Question

With referring to the basic accounting equation: Assets = Liabilities + Owner’s Equity, determine the effect of the following transactions to the equation.  

Oct 1	Commenced business with cash RM200,000, land RM50,000, and equipment RM35,000.
5	Purchased furniture of RM5,000 on account.
7	Purchased supplies for a month, RM500, cash.
10	Provided services to Hakimi RM1,700, on account.
11	Received cash, RM500, from services performed to Saadiah.
17	Received cash from Hakimi.
20	Paid creditor in full for furniture purchased on October 5.
23	Recorded cash collected from services revenue during October, RM8,500.
27	Withdrew cash for personal use, RM500.
29	Paid salaries, RM1,000 and electricity bill, RM1,500.

Answer 1

Ans:

Basic Equation is Asset = Liability + Owners Equity. We will prove the same by discussing the transation effect of the given questions:

Note: All amount mentioned here are in RM

1. On October 1st, Commenced business with Cash 200,000/- , Land 50,000 and Equipment 35000/.

As per the above transation it is clear the owner has commenced the business by investing 200,000/- by cash and procured 50,000 worth land and Equipment for a value of 35000/-. The journal entry for booking this transation in to business account is as under.

Cash Account Dr. 200,000

Land Account Dr. 50,000

Equipment Account Dr. 35,000

Owners Capital Account Cr 285,000

Here Cash account, Land Account and Equipment account are Assets of the business. At the same time the cost involved to bring these assets into business is beared by the owner and it is his money. Hence the amount invested by the owner to the business is considered as Owners Equity in busines account. After posting the above journal entry into respective accounts and when applied the above equation here it is proved that the same is correct as under:

= Assets = Liability + Owners Equity.

= Assets ( Cash 200,000 + Land 50000 + Equipment 35000) 285000 = Liability ( 0 ) + Owners Equity 285,000

=285000= 285000

2. Oct 5 - Purchased furniture for 5000 on account:

Here the Furniture (Asset ) for the business purchased on credit from its supplier (Liability). Hence the journal entry for booking this transation into business is

Furniture account Dr 5000

Account Payable Account Cr 5000

Our formula is Asset = Liability + Owners Equity. After posting journal entries to the respective account and apply respective values to the equation it will come as below

Asset (Furniture 5000) = Liabiltiy (Account Payable 5000) + Owners Equity (Nil balance )

= 5000 = 5000

3. Oct 7 Purchased supplies for a month, RM500, cash:

Here we consider supplies as a expense as the supplies purchased for a month and the amount is nominal.

Journal entry shall be

Supplies accont Debit 500

Cash account Credit 500

When we posted this to respective accounts Supplies account is treated here as expense account and other is cash which is current account. Here expense is increased so the profit for the business also will be reduced. Since cash payment is made cash account (Asset) also will be reduced. Reduced profit account when posted to retained earning (which is part of Owners Equity) that account also will be showing a reduced amount. Both Assets and Onwers equity accounts has same effect our formula above will be proved correct.

4. Oct 10 - Provided services to Hakimi RM1,700, on account.:

Here business service is given (Service Income) to Hakimi for a value of 1700 credit. Hence Hakimi is Receivable Account (Asset). Journal entry is as under:-

Account Receivable- Hakimi A/c Dr. 1700

Service Income Cr 1700

Here Account receivable is an asset and when posted the above the account value will increase. Service income will come in P&L account and will increase the profit of the business. Increased profit will cause to increase the retained earning balance (Owners Equity). Since both sides values increased our formula Assets = Owners Equity + Liability proves correct.

5. Oct 11 Received cash, RM500, from services performed to Saadiah

Here the transation is service is rendered to customer for cash. Hence the journal entry is

Cash Account Dr. 500

Service Income Cr 500

In this case also the cash account (Asset) increase and service income cause the increase of net profit and Retained Earning (Owners equity). Since both sides values increased our formula Assets = Owners Equity + Liability proves correct.

6. Oct 17 Received cash from Hakimi.

Here the Hakimi is the customer to whom we have accounted earlier as credit service on Oct.10. Now the cash payment against that credit bill is received. Journal entry shall be:

Cash Account Dr. 1700

Account Receivable - Hakimi A/c Cr. 1700

In this case both cash and Account Receivable accounts are assets in balance sheet. After posting the above transation one of these account (Cash) balance will increase and the other one Account Receivable balance which is showing already a Debit balance will decrease and become 0 in this case. Hence the net effect is remain same in balance sheet.So our formule proved correct here too.

7. Oct 20 Paid creditor in full for furniture purchased on October 5.

Here the Account Payable account 5000 is paid by cash. Hence the journal entry shall be as under

Account Payable A/c Dr 5000

Cash Account Cr 5000

Account payable is a balancesheet liability item and cash is Asset the effect of the above transation is that both side account balance is decreasing. Both accounts balance has same effect (decrese) the formula Assets = Liability + Owners equity proves correct.

8 Oct.23 Recorded cash collected from services revenue during October, RM8,500.

Here the transation is same as of Oct 11. Service rendered and cash collected. Journal Entry shall be

Cash Account Dr. 8500

Sales Income Account Cr. 8500

Here Asset account in balance sheet will increase and Net profit and Retained earning also will increase. Since both sides has same effect (increase) the formula Assets = Liability + Owners equity proves correct.

9. Oct 27 Withdrew cash for personal use, RM500.

Here owner withdras 500/- from business and it is his personal withdrawal. Hence journal entry shall be as under

Owners Drawing Account Dr. 500

Cash Account Cr 500

Owners drawing account will be adjusted in owners Capital Account and will show a decreased balance in balance sheet. Likewise since cash is paid cash account (asset) is also showing a decreased balance in balance sheet. Since both sides has same effect (decrease) the formula Assets = Liability + Owners equity proves correct.

10. Oct 29 Paid salaries, RM1,000 and electricity bill, RM1,500.

Here the business expenses like salary and electricity bill is paid through cash. Hence journal entry shall be

Salary Account Dr.1000

Electrictiy Account Dr.1500

Cash Account Credit 2500

Here both expense account will cause to reduce the net profit and Retained earning. At the same time cash (asset) also will be reduced as it is a payment. Since both sides has same effect (decrease) the formula Assets = Liability + Owners equity proves correct.

After posting the above transations in respective accounts the respective account balance in summarised format is as under which will help to give a more clarity to the formula Asset = Owners Equity + Liability is correct.

Income Statement for October
Sales Income		10700
Salary Account	1000
Electricity	1500
Supplies Expense	500
Net Profit	7700
Total	10700	10700

Balance Sheet for October
Asset
Cash Account	202200
Land	50000
Equipment	35000
Furniture	5000
Total Assets	292200
Owners Equity & Liability
Owners Equity (Drawing adj)	284500
Retained Earning	7700
Total Liability Equity	292200

= 292000 = 292000

The balance sheet is prove that Assets = Owners Equity + LIability is correct