Book-Keeping and Accountancy · Ch 2 — Meaning and Fundamentals of Double Entry Book-Keeping
The Accounting Equation
The Accounting Equation
The Dual Aspect Concept can be expressed, at any point in time, in a single equation that must always hold true for every business, however large or small.
Accounting Equation
Assets = Liabilities + Capital
(equivalently, Capital = Assets − Liabilities)
- Assets are the economic resources owned by the business.
- Liabilities are the amounts the business owes to outsiders.
- Capital is the amount the business owes to its owner — the owner's own claim on the assets of the business, after outside liabilities are met.
The equation holds because of the Dual Aspect Concept: every asset the business holds has been financed from one of only two sources — money the owner has put in (Capital) or money the business has borrowed or owes to others (Liabilities). There is no third source, so the two sides of the equation can never fall out of balance.
Effect of transactions on the Accounting Equation
Every transaction changes at least two items in the equation, but always leaves both sides equal. The table below traces a short sequence of transactions for a trader, Mr. Anil, showing the equation after each one.
| # | Transaction | Cash (₹) | Stock (₹) | Furniture (₹) | = | Creditors (₹) | + | Capital (₹) |
|---|---|---|---|---|---|---|---|---|
| 1 | Started business with cash ₹1,00,000 | 1,00,000 | — | — | = | — | + | 1,00,000 |
| 2 | Purchased goods for cash ₹30,000 | 70,000 | 30,000 | — | = | — | + | 1,00,000 |
| 3 | Purchased furniture on credit ₹10,000 | 70,000 | 30,000 | 10,000 | = | 10,000 | + | 1,00,000 |
| 4 | Paid rent ₹2,000 (an expense — reduces capital) | 68,000 | 30,000 | 10,000 | = | 10,000 | + | 98,000 |
| 5 | Paid ₹5,000 to the furniture creditor | 63,000 | 30,000 | 10,000 | = | 5,000 | + | 98,000 |
Assets = Liabilities + Capital; expresses that every asset a business holds has been financed either by the owner (Capital) or by …