Accounting Equation Chapter # 2
GUL NAWAZ INSTITUTE OF SUSTAINABLE DEVELOPMENT & TECHNOLOGY
Gul Nawaz
Introduction
We have discussed basic terms used in accounting. One of the most important term is the Balance Sheet. In this chapter we shall explain this term and show the effect of transaction on the balance sheet.
GUL NAWAZ INSTITUTE OF SUSTAINABLE DEVELOPMENT & TECHNOLOGY
Assets and Equities
Assets refer to all the valuable proprieties possessed by the business, while the equities means the claim against these assets. The equity are further divided into Capital And Liability. Capital refer to the owner equity which means right of the owner in the asset of the business and liabilities refer to outsider equities which means the right of outsider in the assets of the business.
GUL NAWAZ INSTITUTE OF SUSTAINABLE DEVELOPMENT & TECHNOLOGY
Balance Sheet Equation
When any assets is purchased, the owner not only acquire the
property but also right associated to that property. These right in assets are equal to the value of assets. In accounting we refer these rights as Clime against assets or equities. From this concept the following equation is derived,
ASSETS
EQUITIES
GUL NAWAZ INSTITUTE OF SUSTAINABLE DEVELOPMENT & TECHNOLOGY
.
As we know that a single person cannot contribute all the required funds from his own pocket. He has to raise fund by means of credit purchase, loan from banks, friends and from many 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
GUL NAWAZ INSTITUTE OF SUSTAINABLE DEVELOPMENT & TECHNOLOGY
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 following business transaction are assumed;
GUL NAWAZ INSTITUTE OF SUSTAINABLE DEVELOPMENT & TECHNOLOGY
Illustration # 1
1.
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 will also increase by similar amount. The equation will appear as follow;
GUL NAWAZ INSTITUTE OF SUSTAINABLE DEVELOPMENT & TECHNOLOGY
ASSATS CASH $ 20000
= =
EQUITIES Alis CAPITAL $ 20000
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.
GUL NAWAZ INSTITUTE OF SUSTAINABLE DEVELOPMENT & TECHNOLOGY
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 the similar amount. The equation will be as follows:
ASSATS CASH $ 20000 -(3000) + Building $ 3000
GUL NAWAZ INSTITUTE OF SUSTAINABLE DEVELOPMENT & TECHNOLOGY
= =
EQUITIES Alis CAPITAL $ 20000
3. Purchase Machinery from Ahmad for $ 1000. In this transaction the assets increase on one side, while the liability are also increase.
ASSATS CASH + Building + Machinery $ 17000 $ 3000 $ 1000 = = EQUITIES CAPITAL + Account Pay $ 20000 $ 1000
GUL NAWAZ INSTITUTE OF SUSTAINABLE DEVELOPMENT & TECHNOLOGY
4. Purchase raw material for cash $ 2000. The transaction will change the composition of assets. The cash will decrease by $ 2000, and material will increase by the similar amount. The equation will be as follows:
ASSATS
CASH + Building + Machinery + Material
= =
EQUITIES CAPITAL + Account Pay $ 20000 $ 1000
$ 17000 ( 2000 )
$ 3000
$ 1000 2000
GUL NAWAZ INSTITUTE OF SUSTAINABLE DEVELOPMENT & TECHNOLOGY
5. Paid salaries $ 2000.
The effect of this transaction will decrease Cash and decrease Owner Equity by $ 2000, The equation will be as follows:
ASSATS
CASH + Building + Machinery + Material $ 15000 $ 3000 $ 1000 2000 ( 2000 ) . 13000 + 3000 + 1000 + 20000
= =
EQUITIES CAPITAL + Account Pay $ 20000 $ 1000 ( 2000 ) . 18000 + 1000 19000
190000
GUL NAWAZ INSTITUTE OF SUSTAINABLE DEVELOPMENT & TECHNOLOGY
Accounting Equation
ASSETS CASH 20000 Building Machinery Material = EQUITIES Capital 20000 Account Pay
(3000)
17000
3000
3000 1000 20000 1000 20000 2000 3000 3000 1000 1000 =
GUL NAWAZ INSTITUTE OF SUSTAINABLE DEVELOPMENT & TECHNOLOGY
17000 (2000) 15000 (2000) 13000 19000
3000
1000 2000 2000
1000 1000 1000
20000 (2000) 18000 19000
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.
GUL NAWAZ INSTITUTE OF SUSTAINABLE DEVELOPMENT & TECHNOLOGY
ACCOUNTING EQUATION
ASSETS
[Link] CASH EQUIPEMEN T
=
FURNITURE A/C REC
EQUITIES
CAPITAL A/C PAY
1 Balance 2 Balance 3 Balance 4 Balance 5 Balance 6 Balance
30000 30000 -500 29500 29500 -200 29300 29300 -300 29000
30000 30000 500 500 1000 500 500 500 1000 1000 2000 1000 2000 30000 -200 29800 2000 31800 -300 31500 30000 1000 1000 1000 1000 1000
GUL NAWAZ INSTITUTE OF SUSTAINABLE DEVELOPMENT & 500 1000 2000 TECHNOLOGY
ILLUSTRATION # 3
Rehman repair shop has the following assets and Equities on April 2012. Cash 3300 Account receivable $ 1900 Supplies $ 1700 Tools $ 8150 Capital $ 3050 Account Payable $ 12000 During the month the following transaction take place;
GUL NAWAZ INSTITUTE OF SUSTAINABLE DEVELOPMENT & TECHNOLOGY
Paid one month rent $ 400. Bought repair supplies $ 100. Paid for supply previously purchase on credit $ 500. Bought tools on credit $ 350. Receive for service rendered $ 900. Service rendered on account $ 210 Received from customer ( Account Receivable) $ 650. Paid for oil and gas used $ 150. Required: Show the effect of above transaction on the accounting equation.
1. 2. 3. 4. 5. 6. 7. 8.
GUL NAWAZ INSTITUTE OF SUSTAINABLE DEVELOPMENT & TECHNOLOGY
ACCOUNTING EQUATION
ASSETS
[Link] CASH Account Receivable Supplies
=
Tools
EQUITIES
CAPITAL Account Payable
Balances 1 Balance 2 Balance 3 Balance 4 Balance 5 Balance 6 Balance 7 Balance 8
3300 -400 2900 -100 2800 -500 2300 2300 + 900 3200 3200 +650 3850 -150
1900 1900 1900 1900 1900 1900 + 210 2110 -650 1460
1700 1700 + 100 1800 1800 1800 1800 1800 1800
8150 8150 8150 8150 +350 8500 8500 8500 8500
3050 -400 2650 2650 2650 2650 +900 3350 + 210 3760 3760 - 150
12000 12000 15000 -500 11500 + 350 11850 11850 11850 11850
Balance
3700
GUL NAWAZ INSTITUTE OF SUSTAINABLE DEVELOPMENT & 1460 1800 8500 TECHNOLOGY
3610
11850
Accounting Equation for Merchandise Business
A merchandise business is one where the goods are purchased 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 recorded under 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.
GUL NAWAZ INSTITUTE OF SUSTAINABLE DEVELOPMENT & TECHNOLOGY
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.
GUL NAWAZ INSTITUTE OF SUSTAINABLE DEVELOPMENT & TECHNOLOGY
ACCOUNTING EQUATION
ASSETS
[Link] CASH Merchandise Inventory
=
Account Receivable
EQUITIES
CAPITAL Account Payable
1 2 Balance 3 Balance 4 Balance
55000 - 12000 43000 43000 43000 + 1250 44250
55000 12000 12000 - 4480 7520 + 7500 15020 - 1000 14020 - 150 13870 + 2500 16370 - 100 16270 5600 5600 5600 5600 5600 5600 5600 55000 + 1120 56120 7500 56120 + 250 56370 56370 56370 - 100 56270 - 250 7500 7500 - 150 7350 + 2500 9850 9850
5
Balance 6 Balance 7 Balance 8 Balance 9
44250 44250 44250 - 250
Balance
44000
GUL NAWAZ INSTITUTE OF SUSTAINABLE DEVELOPMENT & 16270 5600 TECHNOLOGY
56020
9850
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.
GUL NAWAZ INSTITUTE OF SUSTAINABLE DEVELOPMENT & TECHNOLOGY
ACCOUNTING EQUATION
ASSETS
[Link] CASH Merchandise Inventory Computer
=
Account Receivable
EQUITIES
CAPITAL Account Payable
1 2 Balance 3 Balance 4 Balance 5 Balance 6 Balance 7 Balance 8 Balance
20000 - 5000 15000 - 10000 5000 5000 5000 + 1000 6000 + 800 6800 - 400 6400
20000 5000 5000 5000 - 1400 3600 + 500 4100 4100 - 750 3350 3350 10000 10000 1800 10000 10000 10000 10000 10000 1800 1800 - 1000 800 800 800 20000 + 400 20400 500 20400 20400 + 50 20450 -400 20050 500 500 500 500
Totals
GUL NAWAZ INSTITUTE OF SUSTAINABLE DEVELOPMENT & 20550 = TECHNOLOGY
20550
To be sold by students
Q # 1 Mr. Naseer started business with Cash Rs. 10000, and Furniture 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.
GUL NAWAZ INSTITUTE OF SUSTAINABLE DEVELOPMENT & TECHNOLOGY
Q#2
Show 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.
GUL NAWAZ INSTITUTE OF SUSTAINABLE DEVELOPMENT & TECHNOLOGY
GUL NAWAZ INSTITUTE OF SUSTAINABLE DEVELOPMENT & TECHNOLOGY