Accounting Transactions - Effect on the Fundamental

Accounting Equation
Every accounting transaction effects the Fundamental Accounting
Equation
Every Business transaction which is to be considered for accounting i.e. every
Accounting transaction, has its effect on the fundamental accounting equation.

Each transaction alters the expressions forming the equation in such a way that
the accounting equation is satisfied after every such alteration.

The values forming the various terms of the expressions within the equation are
altered in such a way that the basic fact, rule or equation, Capital + Liabilities =
Assets is always satisfied.

Illustration

Go through the explanation to the following few transactions which have

occurred towards the beginning of a newly started business.

1. A business is proposed to be started by Mr. Oberoi.

Since the business has only been proposed and not yet started it has
neither assets nor liabilities.

Capital + Liabilities = Assets

0 + 0 = 0

The equation is satisfied.

2. He brought in a cash of 1,00,000 as his capital contribution for the

business.

This transaction in accounting books is read and interpreted as

Started business with a capital of 1,00,000 in cash.

 Since capital in the form of cash is being brought into the business,

 The value of capital has increased from zero to 1,00,000 and

 The cash available with the business has also increased from
zero to 1,00,000.

Cash, since it is capable of being liquidated, is an asset.

Capital + Liabilities = Assets

1,00,000 + 0 = 1,00,000 (Cash)

The equation is satisfied.

3. He then purchased some furniture for 25,000.

Accounting interpretation of the transaction

Bought Furniture for cash 25,000.

Since Furniture is being bought by paying cash,

 The value of Furniture has increased from zero to 25,000.

Furniture, since it is capable of being liquidated, is an asset.

 The cash available with the business would reduce by 25,000 to

75,000.

This transaction does not have any effect on either capital or liabilities.

Capital + Liabilities = Assets

1,00,000 + 0 = 75,000 (Cash)

+ 25,000 (Furniture)
 The equation is satisfied.

4. He then purchased some goods for cash for 25,000 from M/s Roxy
Brothers.

Accounting interpretation of the transaction

Bought Goods for cash 25,000.

Vendor/Seller name irrelevant in cash purchase

When we make a cash purchase, the party from whom the purchase is
made is irrelevant unless when there is a substantial time gap between
the transaction of purchase and transaction of paying cash that it
requires us to view them as distinct transactions.

The vendor's name may also be considered if the organisation intends

to record all purchases as credit purchases. In such a case, the cash
paid for the purchase would be treated as payment made to clear the
due. In such a case, there would be two transactions in place of one.
One for purchase and the other for clearing the due.

The name of the vendor M/s Roxy brothers would become irrelevant,
since the purchase is for cash.

Since goods are bought by paying cash,

 The value of Goods/Stock has increased from zero to 25,000 and

Goods/Stock, since it is capable of being liquidated, is an asset.

 The cash available with the business would reduce by 25,000 to

50,000.

This transaction does not have any effect on capital, liabilities and
furniture.

Capital + Liabilities = Assets

 Capital + Liabilities = Assets

1,00,000 + 0 = 50,000 (Cash)

+ 25,000 (Furniture)
+ 25,000 (Stock)

The equation is satisfied.

5. He then purchased some goods valued 10,000 from Mr. Shyam Rao on
credit.

Accounting interpretation of the transaction

Bought Goods from Mr. Shyam Rao on credit for 10,000.

Since 10,000 worth of goods have been bought on credit,

 The value of Goods/Stock has increased from the existing

25,000 to 35,000.
 The liabilities of the business would increase from zero to
10,000.

Since they are bought on credit, the organisation owes this

amount to the seller.

This liability is identified by the name of the vendor who gave the
goods on credit i.e. Mr. Shyam Rao and he is a creditor for the
business.

This transaction does not have any effect on capital, furniture or cash.

Capital + Liabilities = Assets

1,00,000 + 10,000 (Mr. Shyam Rao) = 50,000 (Cash)

+ 25,000 (Furniture)
Capital + Liabilities = Assets

+ 35,000 (Stock)

The equation is satisfied.

6. He then sold some goods for 20,000 on cash basis to Mr. Peter.

Accounting interpretation of the transaction

Sold Goods for cash 20,000.

Buyer name irrelevant in cash sale

When we make a cash sale, the party to whom the sale is made is
irrelevant unless there is a substantial time gap between the
transaction of sale and transaction of receiving cash that it requires us
to view the two as distinct transactions.

The buyer's name may also be considered if the organisation intends

to record all sales as credit sales. In such a case, the cash received for
the sale would be treated as receipt to clear the due. In such a case,
there would be two transactions in place of one. One for sale and the
other for receiving the amount to clear the due.

The name of the buyer Mr. Peter would become irrelevant, since the
sale is for cash.

Since 20,000 worth of goods are sold for cash,

 The value of Goods/Stock has decreased from 35,000 to 15,000.

 The cash available with the business would increase from 50,000
to 70,000.

This transaction does not have any effect on capital, furniture and
liabilities i.e. Mr. Shyam Rao.
 Capital + Liabilities = Assets

1,00,000 + 10,000 (Mr. Shyam Rao) = 70,000 (Cash)

+ 25,000 (Furniture)
+ 15,000 (Stock)

The equation is satisfied.

Please ignore the profit being made on sale of goods for now. Assume
that they are being sold at cost.