Page 58 - DMGT104_FINANCIAL_ACCOUNTING

Financial Accounting

Notes 4.1.1 Effect of Transactions on the Accounting Equation

You have learnt that assets, liabilities and capital are the three basic elements of every business
transaction, and their relationship is expressed in the form of accounting equation which always
remains equal. At any point of time, there can be a change in the individual asset, liability or
capital, but the two side of the accounting equation always remain equal. Let us verify this fact
by taking up some transactions and see how these transactions affect the accounting equation:

Example:
1. Mr. Kamlesh started business with cash of 2,00,000.
In this transaction, one side cash is coming into business and in the other side capital
is being brought by Mr. Kamlesh. Thus:
Capital = Assets (Cash)
2,00,000 = 2,00,000
2. In the next transaction, if a plant of 50,000 is purchased in cash, this transaction will
also leave two sides. In one side cash is going and in other side plant is coming. In
this situation, the accounting equation will be as follows:
Capital = Plant + Cash (Assets)
2,00,000 = 50,000 + (2,00,000 – 50,000)
3. If a loan of 1,50,000 is taken from the SBI, it will also affect the accounting equation
by two sides. On one side, cash will increase and on the other side, liabilities of the
business will increase. This may be depicted as follows:
Capital + Liability (Loan) = Plant + Cash
2,00,000 + 1,50,000 = 50,000 + (1,50,000 + 1,50,000)
3,50,000 = 3,50,000
4. If some goods of 20,000 are purchased on credit, it will also affect the accounting
equation in two ways. On one side it increases the goods and on the other side it
increases the liability (creditors). Now the changed form of the above accounting
equation will be as follows:
Capital + Liabilities = Assets
Capital + Loan + Creditors = Plant + Cash + Goods
2,00,000 + 1,50,000 + 20,000 = 50,000 + 3,00,000 + 20,000
3,70,000 = 3,70,000
Illustration 1: Consider X Ltd. having the following position of assets and liabilities as on 31st
March, 2011:
Assets ( in lakhs)
Land & Building 120
Plant & Machinery 235
Furniture & Fittings 35
Inventory 90
Debtors 40
Cash & Bank Balance 25
545

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