Meenakshi's First Month: Reading the Balance Sheet Through the Equation
Meenakshi begins a textile trading business in Coimbatore on 1 April 2024, bringing in ₹5,00,000 cash and goods worth ₹1,50,000 from her own stock. During April the following transactions take place: (a) she obtains a bank loan of ₹2,00,000 credited to the firm's current account; (b) furniture is bought for ₹80,000, of which ₹30,000 is paid in cash and the balance is due to the supplier in 30 days; (c) goods costing ₹40,000 are sold on credit to a customer for ₹52,000; (d) that customer pays ₹20,000 in cash on 28 April; (e) shop rent of ₹15,000 is paid; (f) Meenakshi withdraws ₹10,000 in cash for household expenses. No other transactions take place in April, and she keeps no separate personal cash record. At the end of the month she is confused about whether her capital has really grown, because the only cash she has actually received from the credit customer is ₹20,000.
1. Prepare an accounting equation working showing the effect of each transaction and the final balances of assets, liabilities and capital. Verify that the equation holds after the last transaction.
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Step 1 – Opening entry. Cash ₹5,00,000 + Stock ₹1,50,000 are both brought in by the owner, so Capital = ₹6,50,000. Nothing is owed, so Liabilities = 0.
| Transaction | Effect on items | Assets ₹ | Liabilities ₹ | Capital ₹ |
|---|---|---|---|---|
| Opening | Cash + 5,00,000; Stock + 1,50,000; Capital + 6,50,000 | 6,50,000 | – | 6,50,000 |
| (a) Bank loan | Bank + 2,00,000; Loan + 2,00,000 | 8,50,000 | 2,00,000 | 6,50,000 |
| (b) Furniture | Furniture + 80,000; Cash – 30,000; Creditor + 50,000 | 9,00,000 | 2,50,000 | 6,50,000 |
| (c) Credit sale | Stock – 40,000; Debtors + 52,000; Capital + 12,000 (profit) | 9,12,000 | 2,50,000 | 6,62,000 |
| (d) Collection | Cash + 20,000; Debtors – 20,000 (only an exchange of assets) | 9,12,000 | 2,50,000 | 6,62,000 |
| (e) Rent | Cash – 15,000; Capital – 15,000 (expense) | 8,97,000 | 2,50,000 | 6,47,000 |
| (f) Drawings | Cash – 10,000; Capital – 10,000 (personal use) | 8,87,000 | 2,50,000 | 6,37,000 |
Step 2 – Final composition of assets: Cash 4,65,000 + Bank 2,00,000 + Furniture 80,000 + Stock (1,50,000 – 40,000) 1,10,000 + Debtors (52,000 – 20,000) 32,000 = ₹8,87,000.
Step 3 – Check: Liabilities ₹2,50,000 (loan 2,00,000 + creditor 50,000) + Capital ₹6,37,000 = ₹8,87,000. The equation balances because every transaction has a two-sided effect; the only two transactions that changed capital were the profit-earning sale and the expense/drawings, not the mere movement of cash.
2. Meenakshi argues: 'The credit sale brought in no cash, so my capital should not change until I collect the money.' Evaluate this claim using the relevant accounting concepts.
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Her claim is wrong, and two concepts explain why.
- Realisation / revenue recognition concept. Revenue is treated as earned when the goods are transferred to the buyer and the buyer becomes legally liable to pay, not when cash arrives. On the credit sale the goods (cost ₹40,000) have left the business and a debtor of ₹52,000 has arisen, so ₹52,000 of revenue has been realised and ₹12,000 of profit has accrued to the owner.
- Accrual concept. Income and expenditure are recorded in the period to which they relate. April's profit must include the ₹12,000 earned in April even though the money is still with the customer.
The accounting equation proves the point: stock falls by ₹40,000 while debtors rise by ₹52,000, and the ₹12,000 difference cannot sit anywhere except in capital. So capital rises from ₹6,50,000 to ₹6,62,000 on the day of sale, even with zero cash received.
Collection of ₹20,000 in (d) changes nothing in capital: cash rises and debtors fall by the same amount. Students often confuse earning with collecting; only the first affects capital. The residual ₹32,000 receivable remains a valid asset, and only if it later proves irrecoverable would prudence require a write-off or a provision.
3. How should the ₹10,000 withdrawal be recorded, and why is it not an expense? Suppose the ₹2,00,000 had instead been lent by Meenakshi's brother to her personally, to be repaid from her household funds; would it appear in the firm's books?
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The withdrawal is drawings, not an expense. Entry: Drawings A/c Dr ₹10,000; To Cash A/c ₹10,000; and at the close of the year Drawings A/c is transferred to Capital A/c (Capital A/c Dr ₹10,000; To Drawings A/c ₹10,000). Reason: under the business entity concept the owner and the business are separate. Household spending produces no revenue for the firm; it simply reduces the owner's claim on the business. Charging it to profit and loss would understate profit by ₹10,000 and overstate the capital that remains in the firm. After the transfer, capital falls from ₹6,47,000 to ₹6,37,000, which ties back to the equation above.
The brother's loan to Meenakshi personally: this is a transaction between two individuals, not between the business and an outsider, so it is not recorded in the firm's books at all - the business entity concept again. If, however, the brother had lent the money to the firm (say, credited to the firm's bank account with repayment terms), it would be recorded as Loan from Brother A/c under liabilities, because the firm then has an obligation to an external party; it would never be credited to Capital, since a lender is not an owner.