*Analysis of Transactions* Use accounting equation to show the effect of the following transactions of M/s Royal Traders: | | Transaction | ₹ | |---|---|---| | (a) | Started business with cash | 1,20,000 | | (b) | Purchased goods for cash | 10,000 | | (c) | Rent received | 5,000 | | (d) | Salary outstanding | 2,000 | | (e) | Prepaid Insurance | 1,000 | | (f) | Received interest | 700 | | (g) | Sold goods for cash (Costing ₹5,000) | 7,000 | | (h) | Goods destroyed by fire | 500 |

> [!TLDR] > M/s Royal Traders' transactions leave **Assets ₹1,27,200 = Outstanding salary ₹2,000 + Capital ₹1,25,200**. (The balancing cash figure is **₹1,21,700**; see the note in WN 6.) **Treatment.** (c) rent received and (f) interest received are incomes → Cash ↑ and Capital ↑. (d) salary outstanding is an expense not yet paid → a liability ↑ and Capital ↓. (e) prepaid insurance converts Cash into an asset (Prepaid Insurance). (g) cash sale above cost → profit to Capital. (h) goods destroyed by fire is a loss → Goods ↓ and Capital ↓. **Accounting Equation** | # | Transaction | Cash (₹) | Goods (₹) | Prepaid Ins. (₹) | Total Assets (₹) | = | O/s Salary (₹) | + | Capital (₹) | |---|---|---|---|---|---|---|---|---|---| | (a) | Started with cash | 1,20,000 | — | — | 1,20,000 | = | — | + | 1,20,000 | | (b) | Goods for cash ₹10,000 | 1,10,000 | 10,000 | — | 1,20,000 | = | — | + | 1,20,000 | | (c) | Rent received ₹5,000 | 1,15,000 | 10,000 | — | 1,25,000 | = | — | + | 1,25,000 | | (d) | Salary outstanding ₹2,000 | 1,15,000 | 10,000 | — | 1,25,000 | = | 2,000 | + | 1,23,000 | | (e) | Prepaid insurance ₹1,000 | 1,14,000 | 10,000 | 1,000 | 1,25,000 | = | 2,000 | + | 1,23,000 | | (f) | Interest received ₹700 | 1,14,700 | 10,000 | 1,000 | 1,25,700 | = | 2,000 | + | 1,23,700 | | (g) | Sold goods (cost 5,000) ₹7,000 | 1,21,700 | 5,000 | 1,000 | 1,27,700 | = | 2,000 | + | 1,25,700 | | (h) | Goods lost by fire ₹500 | 1,21,700 | 4,500 | 1,000 | 1,27,200 | = | 2,000 | + | 1,25,200 | | | **Total** | **1,21,700** | **4,500** | **1,000** | **1,27,200** | = | **2,000** | + | **1,25,200** | **Working Notes** 1. (c) Rent received ₹5,000 (income) → Capital ₹1,20,000 → ₹1,25,000. 2. (d) Salary outstanding ₹2,000 → liability ₹2,000, Capital ₹1,25,000 → ₹1,23,000. 3. (e) Prepaid insurance ₹1,000 — Cash ↓ ₹1,000, new asset ₹1,000; Capital unaffected (a prepaid expense, not yet an expense). 4. (f) Interest received ₹700 (income) → Capital ₹1,23,000 → ₹1,23,700. …

*Analysis of Transactions* Use accounting equation to show the effect of the following transactions of M/s Roy

Numerical Questions · Q5

Analysis of Transactions

Use accounting equation to show the effect of the following transactions of M/s Royal Traders:

	Transaction	₹
(a)	Started business with cash	1,20,000
(b)	Purchased goods for cash	10,000
(c)	Rent received	5,000
(d)	Salary outstanding	2,000
(e)	Prepaid Insurance	1,000
(f)	Received interest	700
(g)	Sold goods for cash (Costing ₹5,000)	7,000
(h)	Goods destroyed by fire	500

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Concept understanding — Accounting Equation

The Accounting Equation: The Foundation of Double-Entry Bookkeeping

Imagine you start a small business. You put in ₹1,00,000 of your own money. The business now has ₹1,00,000 in cash. But where did that cash come from? It came from you, the owner. So the business owes you ₹1,00,000. That's the core idea: everything the business owns (assets) is matched by a claim against it (liabilities or owner's equity).

The Precise Meaning

The accounting equation states:

Assets = Liabilities + Owner's Equity

This is not a suggestion — it is an identity. It must always hold true, after every single transaction, without exception. Let's break it down:

Assets are resources the business controls (cash, inventory, machinery, buildings, debtors).
Liabilities are claims of outsiders (creditors, bank loans, outstanding expenses).
Owner's Equity (also called Capital) is the owner's claim on the business. It equals the amount the owner originally invested plus any profits retained, minus any withdrawals.

Important

The equation is always in balance. Every transaction affects at least two accounts, and the equation remains true. This is the entire point of double-entry bookkeeping.

Why It Matters

The accounting equation is not just a theory — it is the practical tool that tells you whether a transaction has been recorded correctly. If you ever prepare a trial balance and it doesn't tally, the equation is the first place you look. It also helps you understand the financial position of a business at a glance.

For example, if a business has total assets of ₹5,00,000 and liabilities of ₹2,00,000, then the owner's equity must be ₹3,00,000. That tells you the net worth of the business from the owner's perspective.

Accounting Treatment: Debit and Credit

Every transaction affects the equation. The rules are simple:

Increase in an asset → Debit that asset account
Decrease in an asset → Credit that asset account
Increase in a liability → Credit that liability account
Decrease in a liability → Debit that liability account
Increase in owner's equity → Credit the capital account
Decrease in owner's equity → Debit the capital account

Let's see this with a few common transactions.

Transaction 1: Owner invests cash into the business

The business receives cash (asset increases) and owes the owner more (capital increases).

Account	Debit (₹)	Credit (₹)
Cash A/c	1,00,000
To Capital A/c		1,00,000

Effect on equation: Assets (+₹1,00,000) = Liabilities (no change) + Owner's Equity (+₹1,00,000). Balanced.

Transaction 2: Purchase machinery on credit

The business gets machinery (asset increases) and creates a liability to the supplier.

Account	Debit (₹)	Credit (₹)
Machinery A/c	50,000
To Creditors A/c		50,000

Effect on equation: Assets (+₹50,000) = Liabilities (+₹50,000) + Owner's Equity (no change). Balanced.

Transaction 3: Pay rent in cash

The business pays rent (expense), which reduces owner's equity (profit decreases). Cash also decreases.

Account	Debit (₹)	Credit (₹)
Rent A/c	10,000
To Cash A/c		10,000

Effect on equation: Assets (-₹10,000) = Liabilities (no change) + Owner's Equity (-₹10,000). Balanced.

Note

Expenses and drawings reduce owner's equity. Revenues and gains increase owner's equity. That is why expenses are debited (they reduce equity, which is normally credited) and revenues are credited.

The Expanded Accounting Equation

For a more complete picture, especially when dealing with revenues, expenses, and drawings, the equation expands to:

Assets = Liabilities + (Owner's Capital – Drawings + Revenues – Expenses)

This is the same equation, just unpacked. It shows that profit (Revenue – Expense) increases owner's equity, and drawings decrease it.

A Practical Example: The Full Cycle …

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Transaction	Cash	+ Goods	+ Prepaid Ins.	= O/s Salary	+ Capital
(a) Cash 1,20,000	1,20,000	—	—	—	1,20,000
(b) Goods for cash 10,000	1,10,000	10,000	—	—	1,20,000
(c) Rent received 5,000	1,15,000	10,000	—	—	1,25,000
(d) Salary outstanding 2,000	1,15,000	10,000	—	2,000	1,23,000
(e) Prepaid insurance 1,000	1,14,000	10,000	1,000	2,000	1,23,000
(f) Interest received 700	1,14,700	10,000	1,000	2,000	1,23,700
(g) Sold goods (cost 5,000) for 7,000	1,21,700	5,000	1,000	2,000	1,25,700
(h) Goods lost by fire 500	1,21,700	4,500	1,000	2,000	1,25,200
Total	1,21,700	4,500	1,000	2,000	1,25,200

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M/s Royal Traders' transactions leave Assets ₹1,27,200 = Outstanding salary ₹2,000 + Capital ₹1,25,200. (The balancing cash figure is ₹1,21,700; see the note in WN 6.)

Treatment. (c) rent received and (f) interest received are incomes → Cash ↑ and Capital ↑. (d) salary outstanding is an expense not yet paid → a liability ↑ and Capital ↓. (e) prepaid insurance converts Cash into an asset (Prepaid Insurance). (g) cash sale above cost → profit to Capital. (h) goods destroyed by fire is a loss → Goods ↓ and Capital ↓.

Accounting Equation

#	Transaction	Cash (₹)	Goods (₹)	Prepaid Ins. (₹)	Total Assets (₹)	=	O/s Salary (₹)	+	Capital (₹)
(a)	Started with cash	1,20,000	—	—	1,20,000	=	—	+	1,20,000
(b)	Goods for cash ₹10,000	1,10,000	10,000	—	1,20,000	=	—	+	1,20,000
(c)	Rent received ₹5,000	1,15,000	10,000	—	1,25,000	=	—	+	1,25,000
(d)	Salary outstanding ₹2,000	1,15,000	10,000	—	1,25,000	=	2,000	+	1,23,000
(e)	Prepaid insurance ₹1,000	1,14,000	10,000	1,000	1,25,000	=	2,000	+	1,23,000
(f)	Interest received ₹700	1,14,700	10,000	1,000	1,25,700	=	2,000	+	1,23,700
(g)	Sold goods (cost 5,000) ₹7,000	1,21,700	5,000	1,000	1,27,700	=	2,000	+	1,25,700
(h)	Goods lost by fire ₹500	1,21,700	4,500	1,000	1,27,200	=	2,000	+	1,25,200
	Total	1,21,700	4,500	1,000	1,27,200	=	2,000	+	1,25,200

Working Notes

(c) Rent received ₹5,000 (income) → Capital ₹1,20,000 → ₹1,25,000.
(d) Salary outstanding ₹2,000 → liability ₹2,000, Capital ₹1,25,000 → ₹1,23,000.
(e) Prepaid insurance ₹1,000 — Cash ↓ ₹1,000, new asset ₹1,000; Capital unaffected (a prepaid expense, not yet an expense).
(f) Interest received ₹700 (income) → Capital ₹1,23,000 → ₹1,23,700. …

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