Accounting Fundamentals and the Accounting Equation
This domain tests the accounting equation and double entry, the foundation of all later accounting. Expect questions on accounting concepts, the effect of transactions on assets, capital and liabilities, and debit and credit rules.
Accounting and its users
Accounting identifies, records, classifies, summarises and communicates financial information. Users include owners, managers, lenders, suppliers, government and employees. Concepts include business entity (owner separate from business), going concern, accrual, consistency, prudence, money measurement and historical cost.
The equation
Assets = Capital + Liabilities. Assets are resources controlled; liabilities are amounts owed; capital is the owner’s claim. Expanded: Capital = opening capital + additional investment + profit − drawings − loss.
Double entry means every transaction affects at least two accounts, with equal debits and credits. Debit entries increase assets and expenses; credit entries increase liabilities, capital and income.
Worked example
The owner starts with cash Rs. 500,000 and a bank loan Rs. 200,000; equipment is bought for Rs. 150,000 cash. Assets: cash = 500,000 + 200,000 − 150,000 = Rs. 550,000; equipment = Rs. 150,000; total = Rs. 700,000. Liabilities = Rs. 200,000; capital = Rs. 500,000. Equation: 700,000 = 500,000 + 200,000. The equipment purchase is an asset swap: equipment increases, cash decreases, so total assets are unchanged.
Traps
Treating drawings as a business expense; recording a loan as capital; ignoring the business entity concept; mixing personal and business cash.