The accounting equation shows that a firm's assets are always equal to its liabilities plus owner's equity. It is based on the dual aspect concept where every transaction has equal debit and credit effects. The accounting equation always holds true as it is affected by transactions that may increase or decrease either one or two sides of the equation by equal amounts. Examples are provided to illustrate how common business transactions impact the accounting equation components of assets, liabilities, and owner's equity.

1. Accounting Equation
Md. Shihab Ali
Daffodil International University
Department Of CSE

2. What is Accounting Equation
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 concept of accounting meaning, every
transaction has two aspects-debit and credit.
•That further means in every business transaction 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 equal the total
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).

3. Nature of Accounting Equation
• An Accounting Equation always holds true with every change that occurs due to
transaction entered into. It is because of this reason that it is based on the dual
aspect concept of accounting.
• A transaction may affect either both sides of the equation by the same amount or
one side of the equation only, by both increasing or decreasing it by equal
amounts.
• Transactions from the Accounting Equation viewpoint, can be divided into two,
i.e.,
1. Transactions Affecting Two Items and
2. Transactions Affecting More Than Two Items.

4. Transactions Affecting Two items:
• As the title suggests, these are those transactions that affect two items of
the accounting equation or Balance Sheet.
• (a) Transactions affecting opposite sides are:
• Increase in Asset, Increase in Liability.' Transaction such as credit purchases
increase asset (stock) and also increase liability (creditor). Similarly, loans
from bank increase asset (cash) and also increase liability (Loan).
• Decrease in Liability, Decrease in Asset: Transaction of payment to a creditor
decreases Liability (creditor) and also reduces asset (cash or bank).
• Increase in Asset, Increase in Owner's Equity: Introduction of capital by the
proprietor
• increases asset (cash or bank) and also liability (capital).
• Decrease in owner's Capital, Decrease in Asset: Drawings by the proprietor
decreases liability (capital) and also asset (cash or bank).

5. Transactions Affecting Two items:
B) Transactions affecting same side but in opposite direction are:
• Increase in one Asset, Decrease in Another Asset: Transactions such as cash
purchases or receipt from debtors increase one asset (goods and cash or bank,
respectively) and decrease another asset (cash or bank and debtors).
• Decrease in one Liability, Increase in Another Liability: Settlement of creditor by
issue of Bill of Exchange decreases a liability (creditor) and increases another
liability (BiII of Exchange).

6. Transactions Affecting More Than
Two items:
• Some transactions affect more than two items of the accounting equation or a
Balance Sheet.
• For example, when a sale is made in cash for Rs. 30,000, it is made at cost (Rs.
25,000)
• plus profit (Rs. 5,000).
• Cost of goods (Rs. 25,000) reduces asset (stock of goods);
• Cash increases by Rs. 30,000; and
• Owner's capital increases by the profit (Rs. 5,000).
• It should be noted that profit increases the owner's capital and loss decreases it.

7. Procedure to prepare Accounting
Equations
• The procedure to workout an Accounting Equation is:
• Analyze the transaction in terms of such variables as assets, liabilities, capital,
revenues
• and expenses.
• Decide the effect of the transactions in terms of increase or decrease on variables
assets, liabilities, capital, revenues and expenses.
• Record the effect on the relevant side of the equation.

8. All businesses have three parts to
their financial makeup:
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• The things or property that the company owns. We call these
things ASSETS.
• The money that the company owes to other people. We call
these obligations LIABILTIES.
• The claim of the owner of the business to the Assets after
the Liabilities are paid.
• We call this claim OWNER’S EQUITY (or just EQUITY).

9. These three parts ALWAYS have the
same relationship to each other.
We call this relationship the
Assets = +Liabilities Equity
Accounting Equation
9

10. The Accounting Equation could also apply to a
personal situation. Suppose you buy a car for
$5,000, borrow $4,000 from the bank, and pay
the rest yourself. Here’s the result:
Assets
= Liabilities + Equity
Accounting Equation
$5,000
10
= $4,000 + $1,000

11. ASSETS are theRESOURCES
OWNED BY A BUSINESS .
Here are some types of
assets that might be owned
by a business company:
Land
Equipment
Buildings
Cash
Vehicle
s
Store
Supplies
Notes
Receivable
Accounts
Receivable
ASSETS
11

12. LIABILITIES are the
CREDITOR’S CLAIMS ON ASSETS.
12
Creditors are the people or companies to whom a business
owes something (like money).
Here are some types of liabilities that a company might owe:
Taxes
Payable
Wages
Payabl
e
Notes
Payable
Accounts
Payable
LIABILITIES

13. EQUITY is the OWNER’S CLAIM ON ASSETS
In a business EQUITY is composed of four
parts that either increase or decrease
equity:
CAPITAL:
What the
owner puts
into the
business
−
WITHDRAWALS:
What the owner
takes out of the
business
+
REVENUES:
What the
company
receives for
sales
−
EXPENSES:
What the
company
pays to
operate the
business.
INCREASE
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DECREASE INCREASE DECREASE
EQUITY

14. Sometimes we expand the Accounting Equation
to show all the Equity components. This
is called the EXPANDED ACCOUNTING
EQUATION.
This equation must
ALWAYS BE IN
BALANCE
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15. Illustrations

16. Let us take a few transactions to understand the accounting equation.
Transaction 1:
Mr. Riaz commences his business with cash Rs.50,000.
This is an example of investment of asset in the business by the owner. The effect of
this
transaction on the accounting equation is that cash asset is increased by
Rs.50,000 and the proprietorship (Riaz’s capital) is also increased by the same amount
such as:
Assets = Liabilities + O.E/ Capital
Cash Riaz, Capital
+ 50,000 = —- + 50,000
Note that assets and equities increased by equal amounts

17. Transaction 2:
Purchased furniture on cash Rs.10,000.
This transaction effected accounting equation as the increase in one new
asset furniture and decreases in assets cash with the same amount. Thus
Assets = Liabilities + O.E / Capital
Cash Furniture Riaz, Capital
+ 50,000 = —- + 50,000
- 10,000 + 10,000
40,000 + 10,000 = 50,000
Note that this transaction has affected assets side only and no change is made
in equities side of the equation.

18. Transaction 3:
Purchased merchandise for cash Rs.10,000.
This transaction will introduce a new element (merchandise) on the assets
side and decrease the cash by Rs.10,000.
Assets = Liabilities + O.E / Capital
Cash Furniture Merchandise Riaz, Capital
+ 40,000 + 10,000 = —- + 50,000
-10,000 – + 10,000
30,000 10,000 +10,000 = 50,000
Note that this transaction has affected assets side only and no change is made
in
equities side of the equation.

19. Transaction 4:
Purchased merchandise on account (on credit) Rs.5,000.
Assets = Liabilities + O.E / Capital
Cash Furniture Merchandise Creditors Riaz, Capital
+ 30,000 + 10,000 + 10,000 = + 50,000
+ 5,000 + 5,000
30,000 +10,000 + 15,000 = + 5,000 +50,000
Note that this transaction has affected assets side and liabilities. Both the sides of
equation has increased with the same amount.

20. Transaction 5:
Sold merchandise for cash Rs.2,000 cost of these merchandise were
Rs.1,500
Assets = Liabilities + O.E / Capital
Cash Furniture Merchandise Creditors Riaz, Capital
+ 30,000 + 10,000 + 15,000 = + 5,000 + 50,000
+ 2,000 - 1,500 + 500 (Profit)
+ 32,000 +10,000 + 13,500 = + 5,000 +50,500
Note that this transaction has affected assets side and also the proprietorship. Difference
between sales price and cost price is treated as profit and has been added to capital.

21. Assets = Liabilities + O.E / Capital
Cash Furniture Merchandise Debtors Creditors Riaz, Capital
+ 32,000 + 10,000 + 13,500 = + 5,000 + 50,500
- 3,000 + 4,000 + 1,000
32,000 +10,000 + 10,500 +4000 = +5,000 +51,500
Transaction 6:
Sold merchandise on credit for Rs.4,000 costing Rs.3,000.
Note that this transaction has affected assets side and also the proprietorship. Anew
element “debtors” has been introduced. Difference between sales price and cost
price is treated as profit and has been added to capital.

22. Transaction
7:Paid Rs.1,000 to creditors for merchandise
purchased.
Assets = Liabilities + O.E / Capital
Cash Furniture Merchandise Debtors Creditors Riaz, Capital
+ 32,000 + 10,000 + 10,500 + 4,000 = + 5,000 + 51,500
- 1,000 - 1,000
31,000 +10,000 +10,500 + 4000 = +4,000 +51,500

23. Transaction 8:
Received cash from a debtor Rs 1,000 whom a sale on credit was made
earlier.
This is an example of collection from debtors. This transaction is an exchange of
one
asset for another. the effect is on one side of the equation, i.e., asset side. Thus:
Assets Liabilities + O.E / Capital
Cash Furniture Merchandise Debtors Creditors Riaz, Capital
+ 31,000 + 10,000 + 10,500 + 4,000 + 4,000 + 51,500
+ 1,000 - 1,000
32,000 +10,000 + 10,500 + 3000 = +4,000 +51,500

24. Example

25. Solve

26. Summarizing
1. Each transaction must have effects on
the three components (assets, liabilities,
and Owner's equity) of the accounting
equation
2. The two sides of the equation must
always be equal.