05/07/2020
Topic:
Accounting Equation.
(How to master Accounting Equation)
In Accounting Equation there are three elements involved which are mainly Assets,Liabilities and Owner's Equity.
-It is important to know what increases or decreases each of the three elements. -It is also important to know which side does each of the three elements involved increase and decrease on(Dr/Cr)
•Assets(Dr+)(Cr-)
-Assets increase when the business receives money into the business's accounts.(it does not matter if it's a loan,income or capital contribution)(Dr+)
-Assets also increase when the business purchase assets(land & building,vehicles or equipments e.t.c)(Dr+)
-Assets increase when the business receives items on credit(Stock on credit,loans,vehicles or equipment on credit)(Dr+)
-Assets decrease when the business makes purchases or payments using the business's bank account.(Cr-)
-Assets also decrease when our debtors do not pay their accounts.(Cr-)
•Owner's Equity(Cr+)(Dr-)
-Owner's Equity increases when the business owner makes a capital contribution or when the business makes profit/Income(Cr+)
-Owner's Equity decreases when the business's expenses increase and when the business makes a loss.(Dr-) •Liabilities(Cr+)(Dr-)
-Our liabilities increase when the business makes credit purchases or loans.(Cr+)
-Our liabilities decrease when the business makes payments to creditors.(Dr-)
[See Example Below]
How to master Accounting Equation? •Follow the following steps.
•Step 1:Read and understand the transaction/adjustment. E.g B. Johnson bought stock on credit worth INR 50,000.
•Step 2:Identify the accounts affected "B. Johnson bought "stock" on "credit" worth INR 50,000." What are the accounts affected here? Trading stock Creditors control
•Step 3:Classify the accounts affected(what type of the accounts are they?Assets,Liabilities Or Owner's Equity?) -Trading stock is an ASSET -Creditors control is a LIABILITY
Step 4: Deicide which account must be "debited" or "credited." Remember: Stock was purchased on "credit." Assets will increase with a trading stock worth INR 50,000 (Dr+) Liabilities will increase with creditors control of INR 50,000(Cr+) More Information Our assets have increased because we purchased INR 50,000 worth of stock on credit.
1. So why did our assets increase?
-Because we have more stock added(tradingstock(Dr+)
2. So why didn't our bank decrease?
-Because we bought this stock on credit,that means we did not use money to buy the stock.
3. So why did our Liabilities increase?
-Because we owe more to our creditors or because our debts have increased.(Creditors Control (Cr+))
4. So why doesn't our Owner's Equity increase or decrease?
-Because it does not affect Owner's Equity.
-Owner's Equity will only increase when there is a capital contribution or when the business makes profit/Income.
-Owner's Equity will decrease when the business makes loss and when the business has expenses e.g Rent expense will decrease Owner's Equity but Rent Income will increase Owner's Equity.
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