The accounting equation is also known as the balance sheet (statement of financial position) equation. It depicts that the resources of any business firm must have been provided by the owner(s). And that all the resources (assets) of the business must, at all times, be equal to the claims against such assets. The claims against the assets are the capital or liabilities.
Case1 – All assets are provided by the owner(s)
Where all the assets of the business are provided by the owner(s), then the accounting equation is
Assets = Capital
Assets = the resources of owned by the business from which future economic benefits are expected be derived by the business from such assets.
Capital = the money or money worth provided by the owner(s) of the business.
Case2 – Some of the assets are provided by third parties
Where some of the assets of the business are provided by some person(s) other than the owner(s) of the business, then the equation will appear thus
Assets = Capital + Liabilities
Liabilities = Debts owed by the business.
Total Assets – Liabilities = Capital (making ‘capital’ the subject of the equation
Thus, Net Assets = Capital
By this, we may accept that capital is the net assets of a business.
Accounting Equation and Business Transactions
At all times, the accounting equation must hold true irrespective of the size of the business firm. This is demonstrated by the fact that the statement of financial position must always balance (agree).
The transactions can only result in changing the figures of the affected items in the chart of accounts.
Examples
The following figures were extracted from the books of YourFATutor Enterprises, a trading firm as at 30th November, 20x1.
Required
Redraft the above statement of financial position of YourFATutor Enterprises after each of the following transactions:
Solution
1st Dec, 20x1 Sold goods worth N1, 500 and payment was
received by cheque.
What happens here is that goods (stock) will decrease by N1500 while bank/Cash will increase by same amount of N1500. The statement of financial position after this transaction is now redrafted as shown below. The affected accounts are colored for your quick attention.
5th Dec, 20x1 A debtor paid YourFATutor Enterprises by cheque N2,500
The above transaction will decrease Debtors’ balance by N2,500 and increase Bank/Cash balance by same amount. The new statement of financial position after the above transaction is now shown.
Again, the affected items are colored for quick reference.
10th Dec, 20x1 Bought some goods on credit worth N6,000
You will notice here that a new item “creditors” is now introduced. This wasn’t in the statement before the above transaction. Stock of goods was purchased on credit – though the creditor’s name not mentioned – thus, we had to introduce debts (creditor’s balance) into the statement as shown above.
21st Dec, 20x1 Bought a motor van by cheque NN7,500
From this transaction, an item of fixed asset (motor van) has been purchased. Take note that fixed assets are now referred to as Non-Current Assets. Thus, the items affected are Non-current assets and Bank
The new statement of financial position is now redrafted as shown below.
31st Dec, 20x1 Paid creditors by cheque N3,500
Here, the affected items are creditors and Bank. Thus, the new statement of financial position after this transaction will appear as follows
Effects of Above Transactions of YourFATutor Enterprises on its Statement of Financial Position
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