C hapter 2: The accounting equation

Contents of chapter
This chapter explains what the accounting equation is, and shows it in the accounting equation.

Notes for teachers

The basic idea underlying all financial accounting is seen to be quite simple, but very logical. This is the
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use of the accounting equation. If students can understand the simple arithmetical effects of changes in
either assets, liabilities or capital, it should make double entry easier for them to learn.

Students should be first taught how to distinguish which items are ASSETS and which are LIABILITIES. It
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is crucial that they understand the accounting equation: Assets = Capital + Liabilities.

Students should be reminded that each transaction affects two items and that the two sides of the
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equation would always be equal.

There are six ways to change the accounting equation. These are:
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Assets = Capital + Liabilities
(i) + +
(ii) + +
(iii) +
–
(iv) – –
(v) – –
(vi) + –

5 It is better to start slowly. Make certain that students understand properly before going on to the next
chapter. If a student does not understand these early chapters fully, he/she will get into difficulties later
on.

6 If a student can do the exercises properly, this will give him/her confidence. That is an essential feature in
his/her becoming interested in accounting. So take great care in teaching at this stage.

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Answers to MCQs and exercises
2.1 C 2.2 B 2.3 C 2.4 A 2.5 C

2.6
(a) $10,700 (b) $23,100 (c) $4,300 (d) $3,150 (e) $25,500 (f) $51,400

2.7X
(a) $38,100 (b) $51,600 (c) $7,600 (d) $104,100 (e) $26,000 (f) $159,000

2.8
(a) Asset (b) Liability (c) Asset (d) Asset (e) Liability (f) Asset

2.9X
(a) Asset (b) Asset (c) Liability (d) Asset (e) Asset
(f) Liability (g) Asset (h) Liability (i) Asset

2.10
Assets side: Loan from S Sun, Creditors; Liabilities side: Stock, Debtors.

2.11
Assets: Motor vehicles $2,000; Premises $5,000; Stock $1,000; Bank $700; Cash $100 = $8,800.
Liabilities: Loan from L Po $3,000; Creditors $400 = $3,400.
Therefore, capital = $8,800 – $3,400 = $5,400.

2.12X
Assets = Fixtures $2,000 + Motor vehicles $5,000 + Stock $3,500 + Bank $2,800 + Cash $100
= $13,400
Liabilities = Loan from S Fung $3,000 + Creditors $1,400 = $4,400
Capital = $13,400 – $4,400 = $9,000

2.13
Assets Liabilities Capital
(a) Cash ↓ $70 Creditors ↓ $70
(b) Bank ↓ $200
Fixtures ↑ $200
(c) Stock ↑ $275 Creditors ↑ $275
(d) Cash ↑ $500 Capital ↑ $500
(e) Cash ↑ $200 Loan from K Yiu ↑ $200
(f) Bank ↑ $50
Debtors ↓ $50
(g) Fixtures ↑ $5,000
Bank ↓ $5,000

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 2.14
Assets:
Fixtures = $3,500 + (3) $1,000 = $4,500
Motor vehicles = $4,200
Stock = $4,950 + (1) $770 = $5,720
Debtors = $3,280 – (2) $280 = $3,000
Bank = $6,450 – (3) $1,000 = $5,450
Cash = $120 + (2) $280 = $400
Capital:
Capital = $18,900
Liabilities:
Creditors = $1,600 + (1) $770 = $2,370
Loan from S Sun = $2,000
Assets = Capital + Liabilities
$23,270 = $18,900 + $4,370

2.15X
(a) Assets Cash ↓ $1,500
Assets Stock ↑ $1,500
(b) Assets Van ↑ $25,000
Liabilities Creditor ↑ $25,000
(c) Assets Bank ↓ $750
Liabilities P Chu ↓ $750
(d) Assets Bank ↑ $10,000
Capital Capital ↑ $10,000
(e) Assets Stock ↑ $2,000
Assets Bank ↓ $2,000
(f) Assets Machinery ↑ $8,000
Assets Cash ↓ $8,000
(g) Assets Cash ↓ $10,000
Liabilities S Leung ↓ $10,000

2.16X
Assets:
Premises = $30,000
Office equipment = (18) $5,500 – (25) $1,000 = $4,500
Motor vehicles = $12,000
Stock = $15,000 + (2) $3,000 + (7) $350 = $18,350
Debtors = $6,500 – (7) $350 – (28) $3,500 = $2,650
Bank = $26,500 – (2) $3,000 – (5) $7,000 – (11) $10,000 + (21) $8,000 + (28) $3,500 = $18,000
Capital:
Capital = $60,000 + (21) $8,000 = $68,000
Liabilities:
Creditors = $20,000 – (5) $7,000 + (18) $5,500 – (25) $1,000 = $17,500
Loan from W Yeung = $10,000 – (11) $10,000 = $0
Assets = Capital + Liabilities
$85,500 = $68,000 + $17,500