Transactions and the Accounting Equation

Transactions and the accounting equation

Given that the balance sheet indicates the financial position of an enterprise at a given point in time, successive transactions would maintain the accounting equation on which the balance sheet rests, though its dimensions and its constituent elements would vary. It is possible to record the effects of successive transactions on the balance sheet equation.

Transaction 1. Returning to the example cited earlier, where J. Soap invested £10,000 on 1 April 19X0 in a ladies hairdressing business.

The manner in which the subsequent transactions affect the balance sheet through the accounting equation may be seen from the following examples:

Transaction 2. J. Soap paid the monthly rent for the business amounting to £500. This is an expense of the month. Its effect on the balance sheet is to reduce cash by £500, and at the same time reduce the capital by the same amount.

Transaction 3. J. Soap purchased equipment for £2000 from Hairdressers' Supplies Ltd on credit. As a result of this transaction, a new asset appears on the balance sheet in the form of the equipment purchased, and a liability of £2000 is created in respect of the amount unpaid.

It will be noted that, although the balance sheet totals increase by £2000, there is no change in the capital of the business. Instead, the balance sheet shows that the equipment purchased has been financed by a liability of exactly that amount.

Transaction 4. J. Soap paid salaries amounting to £200 in cash for part-time assistance. This is an expense of the month, and its effect on the balance sheet is to reduce cash by £200 and the capital by the same amount.

Transaction 5. J. Soap's revenue from clients for the month of April amounted to £1500, of which £400 was received in cash. Clients who had accounts with him were charged a total of £1100, and at the end a sum of £100 remained outstanding in respect of these credit accounts. The effect of these transactions is to increase the capital by £1500 and to increase cash at bank by £1400. The amount outstanding of £100 requires a new asset account to be opened-Debtors-in the sum of £100.

Transaction 6. J. Soap withdraws cash in the sum of £400 for his own use. The effect of this withdrawal is to reduce capital by £400 and cash by the same amount. The withdrawal of cash from the business is the reverse of the first transaction in which J. Soap invested in the business. Consequently, the capital account is reduced by the amount of the withdrawal.


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Read on: Data Processing and Double-entry Book-keeping

Data processing and double-entry book-keeping

We saw in the preceding webpage that financial accounting data has its source in original records of financial transactions. We noted two very important aspects of data generation in accounting. First, when reporting to external users, accounting information is presented in a form which is only concerned with the monetary aspect of a firm's activities. Hence, it ignores data which deals with the type and quantities of resources which the firm utilizes, the nature and the quantity of its products, and the quality and usefulness of those products... see: Data Processing and Double-entry Book-keeping