Accounting Equation

Rayhan Academy

Accounting Equation

An accounting transaction is a business activity or event that causes a measurable change in the accounting equation. An exchange of cash for merchandise is a transaction. Merely placing an order for goods is not a recordable transaction because no exchange has taken place. In the coming sections, you will learn more about the different kinds of financial statements accountants generate for businesses.

 The accounting equation is:

ASSETS = LIABILITIES + OWNERS CAPITAL

For Example:

A sole proprietorship business owes Tk.12,000 and you, the owner personally invested Tk.100,000 of your own cash into the business. The assets owned by the business will then be calculated as:

Tk.12,000 (what it owes) + Tk.100,000 (what you invested) = Tk.112,000 (what the company has in assets)s

Assets	=	Liabilities	+ Capital
1,12,000	=	12,000	100,000

In a sole-proprietorship, Capital is actually Owner’s Capital.  If the business in question is a corporation, Capital will be held by stockholders, which uses stockholder’s Capital but the basic equation is the same:

Rules Of Accounting Equation

1. Owners invested cash

Kabir Agro started business in  Cash Tk.50,000.

Assets

=

Liabilities

+ Capital

    50,000               =                    0                             +50,000

1.Owner invested in cash Tk.+50,000

•                Let’s check the accounting equation: 

Assets Tk.50,000 = Liabilities Tk0 + Capital Tk.50,000

2. Purchased equipment for cash

Kabir agro paid Tk.5,500 cash for equipment (two computers).

Transaction analysis:

• Kabir agro  purchased new asset (equipment) for Tk. 5,500 and paid cash.
• We want to increase the asset Equipment and decrease the asset Cash since we paid cash.

	Assets		Owners Capital
Transaction	Cash	Equipment	Capital
1. Owner invested cash	+ 50,000		+50,000
2. Purchased equipment for cash	– 5,500	+5,500
Balance:	44,500	5,500	50,000

• Let’s check the accounting equation: 

Assets Tk.50,000 (Cash Tk.44,500 + Equipment Tk5,500)  = Liabilities Tk0 +  Capital Tk.50,000

3. Purchased truck for cash

Kabir agro paid Tk 8,500 cash for a truck.

Transaction analysis:

• Kabir agro purchased new asset (truck) for Tk. 8,500 and paid cash.
• We want to increase the asset Truck and decrease the asset cash for Tk.8,500.

	Assets			Owners Capital
Transaction	Cash	Equipment	Truck	Capital
1. Owner invested cash	+50,000			+50,000
2. Purchased equipment for cash	– 5,500	+5,500
3.  Purchased truck for cash	-8,500		+  8,500
Balance:	36,000	5,500	8,500	50,000

•               Let’s check the accounting equation:

AssetsTk.50,000 (Cash Tk.36,000 + Equipment Tk.5,500 + Truck Tk.8,500)  = Liabilities Tk.0 + Capital Tk.50,000

4. Purchased supplies on account.

Kabir agro purchased supplies on account from Office supplies for Tk.500.

Transaction analysis:

• Kabir agro purchased new asset (supplies) for Tk. 500 but will pay for them later.
• We want to increase the asset Supplies and increase what we owe with the liability Accounts Payable.

	Assets =				Liabilities +	Owners Capital
Transaction	Cash	Supplies	Equipment	Truck	Accounts Payable	Capital
1. Owner invested cash	+50,000					+50,000
2. Purchased equipment for cash	-5,500		+5,500
3.  Purchased truck for cash	-8,500			+ 8,500
4.  Purchased supplies on account.		+ 500			+500
Balance:	36,000	500	5,500	8,500	500	50,000

•               Let’s check the accounting equation:

Assets Tk.50,500 (Cash Tk.36,000+ Supplies Tk.500 + Equipment Tk.5,500 + Truck Tk.8,500)  = Liabilities Tk.500 +  Capital Tk.50,000

5. Making a payment to creditor.  

Kabir agro issued a check to Office Supplies   for Tk.300 previously purchased supplies on account.

Transaction analysis:

• Kabir agro paid Tk.300 in cash and reduced what they owe to Office Supplies .
• We want to decrease the liability Accounts Payable and decrease the asset cash since we are not buying new supplies but paying for a previous purchase.

	Assets =				Liabilities +	Owners Equity
Transaction	Cash	Supplies	Equipment	Truck	Accounts Payable	Capital
1. Owner invested cash	+50,000					+50,000
2. Purchased equipment for cash	-5,500		+5,500
3.  Purchased truck for cash	-8,500			+8,500
4.  Purchased supplies on account.		+500			+500
5.  Making a payment to creditor.	-300				-300
Balance:	35,700	500	5,500	8,500	200	50,000

•    Let’s check the accounting equation:

Assets Tk.50,200 (Cash Tk.35,700 + Supplies Tk.500 + Equipment Tk.5,500 + Truck Tk.8,500)  = Liabilities Tk.200 + Capital Tk.50,000

6. Making a payment in advance.

Kabir agro issued a check to Rent Commerce, Inc. for Tk.1,800 to pay for office rent in advance for the months of February and March.

Transaction analysis (to save space we will look at the effects of each of the remaining transactions only):

• Kabir agro prepaid the rent for next two months making an advanced payment of Tk.1,800 cash.
• We will increase an asset account called Prepaid Rent (since we are paying in advance of using the rent) and decrease the asset cash.

	Assets
Transaction	Cash	Prepaid Rent
Previous Balance	35,700
6. Making a payment in advance.	-1,800	+ 1,800
Balance:	33,900	1,800

The only account balances that changed from transaction 5 are Cash and Prepaid Rent.  All other account balances remain unchanged. 

•            The new accounting equation would be:

 Assets Tk. 50,200 (Cash Tk.33,900 + Supplies Tk.500 + Prepaid Rent Tk.1,800 + Equipment Tk.5,500 + Truck Tk.8,500)  = Liabilities Tk. 200 +  Capital Tk.50,000

7. Selling services for cash.

During the month of February, Kabir agro earned a total of Tk.50,000 in revenue from clients who paid cash.

Transaction analysis:

• Kabir agro received Tk.50,000 in cash for services provided to clients.
• We want to increase the asset Cash and increase the revenue account Service Revenue.

	Assets	Revenues
Transaction	Cash	Service Revenue
Previous Balance	33,900
7.  Selling services for cash   .	+  50,000	+  50,000
Balance:	83,900	50,000

Wait a minute…the accounting equation is ASSETS = LIABILITIES + OWNERS CAPITAL and it does not have revenue or expenses…where do they fit in?  Revenue – Expenses equals net income.  Net Income is added to Capital at the end of the period. 

•                  The new accounting equation would be:

Assets Tk.1,00,200 (Cash Tk.83,900 + Supplies Tk.500 + Prepaid Rent Tk.1,800 + Equipment Tk.5,500 + Truck Tk.8,500)= Liabilities Tk.200)+ Owners Equity Tk.1,00,000 (Capital  Tk.50,000 + Net Income Tk.50,000). 

Note:  This does not mean revenue and expenses are Capital accounts!

8. Selling services on credit.

Kabir agro  earned a total of Tk.10,000 in service revenue from clients who will pay in 30 days.

Transaction analysis:

• Kabir agroperformed work and will receive the money in the future.
• We record this as an increase to the asset account Accounts Receivable and an increase to service revenue.

	Assets	Revenues
Transaction	Accounts Receivable	Service Revenue
Previous Balance		Tk. 50,000
8. Selling services on credit.	+ 10,000	+ 10,000
Balance:	Tk. 10,000	Tk. 60,000

Remember, all other account balances remain the same.  The only changes are the addition of Accounts Receivable and an increase in Revenue.

•            The new accounting equation would be: 

 Assets Tk.1,10,200 (Cash Tk.83,900 + Accounts Receivable Tk.10,000 + Supplies Tk.500 + Prepaid Rent Tk.1,800 + Equipment Tk.5,500 + Truck Tk.8,500)= Liabilities Tk.200 + Capital Tk.1,10,000 (Capital  Tk.50,000 + Net Income Tk.60,000).

9. Collecting accounts receivable.

Kabir agro collected a total of Tk.5,000 on account from clients who owned money for services previously billed.

Transaction analysis:

• Kabir agro received Tk.5,000 from customers for work we have already billed (not any new work).
• We want to increase the asset Cash and decrease (what we will receive later from customers) the asset Accounts Receivable.

	Assets
Transaction	Cash	Accounts Receivable
Previous Balance	Tk. 83,900	Tk. 10,000
9.  Collecting accounts receivable.	+ 5,000	– 5,000
Balance:	Tk. 88,900	Tk. 5,000

Assets Tk.1,10,200 (Cash Tk.88,900 + Accounts Receivable Tk.5,000 + Supplies Tk.500 + Prepaid Rent Tk.1,800 + Equipment Tk.5,500 + Truck Tk.8,500)= Liabilities Tk.200 + Capital Tk.1,10,000 (Capital Tk.50,000 + Net Income Tk.60,000).

10. Paying office salaries.

Kabir agro paid a total of Tk.900 for office salaries.

Transaction analysis:

• Kabir agro paid Tk.900 to its employees.
• We will increase the expense account Salaries Expense and decrease the asset account Cash.

	Assets	Expenses
Transaction	Cash	Salary Expense
Previous Balance	Tk.  88,900
10.  Paying Office Salaries.	– 900	+  900
Balance:	Tk. 88,000	Tk. 900

Remember, net income is calculated as Revenue – Expenses and is added to Capital. 

•                 The new accounting equation would show: 

Assets Tk.1,09,300 (Cash Tk.88,000 + Accounts Receivable Tk.5,000 + Supplies Tk.500 + Prepaid Rent Tk.1,800 + Equipment Tk.5,500 + Truck Tk.8,500)= Liabilities Tk.200 + Capital Tk.1,09,100 (Capital Tk.50,000 + Net Income Tk.59,100 from revenue of Tk.60,000 – expenses Tk.900).

11. Paying utility bill.

Kabir agro paid a total of Tk.1,200 for utility bill.

Transaction analysis:

• Kabir agro paid Tk.1,200 in cash for utilities.
• We will increase the expense account Utility Expense and decrease the asset Cash.

	Assets	Expense
Transaction	Cash	Utilities Expense
Previous Balance	Tk. 88,000
11.  Paying Utility Bill	– 1,200	+ 1,200
Balance:	Tk. 86,800	Tk. 1,200

•                     The final accounting equation would be: 

Assets Tk.1,08,100 (Cash Tk.86,800 + Accounts Receivable Tk.5,000 + Supplies Tk.500 + Prepaid Rent Tk.1,800 + Equipment Tk.5,500 + Truck Tk.8,500) = Liabilities Tk.200 + Capital Tk.1,07, 900 (CapitalTk.50,000 + Net Income Tk.57,900 from revenue of Tk.60,000 –  salary expense Tk.900 – utility expense Tk.1,200).

12. Received Tk.5,000 from note payable in Commerce Bank.

Kabir agro Received Tk.5,000 from note payable in Commerce Bank.

Transaction analysis:

• Kabir agro Received Tk.5,000 from note payable.
• We will increase the Assets Cash account and increase the liabilities Note payable

Assets

=

Liabilities

                                Cash                                          Note Payable

Balance                                     86,800                                                   0                                                                                                    

12.Note payable                       5,000                                                    5,000

Balance                                    91,800                                                 5,000

•             The final accounting equation would be: 

Assets Tk.1,13,100 (Cash Tk.91,800 + Accounts Receivable Tk.5,000 + Supplies Tk.500 + Prepaid Rent Tk.1,800 + Equipment Tk.5,500 + Truck Tk.8,500) = Liabilities5,200 (Accounts Payable Tk.200+Note payable5,000) + Capital Tk.1,07, 900 (CapitalTk.50,000 + Net Income Tk.57,900 from revenue of Tk.60,000 –  salary expense Tk.900 – utility expense Tk.1,200).