The Accounting Equation (Copy)
1. The Fundamentals of Accounting
1.2 The Accounting Equation
Key Definitions
Assets
- Resources owned or controlled by a business.
- Provide future economic benefits.
- Examples: cash, inventory, trade receivables, machinery, land.
Liabilities
- Debts or obligations owed to outsiders.
- Settled through transfer of assets (usually cash).
- Examples: trade payables, loans, bank overdraft, accrued expenses.
Owner’s Equity
- The owner’s claim on the business.
- Represents the residual value after deducting liabilities from assets.
Accounting Equation
The fundamental relationship is:
Assets = Liabilities + Owner’s Equity
Rearranged forms:
Owner’s Equity = Assets – Liabilities
Liabilities = Assets – Owner’s Equity
Written and Compiled By Sir Hunain Zia, World Record Holder With 154 Total A Grades, 7 Distinctions and 11 World Records For Educate A Change O Level And IGCSE Accounting Full Scale Course
Transaction Examples
Example 1: Owner introduces capital of $15,000
- Cash increases (asset) → +15,000
- Capital increases (owner’s equity) → +15,000
Assets = Liabilities + Owner’s Equity
15,000 = 0 + 15,000 ✔
Example 2: Business purchases inventory worth $3,000 on credit
- Inventory increases (asset) → +3,000
- Trade payables increase (liability) → +3,000
Assets = Liabilities + Owner’s Equity
18,000 = 3,000 + 15,000 ✔
Example 3: Business sells goods (costing $2,000) for $3,500 cash
- Cash increases → +3,500
- Inventory decreases → –2,000
- Profit (owner’s equity) increases → +1,500
Assets = Liabilities + Owner’s Equity
19,500 = 3,000 + 16,500 ✔
Example 4: Owner withdraws $1,000 as drawings
- Cash (asset) decreases → –1,000
- Drawings reduce owner’s equity → –1,000
Assets = Liabilities + Owner’s Equity
18,500 = 3,000 + 15,500 ✔
Written and Compiled By Sir Hunain Zia, World Record Holder With 154 Total A Grades, 7 Distinctions and 11 World Records For Educate A Change O Level And IGCSE Accounting Full Scale Course
Capital Adjustment Formula
Closing Capital = Opening Capital + Profit – Drawings
If:
Opening Capital = 10,000
Profit = 3,000
Drawings = 1,000
Then:
Closing Capital = 10,000 + 3,000 – 1,000 = 12,000
Summary Table
| Transaction | Assets ($) | Liabilities ($) | Owner’s Equity ($) |
|---|---|---|---|
| Capital introduced | +15,000 | 0 | +15,000 |
| Inventory purchased on credit | +3,000 | +3,000 | 0 |
| Sale of goods (profit $1,500) | +1,500 | 0 | +1,500 |
| Drawings | –1,000 | 0 | –1,000 |
| Final totals | 18,500 | 3,000 | 15,500 |
Assets = Liabilities + Owner’s Equity
18,500 = 3,000 + 15,500 ✔
Written and Compiled By Sir Hunain Zia, World Record Holder With 154 Total A Grades, 7 Distinctions and 11 World Records For Educate A Change O Level And IGCSE Accounting Full Scale Course