Accounting Equation

Dual Aspect Concept' is the basis of accounting equation. Under this concept, the sum of the assets is always equal to the total equities.

This reflects the fundamental accounting equation of:

Equities = Assets

Assets are the economic resources owned by an enterprise as well as claims against outsiders. Assets are things of value from which future economic benefits are expected to flow to the enterprise.

Equities refer to all claims or rights against the assets of an enterprise. These indicate the sources of the assets. The claims against the assets may be external or internal. External claims are outsiders' equity and internal claims are owners' equity. Outsiders' equity is the liability of the business and owners' equity is the capital of the business. This can be expressed as follows:

Internal Claims+ External Claims = Assets

Owners' Equity + Outsiders' Equity = Assets

Capital + Liabilities = Assets

In case of winding up of a business, the owner does not have any claim on the assets of the business until all claims of outsiders are satisfied. Due to this reason, the claims of the owner are

residual and expressed as:

Assets - Liabilities = Capital

It is important to note that capital increases with incomes, gains and additional resources introduced in the business. On the other hand, the capital decreases with expenses, losses and

withdrawal of resources from the business.

Classification of Transactions

Accounting equation signifies that the assets of a business are always equal to the total of capital and liabilities. A business transaction may affect only one main element, two main elements or all the three main elements, Broadly, Transactions are classified under three main

categories:

(A) Transactions affecting only one main element

These transactions are further divided into three categories:

1. Transactions affecting assets only

In this case, a transaction will increase one asset and decrease another asset the examples are:

(i) Purchase of fixed assets for cash

(ii) Purchase of goods for cash

(iii) Sales of fixed asset at par

(iv) Sale of goods at par for cash

(v) Sale of goods at par on credit

(vi) Sale of an asset on credit

(vii) Cash deposited into bank

(viii) Cash withdrawn from bank

(ix) Cash paid for expenses of next year

(x) Cash/cheque received from debtor

(xi) Exchange of one asset with another

(xii) Cash lent to somebody

(xiii) Cash advanced to supplier for goods

(xiv) Goods returned by a debtor

(xv) Accrued income received

(xvi) Lent money got back

(xvii) Cheque received from debtor dishonoured

(xviii) Bill received from debtor dishonoured

(xix) Cash received against bills receivable

(xx) Received delivery of goods against advance sent to supplier.

2. Transactions affecting liabilities only

(i) Bills payable issued to creditors

(ii) Bills payable dishonoured

3. Transactions affecting capital only

(i) Interest on capital provided

(ii) Charged interest on drawings

(B) Transactions affecting any two main elements

These transactions are further divided into three categories:

1. Transactions affecting assets and liabilities. In this case, a transaction will either increase an asset with increase in liability or decrease an asset with decrease in liability. The examples are:

(i) Purchase of goods on credit

(ii) Purchase of fixed asset on credit

(iii) Income received in advance

(iv) Cash borrowed

(v) Taxes collected

(vi) Advance received from customers for supply of goods

(vii) Cheque issued to supplier dishonoured

(viii) Cash paid to creditors

(ix) Goods returned to suppliers

(x) Outstanding expenses, paid

(xi) Borrowed money repaid

(xii) Collected taxes paid to the Government

(xiii) Sent goods to customers against advance received

2. Transactions affecting assets and capital

In this case, a business transaction will either increase an asset and capital or decrease an asset and capital. The examples are:

(i) Cash introduced by proprietor into business

(ii) Cash withdrawn for personal use

(iii) Depreciation on fixed assets

(iv) Loss of goods by fire

(v) Cash stolen

(vi) Income due but not received

(vii) Any expense paid

(viii) Any income received

(ix) Goods withdrawn for personal use/charity/free samples

(x) Bank Charges

(xi) Sale of goods at a profit

(xii) Sale of fixed asset at a profit

(xiii) Sale of goods at a loss

(xiv) Sale of fixed asset at a loss.

3. Transactions affecting liabilities and capital

A business transaction may either increase the liabilities and decreases the capital or decrease the liabilities and increase the liabilities and increase the capital. The examples are:

(i) Expenses outstanding

(ii) Proprietor paying business liability from personal bank account.

(C) Transactions affecting all the three main elements

These transactions are further divided into two categories:

1. Increase in assets, liabilities and capital. In this case, a transaction will increase assets, liabilities and capital of the business. For example, Purchase of running business with assets and liabilities for a certain price.

2. Decrease in asset and liabilities and increase in capital. In this case, assets and liabilities will decrease and capital will increase. For example, payment of bills payable under rebate.

Rules of Debit and Credit

Left hand side of an account is called debit side, right hand side of an account is called credit side. Every transaction has two aspects under Double Entry System of book-keeping. One aspect is debit and the other opposite aspect is credit. Debit and credit are nothing more than the additions to or subtractions from an account.

The following accounts will exhibit the tradition followed in accounting:

Dr. (increase) +ve Asset Account (Decrease) -ve Cr.