THE ACCOUNTING EQUATION

The accounting equation is the foundation of the whole financial accounting and is the basic

behind the preparation of the statement of financial position (balance sheet). The accounting

equation starts as follow;

Resources supplied by the owner = Resources in the business

But in accounting, the resources supplied by the owner are referred as capital while resources in

the business are referred as assets.

So when the owner has supplied all the resources in the business, the accounting equation is

presented as;

Capital = Assets

Nevertheless, the owner cannot supply all the resources to the entity, some other resources are

supplied by other external parties to the business. These include banks which provide loans,

overdrafts e.t.c, these are referred as liabilities.

So the new revised accounting equation is presented as;

Assets(financed) = Capital + Liabilities(financing side)

So no matter what happens to the business or how you present the accounting equation, you

should always keep in mind that this equation must BALANCE.

EFFECTS OF TRANSACTIONS IN THE ACCOUNTING EQUATION AND THE

STATEMENT OF FINANCIAL POSITION

This part shows how different transactions in the entity affect the accounting equation and how

the equation maintains the balance.

1. The owner introduces capital in the business

On 1st January 2011, Mr. Muhammad Hassan commenced a business of selling maize from

Iringa by depositing shs. 120,000,000 into his bank account. The effect is an increase in

current asset bank by 120 million and increase in capital by the same amount hence

balancing.

Mr. Muhammad Hassan

Statement of financial position as at 1st January 2011

shs

Asset: Bank………………………………………………..120,000,000

Capital…………………………………………………….120, 000,000

So the equation is balanced.

2. The owner purchases an asset by cheque

On 5th January 2011, Mr. Hassan bought a Fuso truck to help him transport the crops from

Iringa to Dar es salaam for shs 30 million paying by cheque. The effect is an increase in fixed

assets, motor vehicle by 30 million and decrease in current asset bank by 30 million hence

compensating each other.

 Mr. Muhammad Hassan

Statement of financial position as at 5th January 2011

Shs

Assets

Motor vehicle………………………………………………………30,000,000

Bank………………………………………………………………..90,000,000

Total……………………………………………………………….120, 000,000

Capital……………………………………………………………..120,000,000

3. Purchase of goods on credit

On 2nd February 2011, Mr. Muhammad Hassan bought maize costing shs 20 million from Mr.

Tweve on credit. The effect is an increase in current liability creditors by 20 million and an

increase in inventory (stock) by 20 million hence balanced.

Mr. Muhammad Hassan

Statement of financial position as at 2nd February 2011

Shs

Assets

Motor vehicle………………………………………………………30,000,000

Bank………………………………………………………………..90,000,000

Inventory……………………………………………………………20,000,000

140,000,000

Less: creditors…………………………………………………….. (20,000,000)

Total……………………………………………………………….120, 000,000

Capital……………………………………………………………..120,000,000

4. Sale of goods on credit

On 4th march, Mr. Hassan sold rice on credit to Miss Joyce for the total of shs. 15 million.

The effect is the reduction of assets stock by shs 15 million and increase in another asset

debtor by shs. 15 million hence balancing the equation.

Mr. Muhammad Hassan

Statement of financial position as at 4th March 2011

Shs

Assets

Motor vehicle………………………………………………………30,000,000

Bank………………………………………………………………..90,000,000

Inventory…………………………………………………………….5, 000,000

Debtors……………………………………………………………..15,000,000

140,000,000

Less: creditors…………………………………………………….. (20,000,000)

Total……………………………………………………………….120, 000,000

Capital……………………………………………………………..120,000,000
5. Sale of an asset for immediate payment

On 2nd April, Mr Hassan sold goods costing shs 2.5 million to Mr. Abdul Malik by cash. The

effect of this is the decrease in asset stock by 2.5 million and increase in asset cash by the

same amount hence compensating each other.

Mr. Chris Mashindano

Statement of financial position as at 4th March 2010

Shs

Assets

Motor vehicle………………………………………………………30,000,000

Bank………………………………………………………………..90,000,000

Inventory…………………………………………………………….2, 500,000

Cash………………………………………………………………….2, 500, 000

Debtors……………………………………………………………..15,000,000

140,000,000

Less: creditors…………………………………………………….. (20,000,000)

Total……………………………………………………………….120, 000,000

Capital……………………………………………………………..120,000,000
6. Payment of liability

On 15th June, Mr. Chris paid Mr. Tweve shs. 10 million by cheque as part of the amount owing

to the purchase of goods on credit on 2 nd February 2010. The effect is decreasing the liability

creditors by shs 10 million and decrease in asset bank by shs 10 million.

Mr Chris Mashindano

Statement of financial position as at 4th March 2010

Shs

Assets

Motor vehicle………………………………………………………30,000,000

Bank………………………………………………………………..80,000,000

Inventory…………………………………………………………….2, 500,000

Cash………………………………………………………………….2, 500, 000

Debtors……………………………………………………………..15,000,000

130,000,000

Less: creditors…………………………………………………….. (10,000,000)

Total……………………………………………………………….120, 000,000

Capital……………………………………………………………..120,000,000
7. Collection of cash from debtors

On 7th July, Mr. Chris received shs. 10,000,000 by cheque from Mrs. Ashley being part of the

payment of the amount owing for the sale of goods. The effect is increase in asset bank by shs 10

million and a decrease in another asset debtor by shs.10 million hence compensating each other.

Mr. Chris Mashindano

Statement of financial position as at 4th March 2010

Shs

Assets

Motor vehicle………………………………………………………30,000,000

Bank………………………………………………………………..100,000,000

Inventory…………………………………………………………….2, 500,000

Cash………………………………………………………………….2, 500, 000

Debtors………………………………………………………………..5,000,000

140,000,000

Less: creditors…………………………………………………….. (20,000,000)

Total……………………………………………………………….120, 000,000

Capital……………………………………………………………..120,000,000
SUMMARY OF THE ACCOUNTING EQUATION AND ITS RESPECTIVE

TRANSACTIONS

TRANSACTION IMPACT ON THE

ACCOUNTING EQUATION
1. Proprietor deposits capital into the bank -Increase asset (bank)

-Increase capital
2. Buy goods by cheque -Decrease asset (bank)

-Increase asset (stock)

3. Buy goods on credit -Increase asset(stock)

-Increase liability creditors

4. Sale of goods on credit - Decrease asset (stock)

-Increase asset (debtors)

5. Sale of goods for cash (cheque) -Decrease asset (stock)

-Increase asset (bank)

6. Pay creditor -Decrease asset (bank)

-Decrease liability creditor

7. Debtor pays money owing by cheque -Increase asset (bank)

-Decrease asset (debtors)

8. Proprietor takes money out of the business for - Decrease asset (bank)

own use - Decrease capital

9. Proprietor pays creditors from private money -Decrease liability (creditors)

outside the entity -Increase capital

QUESTIONS ON THE ACCOUNTING EQUATION

Question 1:

Show the effects of the following transactions in the accounting equation;

1. The owner pays a creditor shs 140,000 in cash…………………………………

2. Bought furniture paying shs 400,000 by cheque………………………………..

3. Purchased goods on credit shs 550,000…………………………………………

4. Introduces extra shs 1,000,000 cash into the business………………………….

5. Obtained a loan from the bank shs 200,000…………………………………….

6. A debtor pays the business shs 50,000 by cheque………………………………

7. The owner returned goods costing shs 20,000 to the supplier whose bill had not been

paid……………………………………………………………………

8. Bought 5 computers for shs 3,000,000………………………………………….

Question 2:

Mr. Dwayne had the following assets and liabilities as on 30th November 2009;

- Creditors………………………………...………………………..shs 5,600,000

- Equipment…………………………………………………...….shs 12,400,000

- Motor vehicle…………………………………………………...shs 14,600,000

- Inventory………………………….…………………………….shs 16,200,000

- Debtors…………………………………………………………...shs 8,100,000

- Bank…………………………………………………………….shs 18,200,000

- Cash………………………………………………………………...shs 390,000

During the period to 31st December, the following transactions occurred;

(a). Dwayne bought equipment on credit for shs. 220,000

(b). Dwayne bought extra stock by cheque shs 760,000

(c). Dwayne paid creditors by cheque shs 2,300,000

(d). Debtors paid Dwayne shs 1,280,000 by cheque and shs 180,000 by cash
(e). Dwayne put in an extra shs 1,500 into the business, shs 2,600,000 by cheque and shs

400,000 in cash.

Required: Prepare the statement of financial position as at 31st December 2009.

Question 3

Miss Alicia Fox had the following items in her statement of financial position as at 31st June

2008

- Capital ………………………………………………………….shs 36,800,000

- Creditors………………………………………………………….shs 4,200,000

- Fixtures…………………………………………………………...shs 5,600,000

- Motor van..……………………………………………………….shs 7,800,000

- Inventory…………………………………………………………shs 9,100,000

- Debtors…………………………………………………………...shs 5,560,000

- Bank………………………………………………………….…shs 12,500,000

- Cash………………………………………………………………...shs 440,000

During the period, the following transactions took place;

(a). She bought extra stock costing shs 800,000 on credit.

(b). One of the debtors paid her shs 1,840,000 by cheque

(c). She purchased furniture costing shs 1,700,000 by cheque.

Required: prepare the statement of financial position as at 31st December 2008.