Sold goods (costing ₹ 15,000) for ₹ 18,000 out of which ₹ 5,000 received in cash.
9. Depreciation on furniture provided @ 10%.

Question: 4. Present the following transaction in the Accounting Equation:

₹ ₹
1. Ram started business with cash ₹ 25,000 and 2. Purchased goods on credit 4,000
cheque of ₹ 25,000 to open a Bank Account 4. Purchased furniture for cash 500
3 Purchase goods for cash Rs 1,000 6. Paid rent 200
5. Withdrew cash for private use from Bank Rs 700 8. Sold goods on credit (Cost ₹ 500) 700
7. received interest from bank Rs 100 10. Paid Petty Expenses 200
9 Paid to creditors Rs 400

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Question: 5. How are the following items dealt in Accounting Equation?

(i) Interest due but not received Rs 500

(ii) Rent received in advance Rs 1,000
(iii) Insurance premium paid in advance Rs 1,500
(iv) Salaries due but not paid Rs 2,000

Solution:
(i) Interest due but not received shall be added to assets on one side and to the capital on other side.
(ii) It will increase cash on the assets side and increase the liabilities.
(iii) It will decrease one asset (cash) and increase another asset (Prepaid insurance).
(iv) Salary being an expense will be deducted from the capital and being unpaid will be added to liabilities.

Question: 6. Prepare Accounting Equation of the following transactions and also the Balance Sheet.

1. Manu started business with cash Rs 1,00,000. Opened a Bank Account and transferred 4,00,000 from his Savings Account.

2. Purchased a building from Sohan for 12,00,000 paid by taking a loan from SBI.

3. Paid interest on loan Rs 20,000 and installment of Rs 1,00,000.

4. Purchased goods from Rohan on credit. Rs 1,00,000.

5. Goods returned to Rohan costing Rs 20,000.

6. Sold goods costing 40,000 for Rs 50,000 on credit to Ram.

7. Took goods from business for personal use. Rs 10,000.

8. Accrued interest Rs 5,000.

9. Commission received in advance. Rs 20,000.

10. Cash received from Ram. Rs 10,000.

Question:7. COC had the following transactions:

1. Commenced business with cash Rs 50,000. 2. Purchased goods for cash Rs 20,000 and Credit Rs 30,000. 3. Sold goods for cash
40,000, costing 30,000. 4. Rent paid 500, Salaries 5,000. 5. Rent outstanding 100, Salaries Outstanding 1,000. 6. Bought furniture
5,000 on credit. 7. Bought refrigerator for personal use Rs 5,000. 8. Purchased computer for cash 20,000. 9. Cash withdrawn for
personal use 10,000. 10. Interest on drawings charged 500 and the interest on Capital ₹ 1,000. Use Accounting Equation to show
the effect of the above transactions on his assets, liabilities and capital and also show his Balance Sheet.

Question: 8. Give an example for each of the following types of transactions:

1. Increase in one asset, decrease in another asset.

2. Increase in asset, increase in liability.
3. Increase in asset, increase in owner's capital.
4. Decrease in asset, decrease in liability.
5. Decrease in asset, decrease in owner's capital.
6. Decrease in liabilities, increase in owner's capital.
7. Increase in one liability, decrease in another liability.
8. Increase in liabilities, decrease in owner's capital.

Solution:
1. Purchase of furniture for cash---Increase in furniture and decrease in cash.
2. Purchase of furniture on credit-Increase in furniture and increase in liability.
3. Capital introduced by proprietor-Increase in cash and increase in capital.
4. Payment to creditors-Decrease in cash and decrease in creditors.
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5. Cash withdrawn by proprietor-Decrease in cash and decrease in capital.

6. Conversion of partner's loan into capital-Increase in capital and decrease in loan.
7. Bills payable accepted-Increase in bills payable and decrease in creditors.
8. Outstanding expenses provided--Increase in creditors for outstanding expenses and decrease in capital.

Question: 9. If the capital of a business is ₹ 70,000 and liabilities are of ₹ 40,000. Calculate the total assets.

Question: 10. From the following information, calculate the total assets of the business:

Capital ₹ 4,00,000; Creditors ₹ 3,00,000; Revenue earned during the period ₹ 7,50,000; Expenses incurred during the period ₹
2,00,000; Value of unsold stock ₹ 2,00,000.

Question: 11. A commenced his cloth business on 1st April, 2018 with a capital of ₹ 30,000. On 31st March, 2019 his assets were ₹
50,000 and liabilities were ₹ 10,000. Find out his closing capital and profits earned during the year.

Solution: Profit = Closing Capital – Opening Capital

= ₹ 40,000 - ₹ 30,000 = ₹ 10,000.
Question: 12. X has following assets and liabilities as on 31st March, 2019. Determine his capital.

Cash ₹ 25,000; Bank ₹ 47,000; Debtors ₹ 18,000; Creditors ₹ 22,000; Plant and Machinery ₹ 80,000; Building ₹ 2,00,00; Furniture
₹ 24,000; Bills Receivable ₹ 56,000; Bills Payable ₹ 23,500.

Solutions: Capital =(Cash + Bank + Debtors + Plant & Machinery +Building +Furniture +Bills Receivable)-(Creditors+Bills Payable)
= ₹ (25,000 + 47,500 + 18,000 + 80,000 + 2,00,000 + 24,000 + 54,500 ) – ₹ (22,000 + 23,500)
= ₹ (4,51,000 – 45,500) = ₹ 4,05,500.
Question : 13. Calculate total liability if:

1. Owner’s capital in the beginning is ₹ 60,000.

2. Creditors at the end is ₹ 50,000.
3. Revenue during the period is ₹ 70,000.
4. Expenses during the period are ₹ 65,000.Also calculate amount of owner’s capital at the end.

Solutions: Total Liabilities = Owner’s Capital at the end + Creditors

= ₹ 65,000 + ₹ 50,000 = ₹ 1,15,000.

Owner’s Capital at the end = Owner’s Capital in the beginning + Revenue – Expenses
= ₹ 60,000 + ₹ 70,000 - ₹ 65,000 = ₹ 65,000.
Question: 14. X started a business on 1st April, 2022 with a capital of ₹ 50,000 and a loan of ₹ 25,000 taken from Y. During 2022-
23, he had introduced additional capital of ₹ 25,000 and had withdrawn ₹ 15,000 for personal use. On 31 st March, 2023 his assets
were ₹ 1,50,000. Find his capital as on 31st March, 2023 and profit made or loss incurred during the year 2022-23.

Solutions: Closing Capital = Closing Assets – Closing Liabilities (i.e., Y’s Loan)
= ₹ 1,50,000 - ₹ 25,000 = ₹ 1,25,000.
= Profit = Closing Capital + Drawing – Additional Capital – Opening Capital
= ₹ 1,25,000 + ₹ 15,000 - ₹ 25,000 - ₹ 50,000 = ₹ 65,000.
Question: 15. On 31st March, 2023, the total assets and external liabilities were 1,00,000 and 3,000 respectively. During the year,
the proprietor had introduced additional capital of 10,000 and had withdrawn 6,000 for personal use. He made a profit of 10,000
during the year. Calculate the capital as on 1st April, 2022.

Solution: Closing Capital = Closing Assets - Closing External Liabilities

= ₹ 1,00,000 - ₹ 3,000 = ₹ 97,000.
Opening Capital = Closing Capital + Drawings –Additional Capital – Profits
= ₹ 97,000 + ₹ 6,000 - ₹ 10,000 = ₹ 10,000 = ₹ 83,000.

Question 16. Multiple Choice Questions (MCQs)-- Select the correct alternative:

(i) Which of the following equation is correct?

(a) Assets+ Capital = Liabilities (b) Assets - Liabilities = Capital

(c) Assets + Liabilities = Capital (d) None of these.

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(ii) Which of the following is correct?

Assets Liabilities Capital
(e) ₹ 7,85,000 ₹ 1,25,000 ₹ 6,60,000
(f) ₹ 8,20,000 ₹ 2,80,000 ₹ 11,00,000
(g) ₹ 9,55,000 ₹ 1,15,000 ₹ 8,20,000
(h) ₹ 5,42,000 ₹ 6,54,000 ₹ 1,12,000

(iii) Amount withdrawn by proprietor for personal use will... Cash and Capital.
(a) Increase (b) Decrease
(c) Not Change (d) None of these.

(iv) Which accounting equation is incorrect out of the following?

(a) Liabilities = Assets – Capital (b) Assets = Liabilities - Capital
(c) Capital = Assets -Liabilities (d) Assets = Liabilities + Capital

(v) The liabilities of a firm are ₹ 3,000; the capital of the proprietor in ₹ 7,000. The total assets are
(a) ₹ 7,000. (b) ₹ 10,000.
(c) ₹ 4,000. (d) None of these.

(vi) ‘X’ commenced business on 1st April, 2013 with a capital of ₹ 6,00,000. On 31st March
2014, his assets were worth ₹ 78,00,000 and liabilities ₹ 50,000. Find out his closing capital.
(a) ₹ 7,50,000 (b) ₹ 2,00,000
(c) ₹ 5,50,000 (d) None of these.

(vii) An increase in one asset is accompanied by………

(a) Decrease in another asset. (b) Increase in a liability.
(c) Increase in capital. (d) All of these.

(viii) Decrease in one liability may lead to……..

(a) Decrease in an asset. (b) Increase in another liability.
(c) Either (a) or (b). (d) None of these.

(ix) Purchase of machine by cash means……

(a) Decrease in asset and decrease in liability.
(b) Increase in asset and decrease in asset.
(c) Increase in asset and decrease in liability.
(d) Decrease in asset and increase in capital.

(x) Payment to a creditor means………

(a) Increase in asset and decrease in liability.
(b) Decrease in asset and decrease in liability.
(c) Decrease in asset and increase in liability.
(d) Increase in asset and increase in liability.
[Ans.: (i) (b); (ii) (a); (iii) (b); (iv) (b); (v) (b); (vi) (a); (vii) (d); (viii) (c); (ix) (b); (x) (b).]
Question 17. State whether the following statements are True or False:

(vi) Decrease in one liability may lead to decrease in another liability.

(vii) Difference between Total Assets and External Liabilities is Net Worth.
(viii) Purchase of goods on credit means increase in asset and increase in liability.
(ix) Purchase of computer for office use will decrease the amount of capital.
(x) Sale of machinery at loss will decrease the amount of total assets.
[Ans.: (i) False; (ii) True; (iii) True; (iv) False; (v) True.]

Question 18. Fill-in-the blanks with appropriate words:

a. An Accounting Equation is based on the ________ principle.

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b. The equity of the owner is called ________.

c. Assets =_______+_________.
d. Goods purchased on credit will lead to __________ in stock and creditors.
e. Amount withdrawn by proprietor for personal use will decrease Cash and ________.
f. Goods sold on credit costing ₹ 20,000 for ₹ 24,000 will increase total assets by _________.
(vii) The liabilities of a firm are ₹ 1,50,000; the capital of the proprietor is ₹ 7,00,000. Income earned ₹ 80,000,
the total assets are _______.
(viii) If the Owner's Equity is ₹ 2.40,000 and other liabilities are ₹ 1, 20,000, cash in hand is ₹ 60,000, and total assets
of the firm will be _______.
(ix) If closing capital is ₹ 2,50,000 and drawings during the year were ₹ 40,000, profits ₹ 80,000, the opening capital
was ________.
[Ans.: (i) Dual Aspect: (ii) Capital: (iii) Capital, Liabilities; (iv) increase (v) Capital;
(vi) ₹ 4,000; (vii) ₹ 9,30,000; (viii) ₹ 3,60,000; (ix) ₹ 2,10,000.]

Question 19. Do you think that a transaction can break the Accounting Equation?

Ans. No, a transaction can only change the Accounting Equation but cannot break it.

Question 20. Goods costing ₹ 10,000 have been sold for cash at 25% profit. How will the transaction be shown in the
Accounting Equation?

Ans. Increase cash by ₹ 12,500; Decrease stock by ₹ 10,000; and Increase capital by ₹ 2,500.

Question 21. The capital of a business is ₹ 2,00,000 and outside liabilities are? ₹ 1,50,000. Calculate the total assets of
the business.

Ans. ₹ 3,50,000 (Capital + Outside Liabilities Assets).

Question 22. If total assets of a business are ₹ 1,30,000 and capital is ? ₹ 80,000, calculate the outside liabilities.
Ans. ₹ 50,000 (Outside Liabilities = Total Assets - Capital).
Question 23. If total assets of the business are ₹ 5,50,000 and outside liabilities are ₹ 2,00,000, calculate owner's
equity.
Ans. Assets = Owner's Equity + Liabilities
₹ 5,50,000 = Owner's Equity + ₹ 2,00,000
Owner's Equity = ₹ 3,50.000.

Question 24. Jaspal has purchased a car for ₹ 5,00,000 which he got financed from a Bank to the extent of ₹ 4,00,000. How
will it be shown in the accounting equation?

Ans. ₹ 1,00,000 will be deducted from Asset (Cash/Bank); Asset (Car) will be shown at ₹ 5,00,000 and Bank Loan (on
the Liabilities side) will be shown at ₹ 4,00,000.

Question 25. Amit has incurred an expense of ₹ 5,000 towards repairs. However, the amount is yet to be paid. How will it
be shown in the accounting equation?

Ans. It is an outstanding expense. It will be shown in the accounting equation as deduction from capital and as an
Outstanding Expense on the Liabilities side.

Question 26. Show the accounting equation if there are no liabilities.

Ans. Assets = Capital.

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