Accounting Equation

Understand the basic accounting equation and learn how business transactions affect Assets, Liabilities and Capital

📘 What is an Accounting Equation?

The Accounting Equation expresses the relationship between the assets of a business and the claims against those assets.

It is based on the fundamental principle that the total assets of a business are always equal to the total of its capital and liabilities.

Assets = Capital + Liabilities

📚 Components of Accounting Equation

The Accounting Equation consists of three basic components:

• Assets: Resources owned or controlled by the business which have economic value.
• Capital: The amount invested by the owner in the business.
• Liabilities: Amounts owed by the business to outsiders.

🏠 Assets

Assets are economic resources owned or controlled by a business. They provide future economic benefits to the business.

Examples:

• Cash
• Bank Balance
• Furniture
• Machinery
• Building
• Stock / Inventory
• Debtors

👤 Capital

Capital represents the amount invested by the owner in the business.

For example, if the owner starts a business by investing ₹1,00,000 in cash, the capital of the business is ₹1,00,000.

💰 Liabilities

Liabilities are the amounts payable by the business to outsiders.

Examples:

• Creditors
• Bank Loan
• Outstanding Expenses
• Bills Payable

💡 Example 1 – Starting a Business

Ram starts a business with cash of ₹1,00,000.

Assets	Capital	Liabilities
₹1,00,000	₹1,00,000	Nil

₹1,00,000 = ₹1,00,000 + ₹0

Therefore, the Accounting Equation remains balanced.

💡 Example 2 – Purchase of Goods for Cash

Ram purchases goods worth ₹20,000 for cash.

Cash decreases by ₹20,000, while stock increases by ₹20,000. Therefore, the total assets remain unchanged.

Particulars	Effect
Cash	Decrease ₹20,000
Stock	Increase ₹20,000
Total Assets	No Change

💡 Example 3 – Purchase of Furniture on Credit

Furniture worth ₹30,000 is purchased on credit.

Furniture (Asset) increases by ₹30,000 and Creditors (Liability) also increase by ₹30,000.

Increase in Assets = Increase in Liabilities

📊 Effect of Transactions on Accounting Equation

Transaction	Assets	Capital	Liabilities
Owner introduces cash	Increase	Increase	No Change
Loan taken from bank	Increase	No Change	Increase
Purchase asset for cash	No overall change	No Change	No Change
Purchase asset on credit	Increase	No Change	Increase
Payment to creditor	Decrease	No Change	Decrease

📝 Key Rule to Remember

Assets = Capital + Liabilities

Every business transaction has a dual effect on the accounting equation. Therefore, the equation always remains balanced after recording a transaction.

⭐ Quick Revision

• Assets = What the business owns or controls
• Capital = Owner's claim
• Liabilities = Outsiders' claims
• Accounting Equation: Assets = Capital + Liabilities
• Every transaction has a dual effect.
• The Accounting Equation always remains balanced.

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