The Accounting Equation

Assets = Liabilities + Owners Equity

Assets Liabilities = Owners Equity

The Accounting Equation

The equation must be in balance. If there is an increase to the left side the right side must increase as well. Or an increase to the left side could cause a decrease in another account on the left side.

Assets = Liabilities + Owners Equity

Shift in assets: A shift occurs when the composition of the assets has changed, but the total of the assets remains the same.

Example: Cash is used to purchase inventory. Both are assets the composition has changed but the total of assets is still the same.

Assets = Liabilities + Owners Equity + Revenue

Revenue: An amount earned by performing services for customers or selling goods to customers; it can be in the form of cash and/or accounts receivable. A subdivision of owners equity: as revenue increases, owners equity increases.

Assets = Liabilities + Owners Equity - Expense

Expense: A cost incurred in running a business by consuming goods or services in producing revenue; a subdivision of owners equity. When expenses increase, there is a decrease in owners equity.

Assets = Liabilities + Owners Equity + Capital Withdrawals

Capital: The owners investment of equity in the company. Withdrawals: A subdivision of owners equity that records money or other assets an owner withdraws from a business for personal use.

Assets + Accounts Receivables = Liabilities + Accounts Payable + Owners Equity

Accounts Payable: Amounts owed to creditors that result from the purchase of goods or services on account: a liability. Accounts Receivable: An asset that indicates amounts owed by customers.

Assets = Liabilities + Owners Equity & beyond

Review

When you increase your assets You increase your Owners Equity You have affected two accounts: Assets & Owners Equity The equation is in balance This is double-entry bookkeeping

ILLUSTRATIONS ON THE CONSTRUCTION OF ACCOUNTING EQUATIONS

Illustration One: Ritah started her business with cash of 25,000,000/= Accounting Equation Assets = Liabilities + Owners Equity Cash 25,000,000 = + Capital 25,000,000
Note: The business got an asset called cash from its owner and the owners investment in that business is called capital

Illustration Two

From the cash resources she purchases a lorry for 15,000,000/= Accounting Equation Assets = Liabilities + Owners Equity Lorry 15,000,000 Cash 10,000,000 =+ Capital 25,000,000 25,000,000 25,000,000 Note: The business obtained another asset called Lorry and the asset called cash reduces by 15,000,000/- since it was used to pay for the lorry. Capital remains unchanged.

Illustration Three

She bought stock of goods for 10,000,000/- on credit

Accounting Equation Assets = Liabilities Lorry 15,000,000
Stock 10,000,000

+ Owners equity

= Trade Creditors 10,000,000 + Capital 25,000,000

Cash 10,000,000 = 35,000,000

35,000,000

Note: The business obtained additional asset called stock but also incurred a liability to trade creditors since the stock was bought on credit. Owners equity remains unchanged

Illustration Four

She sold half of the goods for 6,000,000/= on credit Accounting equation

Assets = Liabilities + Owners Equity Lorry 15,000,000 = Capital 25,000,000 Stock 5,000,000 Debtors 6,000,000 = Trade creditors 10,000,000 Add profit 1,000,000 Cash 10,000,000 36,000,000 = 10,000,000 26,000,000

36,0000,0000

36,000,000

Note: The stock sold for 6,000,000/= was bought at a cost of 5,000,000, a
profit of 1,000,000/= was made . Profit added to capital increases owners equity. Since stock was sold on credit, the business got additional asset called debtors or accounts receivable. Debtors are expected to pay the business at a later date.

Illustration Five

She paid five million shillings cash to the suppliers of the goods (Creditors) Accounting Equation Assets = Liabilities + Owners Equity Lorry 15,000,000 Stock 5,000,000 = Capital 25,000,000 Debtors 6,000,000 Cash 5,000,000 = Trade Creditors 5,000,000 Add Profit 1,000,000 31,000,000 = 5,000,000 26,000,000

31,000,000

31,000,000

Note: Both creditors and cash reduced by 5,000,000 because creditors were paid cash

Illustration Six
She sold the remaining balance of stock at 5,500,000 cash Accounting Equation Assets = Liabilities + Owners Equity Lorry 15,000,000 Debtors 6,000,000 Capital 25,000,000 Cash 10,500,000 = Trade Creditors 5,000,000 Add profit 1,500,000 31,500,000 5,000,000 26,500,000 31,500,000 31,500,000 Note: The stock sold had cost 5,000,000/= since it was sold for 5,500,000/=, additional profit of 500,000/= was made. Stock now disappears completely since all of it was sold and cash increases by 5,500,000/=

Illustration Seven

She received 4,000,000/= cash from debtors, paid advertising bill of 1,000,000 cash and paid Accountant Regan, his salary 300,000/= cash Accounting Equation Assets = Liabilities + Owners Equity Lorry 15,000,000 Capital 25,000,000 Debtors 2,000,000= Trade creditors 5,000,000 Add profit 200,000 Cash 13,200,000 5,000,000 25,200,000 30,200,000 = 30,200,000

Note: Payment of advertising bill and accountants salary are called expenses and reduced profits from 1,500,000 to only 200,000/=. The net increase in cash is 2,700,000/= after the above transactions.

To be continued!!!