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Business Transactions And Accounting Equation

Effect of Transactions on the elements of the accounting equation

Date : 08/03/2018

Reetika

Author Information

Uploaded by : Reetika
Uploaded on : 08/03/2018
Subject : Accounting

Business Transactions and Accounting Equation

Accounting equation signifies that the Assets of a business are always equal to the Liabilities and Owner s Equity (Capital). This is expressed in the following format:

Asset = Liabilities + Capital

Now, from the above equation, we are clear that the accounting equation has three main elements& i.e.

1. Assets

2. Liabilities

3. Capital(Owner s Equity)

It is a golden rule that Accounting Equation remains balanced all the time . The reason being that any change resulting from the business transaction also balances its equation simultaneously. Business transaction may affect either only one element (Asset, Liabilities or Capital) or two elements (Assets Liabilities, Asset Capital or Liabilities Capital). In some cases, business transactions may affect all the three elements, simultaneously in a single transaction.

In this article, we will see the effect of business transaction on one element. In my next article, I will explain the effect of business transactions on two or all the three elements.

Transactions Affecting Only One Main Element

These transactions are further classified into three types of transactions& i.e.:

I. Transactions affecting assets only,

II. Transactions affecting liabilities only,

III. Transactions affecting capital only.

I. Transactions Affecting Assets Only:

Business transaction may affect one asset on the one hand and another asset on the other hand. Example:

Transaction:

Purchase of goods in cash.

Affect:

This will increase asset (Stock) on the one hand and decrease asset itself (Cash) on the other hand.

II. Transactions Affecting Liabilities Only:

A business transaction may affect one liability on the one hand and another liability on the other hand.

Transaction:

Bills Payable issued to Creditors.

Affect:

This will reduce one liability (Creditors) on the one hand and increase another liability (Bills Payable) on the other hand.

III. Transactions Affecting Capital Only:

These types of transactions affect capital only.

Transaction:

Charging interest on drawings.

Affect:

Being an income of the business, this will increase the proprietor s capital with the amount of interest on drawings and decreases proprietor s capital with same amount.

Transaction:

Interest on capital.

Affect:

Being an expense of the business, this will reduce the capital by the amount of interest and on the other hand interest on capital would be added to the capital of the proprietor.

Hope you understand the effect of the transactions in three elements, individually. We will learn about the transactions affecting two and all the three elements in my next article.

Stay Tuned!!

This resource was uploaded by: Reetika

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