Explanation of Capital and Personal Accounts

1. Both these accounts are personal accounts. So the golden rule

applicable to personal account will be applicable for these two
accounts also.
2. Capital Account: When ever any person introduces some cash or goods
into business to start the business, it is termed as Capital Account.
3. Any decrease in capital will be debited and any increase in capital will
be credited.
Lets try to understand this using golden rule for personal account. The
golden rule for personal account is:
Receiver: Debited
Giver: Credited
Now suppose Mr. X introduces some cash into business, than as per the
golden rule the two accounts affected will be:
(i)

Cash Account: Cash is coming into business. It comes under

Real Account. So as per golden rule for real account, Cash
account will be debited.
(ii)
Mr. X Account: Personal account and he is giving money from
his pocket so as per rule of personal account Mr. X will be
credited. However instead of writing Mr. X we need to just write
capital account, and hence capital account will be credited.
Now suppose Mr. X takes out some cash from business for personal
use, than as per golden rule the two accounts affected will be:
(i)

Cash Account: But this time cash is going out of business, so as

per rule of real account, Cash account will be credited.
(ii)
Mr. X Account: Here Mr. X is receiving money, so as per the rule
of personal account Mr. X will be debited. However instead of
writing Mr. X we need to just write drawings account, and hence
capital account will be credited.
4. When he introduces cash or goods it is termed as capital account and
when he withdraws cash or goods for personal use, it is termed as
drawings.
5. Nut Shell: Whenever capital increases in business, it will be credited
and debited when decreases.

Explanation of Accounting Equation

When an entrepreneurs start a business, their business assets (such as office
equipment, inventories, office buildings, cash, etc.) come from two sources:
either they purchase them using cash they invest in the business, or they
raise loans and purchase the assets on credit terms in which they promise
some third party to pay the price in future. This simple fact is expressed by
the accounting equation as follows:
Assets = Liabilities + Shareholders' Equity
Accounting equation is the most basic principle of financial accounting. It
states that at a point of time, the value of assets of a business is equal to
sum of the value of its liabilities and its shareholders' equity.
An ASSET is a resource controlled by a business which is of economic use to
the business. Examples of assets include land, buildings, vehicles, inventory,
accounts receivable, cash and cash equivalents, etc.
A LIABILITY is the obligation of a business towards its creditors i.e. those
who provided loaned cash or loaned assets. Settlement of liabilities result in
an outflow of assets. Common liabilties are accounts payable, salaries
payable, taxes payable, etc.
The EQUITY is the claim of the owners of the business on the business'
assets. It represents the assets leftover after all liabilities have been paid off.
Owner's equity contains accounts such as common stock, retained earnings,
etc.
Lets try to understand this equation using few business transactions:

Assets

Opening Balances
Transaction 1:
ABC LTD purchases a
machine costing Rs 1000
for cash.

100000

Liabilitie
s
80000

Owner's
Equity
20000

Remarks

+1000
(Machine)
- 1000
(Cash)

Net Effect:(Balance
After transaction)

100000

80000

20000
Transactions
that only
affect Assets
of the entity

Transaction 2:
ABC LTD receives Rs 500
cash from a receivable
DEF LTD in respect of
goods sold on credit.

+500
(Cash)
-500
(Debtors
(DEF Ltd.)

Net Effect:(Balance
After transaction)

II

100000

Assets

80000

Liabilitie
s
80000

Opening Balances
Transaction 1:

100000

ABC LTD receives Rs

2,500 bank loan in cash.

+ 2500
(Cash)

+ 2500
(Bank
Loan)

Net Effect:(Balance
After transaction)

102500

82500

- 500
(Cash)

- 500
(Creditors
)

102000

82000

Transaction 2:
ABC LTD pays Rs 500
cash to XYZ LTD for
goods purchased on
credit.
Net Effect:(Balance
After transaction)

20000

Owner's
Equity
20000

20000

20000

Remarks

Transactions
that affect
Assets and
Liabilities of
the entity

III
Opening Balances
Transaction 1:
ABC LTD issues share
capital for Rs 2,500 in
cash.
Net Effect:(Balance
After transaction)

Assets

100000

Liabilitie
s
80000

Owner's
Equity
20000
+2500
(Share
Capital)

+ 2500
(Cash)

102500

80000

22500

Transaction 2:
ABC LTD pays dividend
of Rs 500 in cash.

- 500
(Cash)

Net Effect:(Balance
After transaction)

102000

IV
Opening Balances
Transaction 1:

Assets
100000

ABC LTD incurs utility

expense of Rs 500 which
remains unpaid at the
period end.

- 500
(Dividend
)
80000

Liabilitie
s
80000

Transactions
that affect
Assets and
Equity of the
entity

22000

Owner's
Equity
20000

+500
(Accrued
Liability)

-500
(Accrued
Expenses
)

100000

80500

19500

ABC LTD recognizes rent

income for the period of
Rs 500 which it received
in advance in the last
accounting period.

100000

-500
(Accrued
Income)

+500
(Accrued
Income)

Net Effect:(Balance
After transaction)

100000

80000

20000

Net Effect:(Balance
After transaction)

Remarks

Transaction 2:

Remarks

Transactions
that affect
Liabilities and
Equity of the
entity