8 Accounting Equation

Contents

☞ Meaning of Accounting Equation/Balance Sheet Equation ☞ Computation of

accounting equation ☞ Rules of debit and credit ☞ Solved examples
☞ Unsolved questions.

Meaning of Accounting Equation/Balance Sheet Equation

Accounting equation is a statement of equality between the debit and credit which shows that the assets
of a business are always equal to the liabilities and capital (Owner's equity)
A=L+C
Where,
A = Assets
L = Liabilities
C = Capital
It shows the fundamental relationship among the various items of a balance sheet. That's why, it is also
called as Balance Sheet equation. The balance sheet is a statement of assets, liabilities and capital. The
complete accounting system is based on these three terms which are inter-related.

Accounting Equation
Assets = Capital + Liabilities
Cash Trade Creditors/
+ Sundry creditors
Bank balance/ Cash at bank +
+ Bills Payable/
Debtors/Trade debts/Book debts Trade payables
+ +
Bills receivable/Trade receivables Outstanding expenses/
+ Expenses payable
Closing stock/Work in progress/ +
Finished goods/Semi finished goods/ Bank overdraft/

291
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Inventory/Merchandise Short term overdraft

+ +
Prepaid expenses/Expenses paid in advance Loans
+ +
Land and building Capital
+
Plant and machinery
+
Furniture and fixtures
+
Investment

Computation of accounting equation

Every transaction has two aspects debit and credit. The first step is to determine which aspect is to be
debited and which aspect is to be credited. Then, every transaction can be expressed in terms of
accounting equation.

Examples of transactions. How they affect accounting equation

1. Commenced business with cash ` 10,000.

In this transaction, the cash is coming in the business. So, its assets are increased. This amount of
cash the business is supposed to pay to the owners (Proprietor). The accounting equation of this
transaction is as under:
Assets = Liabilities + Capital
+ 10,000 = 0 + 10,000
(Cash)

2. Purchased Machinery for Cash ` 5,000.

Machinery is received by the business. So, its assets are increased and cash is going out, so its assets
are decreased. Thus the overall position of the business remains same. The accounting equation of
this transaction is as under:
Assets = Liabilities + Capital
+ 5,000 = 0 + 0
(Machinery)
- 5,000
(Cash)

3. Purchased goods on credit ` 3,000.

Goods are purchased by the business which increases the stock of business. But at the same time it
creates a liability of creditors. The accounting equation of this transaction is as under:
Assets = Liabilities + Capital
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+ 5,000 = 5,000 + 0
(Stock) (Creditors)
4. Salaries paid ` 2,500.
Salaries are paid in cash by the business. This reduces the balance of cash in the business and also
reduces the liability of business. The accounting equation of this transaction is as under:
Assets = Liabilities + Capital
(2,500) = 0 + (2,500)
(Cash) (Salaries)

Rules of Debit and Credit

The terms debit and credit are commonly used in business transactions. The rules of debit and credit
depends upon the nature of account. For recording transactions of a business, the accounts are classified
into five categories which are as under:
1. Assets
Assets are valuable things owned by the firm for future use and are not meant for resale. Its value
keeps on increasing and decreasing during the year.
For example
➢ Land and building
➢ Furniture and fixture
➢ Plant and machinery
➢ Cash in hand
➢ Sundry debtors/ trade debtors
➢ Bills receivable/ Trade receivables
Rule
Increase in assets is debited.
Decrease in assets is credited.

2. Liabilities/claims/equities
Liabilities are the claims of the outsiders against the business. Its value keeps on increasing and
decreasing during the year.
For example
➢ Sundry creditors/trade creditors
➢ Bills payable/ trade payables
➢ Bank overdraft/ Short term overdraft
➢ Bank loans
Rule
Increase in liabilities is credited.
Decrease in liabilities is debited.

3. Capital/Owner's Equity
It is the amount invested by the proprietor in the business. In case of partnership concern it is
invested by the partners and in case of a company it is invested by shareholders.
 294 Fundamentals of Accounting

Rule
Increase in capital is credited.
Decrease in capital is debited.
4. Revenues/Profits/Gains
Profit is the excess of sales over costs of a business. If the costs are more then the net result is a loss.
Rule
Increase in revenues is credited.
Decrease in revenues is debited.

5. Expenses/ Losses
It is the amount incurred in day to day operations of a business.
For example
➢ Salaries
➢ Rent paid
➢ Accounting charges
➢ Selling expenses
➢ Carriage outward
Rule
Increase in expenses is debited.
Decrease in expenses is credited.

Solved Examples

Illustration 1
Prepare the accounting equation on the basis of following information:
1. Commenced business with cash ` 60,000.
2. Purchased goods on credit from Ram ` 8,000.
3. Paid to Ram in full settlement ` 7,800.
4. Purchased furniture and paid ` 3,000.
Solution
No. Transactions Assets = Liabilities + Capital
Cash + Stock + Furniture = Creditors + Capital
1. Commenced business with cash ` 60,000 60,000 + 0 + 0 = 0 + 60,000

2. Credit purchases of goods ` 8,000 0 + 8,000 + 0 = 8,000 + 0

3. Payment made to Ram in full settlement - 7,800 + 0 + 0 = - 8,000 + 200
` 7,800
 [Chapter 8 → Accounting Equation] 295

4. Purchased Furniture ` 3,000 -3,000 + 0 + 3,000 = 0 + 0

49,200 + 8,000 + 3,000 = 0 + 60,200

Illustration 2
Prepare the accounting equation on the basis of following information.
1. Started business with cash ` 25,000.
2. Paid rent in advance ` 5,000.
3. Sold goods on credit to Ram ` 800.
4. Withdrew for private use ` 600.
Solution
No. Transactions Assets = Liabilities + Capital
Cash + Stock + Prepaid rent + Debtor = Creditors +
Capital +
1. Commenced business with cash 25,000 + 0 + 0 = 0 + 25,000
` 25,000.
2. Paid rent in advance ` 5,000. -5,000 + 0 + 5,000 = 0 + 0
3. Sold goods on credit to Ram ` 800. 0 - 800 + 0 + 800= 0 + 0

4. Withdrew for private use ` 600. - 600 + 0 + 0 + 0= 0 -600

19,400 -800 +5,000 + 800 = 0 + 24,400

Illustration 3
Show how the following transactions will be debited or credited on the basis of rules of debit and credit:
1. Sahil started business with cash ` 5,000.
2. Paid rent ` 800.
3. Received commission ` 5,000.
4. Paid to creditors ` 8,000.
Solution
S. Transaction Accounts Nature of How Debit Credit
No. involved account affected? Amount Amount
(`) (`)
1. Sahil started business with Cash Asset Increase 5,000
cash ` 5,000. Capital Capital Increase 5,000
2. Paid rent ` 800. Rent Expense Increase 800
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Cash Asset Decrease 800

3. Received commission ` 5,000. Cash Asset Increase 5,000
Commission Revenue Increase 5,000
4. Paid to creditors ` 8,000. Creditors Liability Decrease 8,000
Cash Asset Decrease 8,000
Illustration 4
If the total liabilities of a business are ` 70,000 and the capital and business loss are ` 30,000 and ` 5,000.
Find the total assets of a business.
Solution
Assets = Liabilities + Capital - Loss
Assets = 70,000 + 30,000 - 5,000
= ` 95,000

Test your understanding

Q1. State whether the following statements are true or false:

1. Double entry book keeping is the most scientific system.
2. All expenses and losses are debited.
3. All gains and incomes are credited.
4. Assets + Capital = Liabilities.
5. The owner's investment in business is usually called Assets.
6. Sale of office furniture should be credited to sales account.
Answer:
1. True
2. True
3. True
4. False
5. False
6. False

Q2. Fill in the blanks:

1. Goods sold to Ram should be debited to ______________ account.
2. Every business transaction involves atleast ____________ accounts.
3. The difference between total assets and total liabilities is called ____________ .
4. The two sides of a ledger account are ___________ and ____________ .
5. Drawings bring reduction in the _____________ of the business.
6. Capital will be increased if the business makes a _______________ .
Answer:
1. Ram
2. Two
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3. Capital
4. Debit, Credit
5. Capital
6. Profit

Q3. Choose the correct answer:

1. Which of the following event is not a business transaction?
a. Sold goods for cash.
b. Purchased furniture.
c. Dismissed an employee.
d. Paid Rent.

2. Cash introduced into the business by the proprietor should be recorded as:
Debit Credit
a. Business account Cash account
b. Cash account Capital account
c. Drawings account Cash account
d. Purchases account Cash account
3. Purchased goods for cash from Ankit should be recorded as:
Debit Credit
a. Ankit account Cash account
b. Cash account Purchases account
c. Drawings account Cash account
d. Purchases account Cash account
4. When the asset is decreased, it is recorded on the:
a. Debit side
b. Credit side
c. Both side
d. None of these
5. Cash account is a:
a. Nominal account
b. Real account
c. Personal account
d. None of these
6. The assets of a business are ` 50,000 and its liabilities are ` 6,000. Its capital would be:
a. ` 56,000
b. ` 44,000
c. ` 50,000
d. ` 6,000
7. Purchase of furniture in cash will:
a. Increase total assets
 298 Fundamentals of Accounting

b. Increase total liabilities

c. Leave total assets unchanged
d. Decrease total assets
8. Which of the following is a correct statement:
a. Assets + Liabilities = Capital
b. Assets + Capital = Liabilities
c. Assets = Liabilities + Capital
d. Assets - Liabilities = Capital
Answer:
1. c
2. b
3. d
4. b
5. a
6. b
7. c
8. c

Essay type Questions

Q1. Explain the terms "Debit and Credit". How is debit and credit of a transaction determined?
Q2. What do you understand by accounting equation? Explain in detail.
Q3. Write short notes on:
a. Double entry system
b. Transaction
c. Accounting cycle
d. Types of accounts
Q4. Explain the fundamental principles of double entry system.

Unsolved Questions

Q1. Show the effect of following transactions on assets, liabilities and capital through accounting
equation.
a. Started business with cash ` 2,00,000.
b. Purchased furniture from Mohan on credit ` 40,000.
c. Purchased goods for Cash ` 20,000.
d. Withdrawn from business for personal use ` 3,000.
 [Chapter 8 → Accounting Equation] 299

e. Paid Salaries ` 4,500.

f. Sold goods for cash ` 5,000.
Answer:
Assets
Cash = ` 1,77,500
Furniture = ` 40,000
Goods = ` 15,000
Liabilities
Creditors = ` 40,000
Capital = ` 1,92,500

Q2. Show the effect of following transactions on assets, liabilities and capital through accounting
equation.
a. Commenced business with cash ` 31,000.
b. Paid wages in advance ` 4,000.
c. Purchased car on credit from Manish ` 5,600.
d. Received commission ` 3,000.
e. Sold goods on credit (Cost ` 4,900) for ` 5,000.
f. Purchased goods for cash ` 2,000
Answer:
Assets
Cash = ` 28,000
Prepaid wages = ` 4,000
Car = ` 5,600
Debtors = ` 5,000
Stock = ` (2,900)
Liabilities
Creditors = ` 5,600
Capital = ` 34,100

Q3. Show the effect of following transactions on assets, liabilities and capital through accounting
equation.
a. Started business with cash ` 7,000.
b. Paid to creditors ` 4,000.
 300 Fundamentals of Accounting

c. Purchased goods on credit from Yatin ` 500.

d. Paid rent ` 700.
e. Received Commission ` 600.
Answer:
Assets
Cash = ` 2,900.
Stock = ` 500.
Liabilities
Creditors = ` (3,500)
Capital = ` 6,900

Q4. Prepare an accounting equation on the basis of following information.

a. Started business with cash ` 80,000.
b. Purchased goods and paid ` 40,000.
c. Purchased goods on credit ` 30,000.
d. Sold goods and cash received ` 12,000. Its cost was ` 10,000.
Answer:
Assets
Cash = ` 52,000.
Stock = ` 60,000.
Liabilities
Creditors = ` 30,000.
Capital = ` 82,000.

Q5. If the total capital of the business is ` 4,00,000 and the liabilities are ` 40,000, loss is ` 30,000 then,
what is the amount of assets.
Answer:
` 4,10,000.

Q6. If the capital of the business is ` 50,000 and liabilities are ` 20,000. Calculate the total assets of
the business.
Answer:
` 70,000

Q7. State which two accounts are involved in the following transactions:
 [Chapter 8 → Accounting Equation] 301

a. Business started with cash ` 7,000.

b. Sold goods to Hari Om ` 800.
c. Purchased goods for cash ` 4,200.
d. Paid Salaries ` 750.
e. Received dividend ` 900.
Answer:
a. Cash and Capital
b. Hari Om and Sales
c. Purchases and Cash
d. Salaries and Cash
e. Dividend and Cash

Q8. Find the Closing Capital on the basis of following information:

If the opening capital of a business is ` 55,000 and it suffered a loss of 3,000 during the year.
If the additions to capital are ` 6,000 and amount withdrawn for personal use is ` 5,000.
Answer:
Closing Capital = ` 53,000.

Q9. Prepare an accounting equation on the basis of following information.

a. Started business with cash ` 1,00,000.
b. Purchased goods for cash ` 75,000 and on credit ` 15,000.
c. Paid rent ` 6,000.
d. Received Commission ` 7,000.

Answer:
Assets
Cash = ` 26,000
Stock = ` 90,000
Liabilities
Creditors = ` 15,000
Capital = ` 1,01,000

Q10. Create an accounting equation on the basis of following information.

a. Commenced business with cash ` 10,000.
b. Paid wages in advance ` 800.
 302 Fundamentals of Accounting

c. Purchased goods for cash ` 6,000 and on credit ` 4,000.

d. Paid Commission ` 700.
e. Sold goods for cash ` 5,000 (Cost ` 3,500.)
f. Purchased a car for personal use ` 5,000.
Answer:
Assets
Cash = ` 2,500
Prepaid wages = ` 800
Stock = ` 6,500
Liabilities
Creditors = ` 4,000
Capital = ` 5,800

Q11. The total assets and external liabilities were ` 3,00,000 and ` 25,000 respectively. Additions made to
capital during the year were ` 10,000 and drawings were ` 3,000. Profit made during the year was
` 5,000. Calculate the capital at the beginning.
Answer:
Opening Capital = ` 2,63,000.

Q12. Prove that the accounting equation is satisfied in the following transactions.
a. Started business with cash ` 55,000, Goods ` 60,000.
b. Introduced fresh capital ` 6,000.
c. Goods damaged by fire ` 8,000.
d. Withdrew cash for Personal use ` 5,000.
e. Purchased stationary ` 250.
Answer:
Assets
Cash = ` 55,750
Stock = ` 52,000
Liabilities
Creditors = Nil
Capital = ` 1,07,750

Q13.Ram had the following assets and liabilities as on 31stDecember 2012. Calculate his capital.
 [Chapter 8 → Accounting Equation] 303

Cash ` 15,000 Bank ` 7,000 Debtors ` 5,000 Machinery ` 9,000 Furniture ` 5,000 Creditors ` 5,000 Bills
payable ` 8,000 Prepaid expenses ` 40,000.
Answer:
Capital = ` 68,000.

Q14. Gaurav commenced his business on 1st April, 2009 with a capital of ` 15,000. On 31st March, 2010 his
assets are worth ` 30,000 and liabilities are worth ` 5,000. Calculate his closing capital and profit.
Answer:
Closing Capital = ` 25,000
Profit = ` 10,000

Comprehensive Questions

Q1. Prepare an accounting equation on the basis of the following :

`
(a) X started business with cash 1,20,000
(b) Purchased goods for cash 22,000
(c) Furniture purchased for cash 3,000
(d) Commission received 7,000
(e) Sold goods (costing ` 12,000) 21,000
(f) Expenses paid 800
(g) Sold goods on credit (Costing ` 1,500) 2,000
(h) Paid rent 12,000

Q2. Amar commenced business with capital of ` 75,000 on 1st April, 2012. The various transactions that
took place during the year were as follows:
(a) Purchase furniture worth ` 7,000 for office use.
(b) Bought Machinery for ` 10,000.
(c) Purchased goods from Jitinder for ` 5,000.
(d) Purchased goods from Hari in cash ` 8,000.
(e) Sold goods (costing ` 4,000) at a profit of 25% on cost.
(f) Withdrew cash for private use ` 2,000.
(g) Deposited into bank account ` 1,000.
 304 Fundamentals of Accounting

(h) Expenses paid ` 2,000.

Prepare an accounting equation to give effect to the above transactions.

Q3. Madhu started a business with cash ` 1,00,000 and furniture ` 4,000. During the year, the following
transactions took place.
(a) Purchased stock from place.
(b) Paid rent for the year ` 24,000.
(c) Postage and stationery charges paid ` 100.
(d) Paid to Rohit ` 50,000.
(e) Goods purchased for cash ` 10,000.
(f) Purchases of ` 2,000 returned and cash received.
(g) Sold goods to Amit (costing ` 6,000) at a profit of 25% on Sales.
(h) Depreciation charged on furniture ` 100.
Show the accounting equation to give effect to the above transactions.

Q4. On 1st April, 2012, Jai Dev started a business with ` 1,50,000 and a computer worth ` 25,000. During
the year, following transactions took place.
(a) Goods purchased from Parul for ` 20,000 at a trade discounts of 10% and cash discount of 2%.
He paid 50% immediately and avail cash discount.
(b) Bought Motorcycle for office use ` 25,000.
(c) Purchased Machinery for ` 12,500.
(d) Sold goods for cash ` 6,500 (costing ` 6,000)
(e) Deposited into Bank after opening a new account ` 20,000.
(f) Interest received ` 1,700.
(g) Commission paid through bank ` 800.
(h) Salary paid ` 8,000 and outstanding ` 2,500.
(i) Sundry expenses paid ` 200.
(j) Depreciation charged @ 20% on Machine.
Show the effect of above mentioned transactions by way of accounting equation. Also prepare
Balance Sheet of Jai Dev at 31st March, 2013.

Q5. Vivek commenced a business on 1st April, 2012 with cash ` 6,25,000. He bought a personal computer
from his home to the business worth ` 16,000; besides this, the following transactions were entered
into by him during the year.
 [Chapter 8 → Accounting Equation] 305

(a) Goods purchased from Vikram ` 28,000.

(b) Opened a new account in SBI with ` 80,000.
(c) Rent paid for 15 months ` 90,000.
(d) Sold goods to Hari Lal (costing ` 6,000) for ` 6,700.
(e) Received cheque from Hari Lal of ` 6,500 in full settlement.
(f) Withdrew ` 4,000 for personal use.
(g) Donated goods costing ` 1,000 to a charitable trust.
(h) Received commission ` 1,100.
(i) Goods destroyed (sale price ` 3,000) during flood costing ` 2,500.
(j) Securities were purchased for ` 10,000.
Show an accounting equation on the basis of above transactions. Also prepare the Balance Sheet of
Vivek as at 31st March, 2013.

Q6. Show the accounting equation on the basis of the following transactions :
(a) Paramjeet commenced business with ` 11,50,000.
(b) Wages paid ` 4,000 and outstanding ` 6,000.
(c) Goods purchased for ` 80,000.
(d) Computer purchased from Star Computers worth ` 30,000 and paid half the amounts in cash.
(e) Invested ` 90,000 into the bank.
(f) Goods purchased from Vaibhav for ` 8,000 and made the payment by cheque.
(g) Purchased a building for ` 60,00,000 and the payment was made by cash.
(h) 1/2 of the stock available was sold to Mohit at profit of 20% on cost.
Also prepare a Balance Sheet with the final balances.

Q7. V.Stuti had undertaken the following transactions during the year 2012-13. Prepare an accounting
equation to show the effect on his assets, liabilities and capital :
(a) Started business with cash ` 2,31,000.
(b) Purchased goods for cash ` 40,000 and on credit ` 31,000.
(c) Purchased a television for personal use worth ` 26,000.
(d) Sold goods for cash ` 24,000 (costing ` 17,000).
(e) Received commission ` 4,300.
(f) Stationery and posted expenses paid ` 1,000.
(g) Cash payment made for household expenses ` 21,000.
 306 Fundamentals of Accounting

(h) Paid to Creditors ` 19,500.

Q8. Om Ji Traders started a business with cash ` 1,21,000. In respect of his business, following
transactions were recorded:
`
(a) Purchased goods on credit 32,500
(b) Paid wages 2,500
(c) Withdrew for personal use 21,600
(d) Paid to creditors in full settlement 32,000
(e) Purchased furniture for 2,510
(f) Telephone charges paid 18,000
Show an accounting equation on the basis of above transactions.

Q9. From the following information, prepare an accounting equation :

(a) On 1.4.2012 Mr. Aalam started business with cash ` 2,00,000
(b) He purchased goods for ` 20,000.
(c) Purchased machinery for ` 10,000 on 1.7.2010
(d) Interest on capital @ 10% p.a.
(e) Depreciation charged on machinery @ 10% p.a.
Books are being closed on 31st March every year.

Q10. From the following information, prepare an accounting equation :

(a) Mr. Wakeed started a business with cash ` 2,50,000 on 1st April 2012.
(b) He purchased goods worth ` 10,000.
(c) He purchased refrigerator for personal use for ` 10,000.
(d) Interest allowed on Capital @ 5% p.a.
(e) Interest charged on drawings @ 10% p.a.
Books are being closed on 31st December every year.

Additional Questions

Q1. Classify the following accounts to the Traditional Approach and Modern Approach (Accounting
Equation Approach) :
(a) Capital
 [Chapter 8 → Accounting Equation] 307

(b) Furniture
(c) Interest received
(d) Cash paid
(e) Carriage
(f) Entertainment expenses
(g) Bank overdraft
(h) Discount allowed

Q2. Classify the following accounts to the Traditional Approach and Modern Approach (Accounting
Equation Approach):
(a) Purchases A/c
(b) Drawings A/c
(c) Sales A/c
(d) Printing and Stationery
(e) Commission paid
(f) Sales promotion expenses
(g) Carriage outward paid
(h) Interest paid

Q3. Classify the following accounts according to the Traditional Approach and Modern Approach
(Accounting Equation Approach):
(a) Bank A/c
(b) Commission received
(c) Cash received
(d) Building purchased
(e) Discount received
(f) Light, Power and Electricity
(g) Conveyance charges
(h) Wages and Salaries paid

Q4. Classify the following accounts according to the Traditional Approach and Modern Approach
(Accounting Equation Approach):
(a) Subscription paid
(b) Insurance premium paid
(c) Telephone, Postage and Telegram
(d) Cash at Bank
(e) Purchases Return A/c
(f) Interest accrued A/c
(g) Interest received in advance A/c
(h) Outstanding Salary

Q5. Classify the following accounts under Traditional Approach and Modern Approach (Accounting
Equation Approach):
 308 Fundamentals of Accounting

(a) Bad-debt written off

(b) Subscription received
(c) Bad-debt recovered
(d) Repairs incurred
(e) Prepaid Rent A/c
(f) Sales returns
(g) Travelling charges
(h) Loan from Bank

Q6. Analyze the following transactions according to the Traditional Approach (Accounting Equation
Approach ):
(a) Ramesh started business with cash
(b) Purchased goods
(c) Sold goods for cash
(d) Paid to Rahul
(e) Paid Salary
(f) Withdrew cash for personal use

Q7. Analyze the following transactions accounting to the Traditional Approach and state the accounts to
be debited or credited:
(a) Bought furniture from Mr. A on credit
(b) Sold goods to Sunder for cash
(c) Paid interest on loan
(d) Cash deposited into bank
(e) Interest allowed by bank
(f) Paid rent by cheque

Q8. Analyze the following transactions accounting to the Traditional Approach and state the accounts to
be debited or credited:
(a) Purchased goods from Mr. X on credit
(b) Sold goods to Mohan on credit
(c) Borrowed from Mahesh
(d) Received cash from Mohan
(e) Withdrew from bank for office use
(f) Paid instalment of loan

Q9. Analyze the following transactions accounting to the Traditional Approach and state the accounts to
be debited or credited:
(a) Bought goods on credit from Mr. A
(b) Received a cheque from a customer, Mahesh
(c) Deposited Mahesh’s cheque next day
(d) Paid an advance to suppliers of goods
(e) Bank intimated that Mahesh’s cheque was dishonored
(f) Received an advance from customers
 [Chapter 8 → Accounting Equation] 309

Q10. Analyze the following transactions accounting to the Modern Approach and state the accounts to
be debited or credited:
(a) Rohan started business with cash
(b) Purchased goods
(c) Sold goods for cash
(d) Paid to Rahul (Creditor)
(e) Paid Salary
(d) Withdrew cash for personal use

Q11. Analyze the following transactions accounting to the Modern Approach and state the accounts to be
debited or credited:
(a) Bought furniture from Mr. A on credit
(b) Sold goods to Sunder for cash
(c) Paid interest on loan
(d) Cash deposited into Bank
(e) Interest allowed by Bank
(f) Paid rent by cheque
Q12. Analyze the following transactions according to the Modern Approach and state the accounts to be
debited or credited:
(a) Purchased goods from Mr. X on credit
(b) Sold goods to Mohan on credit
(c) Borrowed from Mahesh
(d) Received cash from Mohan
(e) Withdrew from bank for office use
(f) Paid instalment of loan

Q13. Analyze the following transactions according to the Modern Approach and state the accounts to be
debited or credited:
(a) Bought goods on credit from Mr. A
(b) Received a cheque from a customer, Mahesh
(c) Deposited Mahesh’s cheque next day
(d) Paid an advance to suppliers of goods
(e) Bank intimated that Mahesh’s cheque was dishonored
(f) Received an advance from customers

Multiple Choice Questions

Q1. Three key activities of the accounting function are identifying transactions, recording transaction,
and communicating transaction. The proper order for these activities is considered to be which of
the following?
 310 Fundamentals of Accounting

(a) Communicating, recording, and identifying

(b) Recording, communicating, and identifying
(c) Identifying, communicating, and recording
(d) Identifying, recording, and communicating
(e) None of the above

Q2. Which one of the following users of accounting information is considered to be an external user of
accounting information rather than an internal user of accounting information?
(a) Sales staff
(b) Company managers
(c) Company customers
(d) Officers and directors
(e) Budget officers

Q3. All of the following people can properly be called managers. Which one of the following individuals
is not considered an internal user of accounting information?
(a) Service manager
(b) Research and development manager
(c) Production manager
(d) Partner in CA firm charged with conduction the company's external audit
(e) Human resources manager

Q4. A college student pays ` 150 cash for her textbook. In the student's opinion, the textbook is worth
` 50. In accounting, however, the value of the textbook is assumed to be and is recorded at ` 150
amount. The accounting principal that is most demonstrated by this example is:
(a) The cost principle
(b) The going-concern principle
(c) The business entity principle
(d) The monetary unit principle
(e) The conservatism principle

Q5. The basic accounting equation is Assets = Liabilities +Equity. The Equity term of the equation can be
further broken down into several other terms. Assume that the entity is a sole proprietorship. Which
of the following statement is correct?
(a) Additional investment by the business owner will increase equity and revenues will decrease
equity.
(b) Additional investments by the business owner will decrease equity and revenues will increase
equity.
(c) Increase in expense will decrease equity and owner withdrawals will decrease equity.
(d) Revenues will increase equity and owner withdrawals will increase equity.
(e) Revenues will decrease equity and owner withdrawals will increase equity.
 [Chapter 8 → Accounting Equation] 311

Q6. If at the end of the accounting period the company's liabilities total ` 19,000 and its equity total
` 40,000, then what must be the total of assets?
(a) ` 14,000
(b) ` 40,000
(c) ` 21,000
(d) ` 59,000
(e) None of these

Q7. If during the current accounting period the company's assets increased by ` 24,000 and equity
increased by ` 5,000, then how did liabilities change?
(a) Increased by ` 29,000
(b) Increased by ` 24,000
(c) Decreased by ` 5,000
(d) Decreased by ` 19,000
(e) Increased by ` 19,000
Answer:
1. (d)
2. (c)
3. (d)
4. (a)
5. (c)
6. (d)
7. (e)

Space for writing important points for revision

UNSOLVED QUETION COMPREHENSIVE QUTIONS
Transactions Assets Liab + Capital
Cash + Stock + Furniture + Debtors =
Started business with 1,20,000 + 0 + 0 + 0 = 0 + 1,20,000
Cash 1,20,000
New Balance 1,20,000 + 0 + 0 + 0 = 0 +1,20,000
Purchase goods - 22,000 + 22,000 + 0 + 0
New Balance 9,80,000 + 22,000 + 0 +0 = 0 + 1,20,000
Furniture purchase - 3,000 + 0 +3,000 + 0
New Balance 95,000 + 22,000 + 3,000 + 0 = 0 + 1,20,000
 312 Fundamentals of Accounting

+ 7,000 = + 7,000
New Balance 1,02,000 + 22,000 + 3,000 + 0 = 0 + 1,27,000
Sold goods 21,000 - 12,000 + 9,000
New Balance 1,23,000 +10,000 + 3,000 + 0 = 1,36,000
Expenses paid - 800 - 800
New Balance 1,22,200 + 10,000 + 3,000 + 0 = 1,35,200
Sold goods on credit - 1,500 + 200 + 500
New Balance 1,22,200 + 8,500 + 3,000 + 2,000 = 1,35,700
Rent Paid - 12,000 12,000
1,10,200 + 8,500 + 3,000 + 2,000 = 1,23 700
1,23 700 = 1,23,700

Question 2
Transactions Assets Liab + Capital
Cash + Furniture + Mac + St + Bank = Credit + Capital
Stanted Business with 75,000 = 75,000
Cash 75,000
New Balance 75,000 + 0 + 0 + 0 + 0 = 75,000
Purchase - 7,000 + 7,000 + 0 + 0 + 0
New Balance 68,000 + 7,000 + 0 + 0 + 0 = 75,000
Purchase Machine - 10,000 + 0 + 10,000 + 0 + 0
New Balance 58,000 + 7,000 + 10,000 + 0 + 0 = 75,000
Purchase goods from 0 + 0 + 0 + 5,000 + 0 = + 5,000 + 0
New Balance 58,000 + 7,000 + 10,000 + 5,000 + 0 = 5,000 + 75,000
Purchase goods from Hari - 8,000 + 8,000
New Balance 50,000 + 7,000 + 10,000 + 13,000 + 0 = 5,000 + 75,000
Sold goods + 5000 - 4,000 = + 1,000
New Balance 55,000 + 7,000 + 10,000 + 9,000 + 0 = 5,000 + 76,000
- 2,000 - 2,000
New Balance 53,000 + 7,000 + 10,000 + 9,000 + 0 = 5,000 + 74,000
In Bank - 1,000 + 1,000
New Balance 52,000 + 7,000 + 10,000 + 9,000 + 1,000 = 5,000 + 74,000
Expense paid 2000 - 2,000 = - 2,000
New Balance 50,000 + 7,000 + 10,000 + 9,000 + 1,000 = 5,000 + 72,000
77,000 = 77,000
 [Chapter 8 → Accounting Equation] 313

Question 3
Transactions Assets = Liab + capital
Cash + fur + Sto = Creditor + Capital
Stanted business 10,000 + 4,000 + 0 = 0 + 1,04,000
With Cash
New Balance 1,00,000 + 4,000 + 0 = 0 + 1,04,000
Paid Rent - 24,000 - 24,000
New Balance 76,000 + 4,000 + 0 = 0 + 80,000
Postage and Stationery - 100 - 100
New Balance 75,900 + 4,000 + 0 = 0 + 79,900
Goods purchased - 10,000 + 10,000
New Balance 65,900 + 4,000 + 10,000 = 0 + 79,900
Purchase suture 2,000 + 2,000 - 2,000
New Balance 67,900 + 4,000 + 8,000 = 0 + 79,900
Sold goods at 25% Profit + 7,500 - 6,000 + 1,500
60,400 + 4,000 + 2,000 = 0 + 81,400
- 100 -100
Transactions Assets = liabilities + capital
Cash + comp + stock + bank
Started business with cash 6,25,000 + 16,000 + 0 +0 = 0 + 6,41,000
Goods purchased (28,000) + 28,000
New balance 5,97,000 + 16,000 + 28,000 + 0 = 0 + 6,41,000
Opening bank a/c (80,000) + 80,000
New balance 5,17,000+ 16,000 + 28,000+ 80,000 = 0 + 6,41,000
Paid rent (72,000) (72,000)
New balance 4,45,000 + 16,000 +28,000 +28,000 = 0 + 5,69,000
Sold goods 6,700 (6,000) 700
New balance 4,51,700 + 16,000 + 22,000 + 80,000 = 0 + 5,69,700
Withdraw goods (4,000) + = (4,000)
New balance 4,47,700 + 16,000 + 22,000 + 80,000 = 0 + 5,65,700
Goods for charity (1,000) (1,000)
New balance 4,47,700 + 16,000 + 21,000 + 80,000 = 0 + 5,64,700
Receive commission 1,100 + 1,100
New balance 4,48,800 + 16,000 + 21,000 + 80,000 = 0 + 5,65,800
 314 Fundamentals of Accounting

Goods destroyed (2,500) (2,500)

New balance 4,48,800 + 16,000 + 18,500 + 80,000 = 0 + 5,63,300
Security purchased (10,000) (10,000)
New balance 4,38,800 +16,000 + 18,500 + 80,000 = 0 + 5,53,300
Total 5,53,300 = 5,53,300

Question
Transaction Assets = Liabilities + capital
Cash + stock + comp + bank + building = O/S liability
Started business with 11,50,000 + 11,50,000
ash
Wages paid and o/s (4,000) = 6,000 (10,000)
iability
New balance 1,14,6000 = 6,000 + 11,40,000
Goods purchased (80,000) + 80,000
New balance 10,66,000 + 80,000 = 6,0000 + 11,40,000
Purchased comp (15,000) + 30,000 = 15,000 +6,000 + 11,40,000
New balance 10,50,000 + 80,000 + 30,000 = 15,000 + 6,000 + 11,40,000
Paid into bank (90,000)+ +90,000
New balance 9,61,000+80,000+30,000+90,000 = 15,000+6,000+11,40,000
Goods purchased + 8,000 (8,000)
New balance 9,61,000+72,000+30,000+82,000 = 15,000+6,000+11,40,000
Purchased building (60,00,000) +60,00,000
New balance (50,39,000)+72,000+30,000+82,000+60,00,000=15,000+6,000+11,40,000
Sold goods 43,200 (36,000) + 7,200
New balance
Total