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“Politics is for the present
but
an equation is for eternity”
-Albert Einstein
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Chapter Contents
Particulars
What is accounting equation?
The accounting equation with examples
Objective Type Questions
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Page No.
6
7-9
10-35
What is Accounting Equation?
 The equation that is the foundation of double entry accounting
 It shows what a company owns, what a company owes & what stake the
owners have in the business.
 It describes that the total value of assets of a business is always equal to
its external liabilities plus owner’s capital.
 This equation summarizes the essential nature of double entry
accounting systems: Debits always equal Credits, and Assets always
equal the sum of Capital and Liabilities.
The Accounting Equation is as follows:
Assets
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=
Capital
+
External Liabilities
Need and Importance of Accounting Equation:
 The accounting equation is the basic accounting equation, represents
the relationship among the liabilities, assets, and owner's equity of a
business.
 Double entry principle indicates that the total debits are equal to the
total credits for any transaction.
 It is also known balance sheet equation.
 The mathematical expression of the accounting equation is: Assets =
Liabilities + Owner’s Equity or A==L+E.
 It is most commonly used to balance sheet, the final financial statement
for a company. It is the systematic form of representing company
status, displaying the total assets of a company is equal to the total
liabilities and shareholder equity.
 The balance sheet is a complex expression of this equation, presenting
the total assets of a company is equal to the total of liabilities and
owner’s equity.
 It is helpful to make use of the accounting equation at the time of
preparing financial statements, as it would not only help you to
maintain the accuracy, but also enable you to track the debits and
credits, so that you can balance the equation accordingly.
 The importance of accounting equation should not be underestimated,
as it's very much helpful to serve as a basis for all the accounting
transactions. Representing the relationship with the components of the
balance sheet, it reveals the financial standing of a business entity.
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Examples of Entries & their effects in the Accounting Equation:
1. Mr. X purchased Furniture for Rs. 50,000
The Accounting Equation is:
Asset
(Furniture Comes in)
Asset
(Cash Goes Out)
Asset
(50,000- 50,000)
0
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= Capital
+
External Liabilities
=
0
+
0
=
0
+
0
2. Mr. X purchased Goods on Credit Rs.10,000
The Accounting Equation is:
Assets
(Goods Come in)
Liabilities
(Increase in Creditors)
Asset
10,000
= Capital
+
= 0
+
External Liabilities
10,000
3. Mr. X withdrew Rs. 5,000 for his personal use.
Liabilities
Assets
Asset
(5,000)
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(Drawings are deducted from Capital)
(Cash Going Out)
= Capital
= 0
+
External Liabilities
+
(5,000)
4. Mr. X borrowed Rs. 2,500 from Bank of India.
Assets
(Cash Comes In)
Liabilities
(Liability to pay bank occurs)
Asset
2,500
= Capital
+
External Liabilities
= 0
+
2,500
5. Mr. X Paid Rs. 8,000 to Creditors.
Assets
(Cash Goes Out)
Liabilities
(Reduction in amount to be paid to Creditors)
Asset
(8,000)
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= Capital
+
= 0
+
External Liabilities
(8,000)
Objective Type Questions
Q.1.Choose Appropriate Answer
1. The Basic Accounting Equation is Assets = External Liabilities +
__________
A. Drawings
B. Capital
C. Net Profit
D. None of the Above
2. The accounting equation should remain in balance because every
transaction affects how many accounts?
A. Only One
B. Only Two
C. Two Or More
D. None of the Above
3. Which of the following will not cause Assets to increase?
A. Owner‟s Drawings
B. Purchase of Goods on Credit
C. Sale of Goods on Cash
D. None of the Above
4. Which of the following will cause Liabilities to decrease?
A. Purchase of Goods on Cash
B. Sale of Goods on Cash
C. Repayment of Bank Loan
D. Purchase goods on Credit
5. Capital is the money borrowed from the
A. Creditor
B. Debtor
C. Supplier
D. Owner
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Q.2.Tick on the Appropriate Column following the
Accounting Equation
1.
2.
3.
4.
5.
The company purchases equipment with its cash.
The owner withdraws cash from the business for personal use.
The company purchases a significant amount of supplies on credit.
The company receives cash as a loan from a bank.
The company repays the bank that had lent money to the company.
No. Assets
Total Liabilities
Increase
Decrease
No Effect
Increase
Decrease
No Effect
1.
2.
3.
4.
5.
Q.3. Using the Accounting Equation formula, find the
Missing Figure
No.
Assets
Capital
External
Liabilities
1.
50,000
?
30,000
2.
?
60,000
10,000
3.
15,000
5,000
?
4.
7,000
2,000
?
5.
?
9,500
9,500
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Q.4. Solve the Following
1. Show the effects of Accounting Equation from the following transactions:
A. Mr. Shah started business with cash Rs.50,000
B. Mr. Shah purchased goods on credit Rs.10,000
C. Mr. Shah purchased Machinery on Credit Rs.15,000
D. Paid to Creditor Rs.5, 000.
2. Show the effects of Accounting Equation from the following transactions
A. Mr. Patel commenced business with Rs. 1, 00, 000
B. Mr. Patel bought loose tools of Rs. 20,000
C. Mr. Patel sold goods on Cash 15,000
D. Mr. Patel purchased goods on Cash 10,000
3. Show the effects of Accounting Equation from the following transactions
A. Mr. Mehta started business with Rs.10,000
B. He withdrew Rs.500 for personal use.
C. Paid Salary Rs.5,000
D. Purchased Goods on Credit 10,000
4. Show the effects of Accounting Equation from the following transactions
A. Mr. Parekh started business with 60,000
B. Paid for Repairs Rs. 1,050
C. Loan taken from Bank Rs. 15,000
D. Received interest Rs. 3,500.
5. Show the effects of Accounting Equation from the following transactions
A. Mr. Desai started business with cash Rs. 55,000
B. Purchased goods on credit Rs. 6,500
C. Paid to Creditor Rs. 5,000
D. Additional Capital Introduced in business Rs. 18,000
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Answers
Q1.
12345-
B
C
A
C
D
Q2.
No. Assets
Increase
1.
2.
3.
4.
5.
Q3.
1. 20,000
2. 70,000
3. 10,000
4. 5,000
5. 19,000
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Liabilities
External Liabilities
Decrease
No
Effect
Increase
Decrease
Liabilities
Capital
No
Increase
Effect
Decrease
No
Effect
Q4.
1. The first solution provides the Steps and method to solve the Problem
A. The accounting equation will be
Assets= External Liabilities + Capital
50,000(Cash) = 0 + 50,000
B. The Accounting Equation will be
Assets = External Liabilities+ Capital
50,000+ 10,000(increase in assets -goods) = 10,000(increase in creditors) + 50,000
C. The Accounting Equation will be
Assets = External Liabilities+ Capital
50,000+10,000+15,000(increase in assets-Machinery) = 10,000+ 15,000(increase in
creditors) + 50,000
D. The Accounting Equation will be
Assets = External Liabilities+ Capital
50,000-5,000(cash paid) + 10,000 + 15,000 = 10,000+ 15,000- 5,000(Decrease in
liabilities as paid to creditors) + 50,000
Therefore, The Accounting Equation will be
Assets = External Liabilities+ Capital
70,000= 70,000
Transaction
Accounting Equation
Assets
= External
Liabilities
+ Capital
A. Mr. Shah started business with
cash Rs.50,000
50,000
0
50,000
B. Mr. Shah purchased goods on
credit Rs.10,000
10,000
10,000
0
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C. Mr. Shah purchased Machinery
on Credit Rs.15,000
15,000
15,000
0
D. Paid to Creditor Rs.5, 000
(-)10,000
(-)10,000
0
65,000
= 15,000
+ 50,000
2.
Transaction
Accounting Equation
Assets
= External
Liabilities
+ Capital
A. Mr Patel commenced business
with Rs. 1, 00, 000
1,00,000
0
1,00,000
B. Mr Patel bought loose tools of
Rs. 20,000
20,000
0
0
C. Mr Patel sold goods on Cash
15,000
15,000
0
0
D. Mr Patel purchased goods on
Cash 10,000
10,000
0
0
(-)20,000
(-)15,000
(-)10,000
1,00,000
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= 0
+ 1,00,000
3.
Transaction
Accounting Equation
Assets
=
External
Liabilities
+
Capital
A. Mr. Mehta commenced
business with Rs. 10,000
10,000
0
10,000
B. Withdrew for personal use Rs.
500
(-)500
0
(-)500
C. Paid Salary Rs. 5,000
(-)5,000
0
(-)5,000
D. Purchased goods on Credit
10,000
10,000
0
Rs. 10,000
14,500
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=
10,000
+
4,500
4.
Transaction
Accounting Equation
Assets
A. Mr Parekh started business with 60,000
60,000
B. Paid for Repairs 1,050
(-)1,050
= External
Liabilities
0
+ Capital
60,000
0
(-)1,050
C. Loan taken from Bank Rs.15,000 15,000
15,000
0
D. Interest Received 3,500
0
3,500
3,500
77,450
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= 15,000
+ 62,450
5.
Transaction
Accounting Equation
Assets
= External
Liabilities
0
+ Capital
A. Mr. Desai started business with
cash Rs. 55,000
55,000
B. Purchased goods on credit Rs.
6,500
6,500
6,500
0
C. Paid to Creditor Rs. 5,000
(-)5,000
(-)5,000
0
0
18,000
D. Additional Capital Introduced in 18,000
business Rs. 18,000
74,500
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= 1,500
55,000
+ 73,000
Hope you have enjoyed Learning
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