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Accounting Equation

Chapter # 2

Gul NawazGUL NAWAZINSTITUTE OF SUSTAINABLE DEVELOPMENT &TECHNOLOGY

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Introduction

We have discussed basic terms used in accounting. One of

the most important term is the Balance Sheet. In this chapterwe shall explain this term and show the effect of transactionon the balance sheet.

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Assets and EquitiesAssets refer to all the valuable proprieties possessed by thebusiness, while the equities means the claim against theseassets. The equity are further divided into Capital And

Liability. Capital refer to the owner equity which means rightof the owner in the asset of the business and liabilities refer tooutsider equities which means the right of outsider in theassets of the business.


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Balance Sheet EquationWhen any assets is purchased, the owner not only acquire the

property but also right associated to that property. These rightin assets are equal to the value of assets. In accounting we refer

these rights as Clime against assets or equities. From thisconcept the following equation is derived,

ASSETS = EQUITIES


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.

As we know that a single person cannot contribute all therequired funds from his own pocket. He has to raise fund bymeans of credit purchase, loan from banks, friends and frommany sources. In this way the right against the assets i.e.equities into owner equity and outsider equities. Therefore

the balance sheet equation can be written as:

ASSETS = LIABILITIES + CAPITAL


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Transaction and Accounting equation

When a transaction takes place, it effect in terms of

increase or decrease two basic component of accounting

equation. To illustrate this concepts the followingbusiness transaction are assumed;


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Illustration # 11. Mr. Ali started business with Capital of $20000.

The effect of this transaction will be that the cash will

increase in business by $ 20000, and Capital of Mr. Ali willalso increase by similar amount. The equation will appear asfollow;


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NOTE:

It is important to note that while analyzing business transaction, we

are concerned with the business activities of the enterprise which is

treated as distinct entity from its owner. Therefore investment of owner is

treated as increase in business assets on one hand as will as increase in

Capital on the other hand, and vice versa.

ASSATS = EQUITIES

CASH$ 20000

= Alis CAPITAL$ 20000


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2. Ali purchase building for $ 3000.

The transaction will change the composition of assets. The

cash will decrease by $ 3000, and building will increase by thesimilar amount. The equation will be as follows:

ASSATS = EQUITIES

CASH + Building$ 20000-(3000) $ 3000

= Alis CAPITAL$ 20000


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3. Purchase Machinery from Ahmad for $ 1000.

In this transaction the assets increase on one side, while the

liability are also increase.

ASSATS = EQUITIES

CASH + Building + Machinery$ 17000 $ 3000

$ 1000

= CAPITAL + Account Pay$ 20000

$ 1000


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4. Purchase raw material for cash $ 2000.

The transaction will change the composition of assets. The cashwill decrease by $ 2000, and material will increase by thesimilar amount. The equation will be as follows:

ASSATS = EQUITIES

CASH + Building + Machinery + Material

$ 17000 $ 3000 $ 1000

( 2000 ) 2000

= CAPITAL + Account Pay

$ 20000 $ 1000


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5. Paid salaries $ 2000.

The effect of this transaction will decrease Cash anddecrease Owner Equity by $ 2000, The equation will be asfollows:

ASSATS = EQUITIES

CASH + Building + Machinery + Material$ 15000 $ 3000 $ 1000 2000

( 2000 ) .13000 + 3000 + 1000 + 20000

190000

=

=

CAPITAL + Account Pay$ 20000 $ 1000( 2000 ) .18000 + 1000

19000


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Accounting Equation

ASSETS = EQUITIES

CASH Building Machinery Material Capital Account Pay

20000

(3000) 3000

20000

17000 3000

1000

20000

1000

17000(2000)

3000 10002000

20000 1000

15000

(2000)

3000 1000 2000 20000

(2000)

1000

13000 3000 1000 2000 18000 1000

19000 = 19000


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ILLUSTRATION # 2

Show the effect of following transaction on assets liabilities

and owners equity.1. Ali commenced a business by investing Rs.30000.

2. Bought Office equipment for Cash Rs.500.

3. Bought furniture on account Rs.1000.

4. Paid office rent Rs.200.5. Earned Rs.2000, by performing service.

6. Paid salary to a worker Rs.300.


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ACCOUNTING EQUATION

ASSETS = EQUITIES

S.No CASH EQUIPEMENT

FURNITURE A/C REC CAPITAL A/C PAY

1 30000 30000

Balance2

30000-500 500

30000

Balance3

29500 5001000

300001000

Balance4

29500-200

500 1000 30000-200

1000

Balance5

29300 500 10002000

298002000

1000

Balance6

29300-300

500 1000 2000 31800-300

1000

Balance 29000 500 1000 2000 31500 1000GUL NAWAZINSTITUTE OF SUSTAINABLE DEVELOPMENT &TECHNOLOGY

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ILLUSTRATION # 3Rehman repair shop has the following assets and Equities onApril 2012.

Cash 3300

Account receivable $ 1900Supplies $ 1700

Tools $ 8150

Capital $ 3050

Account Payable $ 12000

During the month the following transaction take place;


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1. Paid one month rent $ 400.

2. Bought repair supplies $ 100.

3. Paid for supply previously purchase on credit $ 500.

4. Bought tools on credit $ 350.5. Receive for service rendered $ 900.

6. Service rendered on account $ 210

7. Received from customer ( Account Receivable) $ 650.

8. Paid for oil and gas used $ 150.

Required: Show the effect of above transaction on the

accounting equation.


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ASSETS = EQUITIES

S.No CASH AccountReceivable

Supplies Tools CAPITAL AccountPayable

Balances

1

3300

-400

1900 1700 8150 3050

-400

12000

Balance2

2900-100

1900 1700+ 100

8150 2650 12000

Balance3

2800-500

1900 1800 8150 2650 15000-500

Balance4

2300 1900 1800 8150+350

2650 11500+ 350

Balance5

2300+ 900

1900 1800 8500 2650+900

11850

Balance6

3200 1900+ 210

1800 8500 3350+ 210

11850

Balance7

3200+650

2110-650

1800 8500 3760 11850

Balance8

3850-150

1460 1800 8500 3760- 150

11850

Balance 3700 1460 1800 8500 3610 11850GUL NAWAZINSTITUTE OF SUSTAINABLE DEVELOPMENT &TECHNOLOGY

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Accounting Equation for Merchandise Business

A merchandise business is one where the goods arepurchased on a lower cost and they are sold on a higher price.

The difference between sale and purchase is called profit. The

profit increase owner equity, therefore, it is added in the capital.

When the goods are purchased, their cost price is recordedunder merchandise inventory as addition on assets side. When

the goods are sold, the cost price is deducted from merchandise

inventory on the assets side and profit is added to the capital. If

the sale is on credit basis, it will increase the Account receivable,and if it is on cash basis it will increase Cash on asset side.


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ILLUSTRATION # 4

Show the effect of the following transaction on Accounting Equation;1. Anwar started Business with cash $ 55000.

2. Merchandise purchase for cash $ 12000.

3. Sold merchandise to Ali for $ 5600. Cost is $ 4480.

4. Purchase merchandise from Ahmad $ 7500.

5. Cash sales $ 1250. ( Cost $ 1000)

6. Return merchandise to Ahmad $ 150.

7. Credit purchases from Zia $ 2500.

8. Give away merchandise as charity worth $ 100.

9. Owner withdrew merchandise for personal use worth $ 250.


ASSETS EQUITIES

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ASSETS = EQUITIES

S.No CASH MerchandiseInventory

AccountReceivable

CAPITAL AccountPayable

1

2

55000

- 12000 12000

55000

Balance3

43000 12000- 4480 5600

55000+ 1120

Balance4

43000 7520+ 7500

5600 561207500

Balance5

43000+ 1250

15020- 1000

5600 56120+ 250

7500

Balance6

44250 14020- 150

5600 56370 7500- 150

Balance7

44250 13870+ 2500

5600 56370 7350+ 2500

Balance8

44250 16370- 100

5600 56370- 100

9850

Balance9

44250- 250

16270 5600 56270- 250

9850

Balance 44000 16270 5600 56020 9850GUL NAWAZINSTITUTE OF SUSTAINABLE DEVELOPMENT &TECHNOLOGY

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ILLUSTRATION # 5

Following are the transaction of Mr. Nazeef & Co.1. Introduce cash as capital $ 20000

2. Purchase merchandise for cash $ 5000.

3. Purchase computer for cash $ 10000.

4. Merchandise costing $ 1400. sold to Ahmad for $ 1800.5. Purchase merchandise from Akbar for $ 500.

6. Received $ 1000, from Ahmad.

7. Sold merchandise for cash $ 800. which cost $ 750.

8. Paid salaries $ 400.


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ASSETS = EQUITIES

S.No CASH MerchandiseInventory

Computer AccountReceivable

CAPITAL AccountPayable

1

2

20000

- 5000 5000

20000

Balance3

15000- 10000

5000 10000

Balance4

5000 5000- 1400

100001800

20000+ 400

Balance5

5000 3600+ 500

10000 1800 20400500

Balance6

5000+ 1000

4100 10000 1800- 1000

20400 500

Balance

7

6000

+ 800

4100

- 750

10000 800 20400

+ 50

500

Balance8

6800- 400

3350 10000 800 20450-400

500

Balance 6400 3350 10000 800 20050 500

Totals 20550 = 20550


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To be sold by students

Q # 1 Mr. Naseer started business with Cash Rs. 10000, andFurniture Rs. 2000. His other transaction were as follows,

1. Purchase merchandise on account Rs. 5000.

2. Purchase equipment for cash Rs. 5000.

3. Sold merchandise costing Rs. 5000, for Rs. 8000, on credit.4. Received cash against Account Receivable Rs. 5000.

5. Payment to creditor in full settlement of account Rs. 4900.

6. Rs. 500, was privately used by Mr. Naseer.

7. Paid salary for the month Rs. 500.


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Q # 2Show the effect of the following transaction on assets, liabilities

and owner equities,

1. Introduce cash by owner Rs. 60000.

2. Purchase merchandise on account from Yasir for Rs. 3500.

3. Sold merchandise to Ali for Rs. 1500 (cost Rs.1000)

4. Paid advertisement expenses Rs. 1000.

5. Sold merchandise for cash for Rs. 1400, cost Rs. 1500.

6. Merchandise given as charity Rs. 150.


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Documents

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