Page 56 - DMGT104_FINANCIAL_ACCOUNTING

Financial Accounting Mahesh Kumar Sarva, Lovely Professional University

Notes Unit 4: Accounting Equation and Accounting Cycle

CONTENTS
Objectives
Introduction
4.1 Accounting Equation
4.1.1 Effect of Transactions on the Accounting Equation
4.2 Accounting Cycle
4.2.1 Accounts
4.3 Summary
4.4 Keywords
4.5 Review Questions
4.6 Further Readings

Objectives

After studying this unit, you will be able to:

 Explain the concept of accounting equation
 Describe accounting cycle

Introduction

As discussed earlier accounting is the art of recording, classifying and summarizing the business
transactions of the financial nature. Under the recording process of accounting journal and
subsidiary books are maintained, under classification of transactions the ledger is maintained
while in the summarizing process trial balance and final accounts (P&L A/c and Balance Sheet)
are prepared.

4.1 Accounting Equation

The basic accounting equation is the foundation for the double-entry bookkeeping system. It
shows how assets were financed: either by borrowing money from someone (liability) or by
paying your own money (shareholders’ equity).
Assets = Liabilities + Capital (Shareholders or Owners equity)
The accounting equation is also the basis for the most basic of accounting reports, the aptly
named Balance Sheet. A balance sheet reports what a business owns (assets), what it owes
(liabilities) and what remains for the owners (equity) as of a certain date. This equation should
remain in balance at all times because of double-entry accounting or bookkeeping. This can be
further understood by the following illustrations.
An owner’s investment into the company will increase the company’s assets and will also
increase owner’s equity. When the company borrows money from its bank, the company’s
assets increase and the company’s liabilities increase. When the company repays the loan, the
company’s assets decrease and the company’s liabilities decrease. If the company pays cash for
a new delivery van, one asset (cash) will decrease and another asset (vehicles) will increase. If a
company provides a service to a client and immediately receives cash, the company’s assets
increase and the company’s owner’s equity will increase because it has earned revenue. If the

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