Page 48 - DCOM101_FINANCIAL_ACCOUNTING_I

Financial Accounting-I

Notes
Example: If a business has ` 1,000 of assets at a particular time those assets must be matched

by the total of the claims of creditors and owners. Here is one example of an infinite number of
acceptable balance sheets:

Fazal-ur-Rehman and Sons.
Balance Sheet
`
Assets 1000
Liabilities 500
Equity 500
Total Liabilities and Equity 1000

Equity as Residual Claims

Equity is simply the difference between assets and liabilities. The owner has positive equity only
to the extent that assets exceed liabilities.

Example: If a business has ` 1,000 of assets and ` 600 of liabilities the ` 600 of liabilities
are, in effect, a claim on the assets. Equity is the difference between the assets and liabilities, or
` 400.
Equity = Assets – Liabilities
Equity is simply the difference between assets and liabilities. The owner has positive equity only
to the extent that assets exceed liabilities.

Example: If a business has ` 1,000 of assets and ` 500 of liabilities the ` 500 of liabilities
are, in effect, a claim on the assets. Equity is the difference between the assets and liabilities, or
` 500.

If a business ceases operations remaining assets first go to outside creditors. The claims of owners

can be realized only after outside creditors’ claims are satisfied. So equity represents the owners’

residual claim on business assets.

Notes Rules for Accounting Equation

Following rules help in making the accounting equation:
1. Assets: If there is increase in assets, this increase is debited in assets account. If there
is decrease in assets, this decrease credited in assets account.
2. Liabilities: When liabilities are increase, outsider’s equities are credited and when
liabilities are decreased, outsider’s equities are debited.
3. Capital: When capital is increased, it is credited and when capital is withdrawn, it is
debited.
4. Expenses: Owner’s equity is decreased by the amount of revenue expenses.
5. Income or profi ts: Owner’s equity is increased by the amount of revenue income.

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