ACCOUNTING EQUATION

Key terms
Accounting equation Assets = Equities; or Assets = Liabilities + Stockholders’
equity.
Accounts payable Amounts owed to suppliers for goods or services purchased on credit.
Accounts receivable Amounts due from customers for services already provided.
Assets Things of value owned by the business. Examples include cash, machines, and
buildings.
To their owners, assets possess service potential or utility that can be measured and
expressed in money terms.
There are fixed assets and current assets;
 Fixed assets are assets acquired by the business with the intention of retaining them
within the business to help generate profits. Fixed assets can be assets which have a
lasting of over 12 months
Examples are;
 Tangible assets like land, buildings, equipment, furniture and fittings
 Investment property like rental income or sale at profit
 Intangible assets like goodwill, R&D investment etc
 Financial assets like shares in other companies etc
 Current Assets are assets which arise from day to day trading activities for example
cash or assets that the business intends to turn into cash like
 Stock/ inventory
 Debtors
 Cash in Hand/ cash at bank
 Prepaid expenses
Current assets are things which have a lasting of not more than 12 months in a
business.

Liabilities; These are sources of funds/ amounts owed to people or firms outside the
business. There are Current liabilities and long term liabilities.
 Long term liabilities; These are liabilities/ liabilities falling due after more than one year
like Long term loans and debentures.
 Current liabilities; these are creditors falling due within one year like creditors,
short term borrowings, taxation (<12 months), accrued expenses.

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Balance sheet. Financial statement that lists a company’s assets, liabilities, and
stockholders’ equity (including dollar amounts) as of a specific moment in time. Also called a
statement of financial position.
Capital stock. The title given to an equity account showing the investment in a business
corporation by its stockholders.
Corporation. Business incorporated under the laws of one of the states and owned by a few
stockholders or by thousands of stockholders.
Cost. Sacrifice made or the resources given up, measured in money terms, to acquire some
desired thing, such as a new truck (asset).
Dividend. Payment (usually of cash) to the owners of a corporation; it is a distribution of
income to owners rather than an expense of doing business.
Entity. A business unit that is deemed to have an existence separate and apart from its owners,
creditors, employees, customers, other interested parties, and other businesses, and for which
accounting records are maintained.
Equities Broadly speaking, all claims to, or interests in, assets; includes
liabilities and stockholders’ equity.

Dual Concept in Accounting Equation

Dual concept states that 'for every debit, there is a credit'. Every transaction should have
two-sided effect to the extent of same amount. This concept has resulted in accounting
equation which states that at any point of time assets of any entity must be equal (in monetary
terms) to the total of owner's equity and outsider's liabilities. In other words, accounting
equation is a statement of equality between the assets and the sources which finance the
assets and is expressed as:
Assets = Sources of Finance
Assets may be tangible e.g. land, building, plant, machinery, equipment, furniture, investments,
cash, bank, stock, debtors etc. or intangible e.g. patent rights, trade marks, goodwill etc., Sources
include internal i.e. capital provided by the owner and external i.e. liabilities. Liabilities are
the obligations of the business to others/outsiders. The above equation gets expanded.
Assets = Liabilities + Capital
All transactions of a business can be referred to this equation: Assets = Liabilities
+ Owner's equity
To further explain the transaction of revenues, expenses, losses and gains, the equation can be
expanded thus:

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Assets + Expenses = Liabilities + Revenue + Owner's equity or Assets = Liabilities + (Revenue
– Expenses) + Owner's equity or Assets = Liabilities + Owner's equity + Owner's equity
(income) which ultimately becomes;
Assets = Liabilities + Owner's equity
Let us consider the facts of the following case, step by step, to understand as to how the equation
remains true even in changed circumstances.

An Illustration
1. Commenced business with cash Ugsh. 50,000
2. Purchased goods for cash Ugsh. 20,000 and on credit Ugsh. 30,000
3. Sold goods for cash Ugsh. 40,000 costing Ugsh. 30,000
4. Rent paid Ugsh. 500
5. Bought furniture Ugsh. 5,000 on credit
6. Bought refrigerator for personal use Ugsh. 5,000

Solution:
1. Business receives cash Ugsh. 50,000 (asset) and it owes Ugsh. 50,000 to the proprietor
as his capital i.e. equity.
Assets (=) Liabilities (+) Owner's equity Cash
Ugsh. 50,000 Nil Capital Ugsh. 50,000

2. Purchased goods for cash Ugsh. 20,000 and on credit Ugsh. 30,000. Business has
acquired asset namely – goods worth Ugsh. 50,000 and another asset namely = cash
has decreased by Ugsh. 20,000 while liability– creditors have been created of Ugsh.
30,000.
Assets (=) Liabilities (+) Owner's equity
Cash 30,000 Creditors 30,000 Capital 50,000
Goods 50,000
80,000 = 30,000 + 50,000

3. Sold goods for cash Ugsh. 40,000 costing Ugsh. 30,000

This transaction has resulted in decrease of goods by Ugsh. 30,000 and increase in cash
by Ugsh. 40,000 thus increasing equity by Ugsh. 10,000
Assets (=) Liabilities (+) Owner's equity
Cash 70,000 Creditors 30,000 Capital 60,000
Goods 20,000
90,000 30,000 60,000

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4. Rent paid Ugsh. 500

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This transaction has resulted in an expenditure of Ughs. 500 effecting decrease of cash and
equity by Ugsh. 500 each.

Assets (=) Liabilities (+) Owner's equity

Cash 69,500 Creditors 30,000 Capital 59,500

Goods 20,000
89,500 30,000 59,500

5. Bought furniture on credit Ugsh. 5,000

This transaction results in acquiring an asset namely furniture worth Ugsh. 5,000 and
increasing creditors by Ugsh. 5,000
Assets (=) Liabilities (+) Owner's equity Cash
69,500 Creditors 35,000 Capital 59,500
Goods 20,000
Furniture 5,000
94,500 35,000 59,500

7. Bought refrigerator for personal use Ugsh. 5,000. This transaction will have the effect of
reducing both cash as well as capital by Ugsh. 5,000 each.
Assets (=) Liabilities (+) Owner's equity
Cash 64,500 Creditors 35,000 Capital 54,500
Goods 20,000
Furniture 5,000
89,500 35,000 54,500