Accounting Equation and Transaction Analysis
The core rule
Assets = Liabilities + Capital. Every transaction changes at least two elements and the equation stays balanced. The expanded form is Assets = Liabilities + Capital + Revenues − Expenses − Drawings.
How to analyse a transaction
- Identify the accounts affected.
- Decide whether each is an asset, a liability or a capital item.
- Decide whether it increases or decreases.
- Check that the two sides still agree.
Common effect patterns: increase and decrease within assets (cash used to buy furniture) leaves the total unchanged; a credit purchase increases an asset and a liability; cash brought in or revenue earned increases an asset and capital; cash paid to a creditor decreases an asset and a liability; drawings and expenses decrease an asset and capital.
Worked example
(a) Rajan started business with ₹5,00,000 cash: assets +5,00,000, capital +5,00,000. (b) Bought furniture for cash ₹60,000: furniture +60,000, cash −60,000, total unchanged. (c) Bought goods on credit ₹80,000: stock +80,000, creditors +80,000. (d) Sold goods costing ₹30,000 for ₹45,000 cash: cash +45,000, stock −30,000, capital +15,000 as profit. (e) Withdrew ₹10,000 cash: cash −10,000, capital −10,000. Final position: assets = 5,00,000 − 60,000 + 60,000 + 80,000 − 30,000 + 45,000 − 10,000 = ₹5,85,000; liabilities ₹80,000 plus capital ₹5,05,000 = ₹5,85,000. The balance confirms every entry was analysed on both sides.
Traps
Recording only one effect; treating profit as something separate from capital; forgetting that goods withdrawn for personal use reduce both stock and capital; assuming a credit sale does not affect capital (it does, through profit); confusing the equation with a trial balance total.