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Every accounting student needs to really understand the most basic accounting concept or principle which is the system of double entry and the accounting equation Below are some guidelines and simple snapshots for students to take note of what accountant means by double entry system and accounting equation. Besides there are two worked sample examples with answers to further enhance your understanding.
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The accounting equation is:-
Assets = Owner’s Equity + Liabilities
- Assets are items of value owned by the business
- Liabilities are amounts owed by a business to external parties.
- Owner’s equity is the owner’s interest or claim on the business
- Owner’s Equity=Assets-Liabilities (rearranging formula)
Salient Points On Accounting Equation:-
- The accounting equation is based on the business entity concept which assumes that the business, as a unit by itself, acquires its own assets through funds supplied by the owner or by external sources.
- Owner’s equity can be increased through investment by the owner or as a result of profit earned from business operations
- Owner’s equity can be decreased through withdrawals by the owner for personal use or as a result of losses made from business operations.
- The Balance Sheet is a statement listing all assets, owners’s equity and liabilities AT A PARTICULAR DATE
- The balance sheet totals WILL ALWAYS BALANCE because the assets will always be equal to owner’s equity plus liabilities
- The accounting equation and the Balance Sheet are two different ways of expressing the same idea.
- The equality of the accounting equation and the balance sheet totals are always maintained no matter what transactions take place in the business
Theory of Double Entry System:
- Accounting transactions are recorded by using an accounting system.
- Accounting systems are designed to show the increases and decreases in accounts in the financial statements.
- There are five major accounts in financial statements:
- Assets
- Liabilities
- Owner’s Equity namely Capital & Drawing
- Revenues
- Expenses
Also called the Dual Accounting Concept i.e. for every debit, there is an equivalent credit
Assets or any other item of the accounting equation can increase or decrease but assets will always be equal to capital + liabilities
Transactions which are related to a particular person or item which are of similar nature are grouped to form an “account” . Separate accounts are drawn for each asset, liabilities and one capital
A T account explains how an asset or liability is increasing or decreasing.
Dr is the left hand side of the T account
Cr is the right hand side of the T account
Remember the simple Rules of Dr and Cr.or the theory of Double entry:
|
Assets |
= |
Capital |
+ |
Liabilities |
| Increase |
Dr |
= |
Cr |
+ |
Cr |
| Decrease |
Cr |
= |
Dr |
+ |
Dr |
WORKED EXAMPLES OF ACCOUNTING EQUATION
SAMPLE NO.1
| 1.0 |
Assets |
Liabilties |
Capital |
| a |
40,000 |
10,000 |
? |
| b |
15,000 |
? |
11,000 |
| c |
? |
5,000 |
10,000 |
| d |
11,000 |
8,000 |
|
Answer:
1a $30,000 ($40,000-$10,000)
1b $4,000 ($15,000-$11,000)
1c $15,000 ($5,000+$10,000)
1d $3,000 ($11,000-$8,000)
SAMPLE NO.2
The following is the summary data of ABC Ltd for August presented in equation form. Describe each of the transactions that occurred during August.
| 2.0 |
ASSET
Cash |
ASSETS
Supplies |
ASSETS
Equipment |
= LIABILITIES |
+ |
|
| a |
+$10,000 |
|
|
|
+$10,000 |
Capital |
| b |
-$2,000 |
|
+$2,000 |
|
|
|
| c |
-$200 |
+$200 |
|
|
|
|
| d |
|
|
+$700 |
$700 |
|
|
| e |
+$1,000 |
|
|
|
+$1,000 |
Income |
| f |
-$600 |
|
|
|
-$600 |
Salaries |
| g |
-$300 |
|
|
-$300 |
|
|
| h |
-$100 |
|
|
|
-$100 |
Drawing |
|
$7,800 |
$200 |
$2,700 |
= $400 + |
$10,300 |
|
Answer:
2a The owner made an investment by injecting cash as capital
2b Equipment was bought and paid for
2c Supplies were bought and paid for
2d Additional equipment was bought on account creating a liability
2e The company recorded an income for work done for customers
2f The company paid salaries to the workers
2g Cash was paid to reduce amount owing to Accounts Payable(Liability)
2h Owner withdrew cash for her personal use.