Topic 2:

Accounting Equation
Double Entry Rules, General Journal and Ledger Accounts

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Accounting Equation

Assets = Liabilities + Owner’s Equity (Capital)

1. Assets:
a. An asset can be thought of as something that in the future can generate cash flow.
b. The company will use the amounts of “Capital” and the “Liabilities” to buy assets, that are
why the two sides of the balance sheet should be equal.

Examples,
 Premises (Land & Building), warehouse, properties.
 Machinery, equipment, tools.
 Motor Vehicles, trucks, vans.
 Furniture, fixtures and fittings (F&F).
 Computers, Supplies
 Intangible assets (Goodwill) (Which is the good reputation of the business).
 Cash and cash equivalent (cash in hand, cash at bank, petty cash).
 Trade receivable (amount owed by debtors, customers) buying the company’s goods on
credit.
 Inventory (stock) of goods for manufacturing or resale.
 Other receivable (prepaid expenses and accrued income), amounts paid by the company
in advance. eg.: rent and insurance expenses paid in advance for future use.
* Prepayments = prepaid expenses = expenses paid in advance

Capital and Liabilities

* This side represent the various sources of finance available for the business which include ,

2. Liabilities,
a. This side represents the items owing by the company for goods supplied to the company and
for the expenses made. Also for loans acquired by the firm.
Examples,
1) Bank overdraft: loan payable within 12 months, is the amount due to the bank when the
company withdraws more than its balance in the bank current account.
2) Trade payable (Creditors): is the amount due to suppliers who provide the company with
its needs of stock, goods, raw material, service … but on credit terms.
3) Other payables (owing expenses): are the expenses of the period (current financial year)
which had not yet been paid. eg, unpaid expenses, accrued wages, accrued insurance,
unpaid interest.
*owing = unpaid = accrued = accruals = outstanding.
4) Long Term Loans, money borrowed from banks with promise to pay it back in the long
run. Loans usually have a fixed interest rate but it’s not shown in the balance sheet. It is
to be shown in the Income statement under other expenses line item.

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3. Capital,
Also known as owner’s equity which is the contribution of the owner in financing the firm.
Example, the owner invested $5,000 cash in the business to start with, then his capital is equal
= 5,000, but if he introduced an additional amount of 2,000 then his capital will be 7,000, so any
additional cash or assets contributed to the business will be added up to business’s capital
account.
As shown below:

Capital Balance (opening) 100,000

Add: (+) Investments or (contribution capital) 20,000
(+) Profit of the year (Net profit) 30,000
Or
Subtract (-) Net Loss ___
(-) Drawings (10,000)
_____________________________

= Capital Balance (Ending) 140,000

Identify each of the

following items by writing
the term asset, liability or
owner’s equity in the
space provided.
a. A truck owned by the
business
_______asset________________
___

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b. A bank loan
__________liability___________
_____
c. A building
______asset_________________
___
d. A mortgage
______liabilities_____________
_______
e. Office supplies
_______asset________________
___
f. Assets minus liabilities
_______owner’s
equity________________

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g. A debt to a finance
company
________liability_____________
_____
h. Money owed to our
business
_______asset________________
___
i. We owe money to others
_______liability______________
_
j. Cash on hand
______asset_________________
___

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k. A computer
_______asset________________
___
Example 1: -

Identify each of the following is asset, liability or owner’s equity

Item Assets Liabilities Owner’s Equity

1 A truck owned by the business 0
2 A bank loan 0
3 A building 0
4 A mortgage 0
5 Land 0
6 Inventory 0
7 Office supplies 0
8 Assets minus liabilities 0
9 Money owed to our business
1 We owe money to others
0
1 Cash on hand
1
1 A computer
2
1 Accounts receivable
3
1 Notes payable
4
1 Advances to suppliers
5
1 Petty cash
6
1 Current portion of long-term loan
7
1 Salaries and wages payable
8
1 Accounts payable
9
2 Prepaid insurance
0

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Example 2: -

Show that the accounting equation is satisfied after taking into consideration each of the following
transactions in the books of Mr. Nano

1. Started business with capital 1,00,000

2. Bought furniture 25,000
3. Bought goods for cash 20,000
4. Bought goods from Ram on Credit 5,000
5. Sold goods for cash for 15,000
6. Sold goods to Shyam on credit 8,000
7. Paid cash to Ram 4,000
8. Received cash from Shyam 5,000
9. Paid Cash into Bank 25,000
10. Withdrawn from bank 10,000

Sol:-
Items

1
2
3
4
5
6
7
8
9
10
Total

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Example 3: -

The following are the accounting transactions relating to Mr. Mo Salah’s business. Use the
accounting equation to show their effect on his assets, liabilities and capital.

1. Commenced business with a Capital of 50,000

2. Bought Machinery for cash 10,000
3. Purchased goods for cash 15,000
4. Purchased goods from A on credit 5,000
5. Sold goods for cash 10,000
6. Paid to A 2,000
7. Sold goods to B on credit 3,000
8. Paid into Bank 6,000
9. Paid to A by cheque 1,000
10. Received from B a cheque for 2,000

Sol:-
Items
1
2
3
4
5
6
7
8
9
10
Total

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 Double Entry Rules, General Journal and Ledger Accounts

I. The Duality Principle:

According to this principle there are two main aspects for any financial transactions.
1. The value of any financial transactions should be recorded in two accounts one should
be recorded on the Dr side and the other should be recorded on the Cr side of another
account.
2. Values are to be recorded on the side while represents the nature of the account
unless the account is decreasing, in this case the value should be recorded on the
opposite side.
II. Double Entry Recording Rules:-

Account Nature Increase Decrease

Assets Dr Dr Cr
Liabilities Cr Cr Dr
Capital Cr Cr Dr
Revenue Cr Cr Dr
Expenses Dr Dr Cr
Drawings Dr Dr Cr
Provision Cr Cr Dr

III. Ledger Account T Account

Dr Assets Cr Dr Liabilities Cr Dr Capital Cr

+ ‫ــ‬ ‫ــ‬ + ‫ــ‬ +

Dr Expenses Cr Dr Revenue Cr Dr Purchases Cr

+ + + ‫ــ‬

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 Dr Sales Returns Cr Dr Purchase Returns Cr Dr Drawings Cr
IV.
+ + +

Double Entry (Transactions) and General Journal

Transactions Account Account

should be should be
debited Credited
Dr Cr.
1 The owner invested capital in a business in cash.
2 The owner takes cash from the business for personal use
3 The business pays rent for cash.
4 The business received cash for services provided
5 The business transferred an amount of cash to the business bank.
6 Payment of wages by cheque.
8 Borrowing a long term loan and depositing the amount in the bank
account
9 Purchase of a motor van by cheque.
1 Purchase of office equipment and paying in cash.
0
1 Purchase of goods (Inventory) for resale by cheque.
1
1 Purchase of goods (Inventory) paying in cash.
2
1 Purchase of inventory on credit (on Account) from Ahmed supplier, a
3 credit supplier.
1 Purchase of Machine on credit (on Account) from Morad supplier, a
4 credit supplier.
1 Sales of goods for cash.
5
1 Sales of goods on credit (on Account) to Salma, a credit customer.
6
1 The owner transferred two mobile phoned to be used in the business.
7
1 The owner takes goods for his personal use.
8
1 Repayment of part of the loan by cheque.
9
2 Purchase of equipment and paying part of the amount cash and the
0 remaining on Account
2 Payment for motor expenses in cash.
1
2 Payment of stationary by cheque.
2
2 Payment of cleaning expenses from the petty cash.
3

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Practical Exercises,
Example 1

The following transactions took place during the month of June, 2017.

# Date Transactions
1 June Ali started the business with a capital of $ 10,000; this amount was kept in the cash
1 safe.
2 2 Purchased office premises for $3,000 paid in cash
3 3 Paid $ 400 cash for fixtures and Fittings
4 5 Purchased goods for resale (purchases) $ 1,000 paid cash
5 6 Purchased goods $5,000 on credit from Andy, a credit supplier
6 7 Sold goods $2,000 on credit to Tony, a credit customer

1- Prepare the General Journal to record the previous transactions.

Date Description Dr. Cr.

2- Prepare the ledger accounts to record the previous transactions.

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 Dr Assets Cr Dr Liabilities Cr Dr Capital Cr

Dr Expenses Cr Dr Revenue Cr Dr Purchases Cr

Example 2:

The following transactions took place during the month of May, 2017.

# Date Transactions
1 May Started the business by putting an amount of $ 1,000 into the business bank
1 account.
2 3 Bought working machine on credit from Youssef amounting to $275.
3 4 Withdrew an amount of $200 cash from the bank and placed it in the cash box
4 7 Bought a motor van paying in cash $180.
5 10 Sold some of the machinery for $15 on credit to Malak.
6 21 Returned some of the machinery bought from Youssef, value $27.
7 28 Malak pays the business the amount owing $15 by cheque.
8 30 Bought another motor van paying by cheque amounting to $420
9 31 Paid the amount of $248 to Youssef by cheque.

1- Prepare the General Journal to record the previous transactions.

Date Description Dr. Cr.

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 2- Prepare the ledger accounts to record the previous transactions.

Dr Assets Cr Dr Liabilities Cr Dr Capital Cr

Dr Expenses Cr Dr Revenue Cr Dr Purchases Cr

Example 3:

The following transactions took place during the month of May, 2017.

# Date Transactions
1 May 1 Omar started business with a capital of $5,000 cash.
2 4 Paid rent expenses an amount of $200 in cash.
3 5 Borrowed a loan $3,000 from his cousin and paid it onto a bank account.
4 7 Purchased machinery $700 paid by cheque.
5 15 Purchased goods for resale $900 paid cash.
6 31 Purchased goods for resale $1200 on credit from Ali, a credit supplier

1- Prepare the ledger accounts to record the previous transactions.

Date Description Dr. Cr.

2- Prepare the General Journal to record the previous transactions.

Dr Assets Cr Dr Liabilities Cr Dr Capital Cr

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 Dr Expenses Cr Dr Revenue Cr Dr Purchases Cr

Example 4:

The following transactions took place during the month of March, 2017.

# Date Transactions
1 May 1 Andy started his business with capital of $7,000; this amount was paid into a bank
account.
2 2 Paid the rent of the business premises $500 by cheque.
3 5 Borrowed a loan of $6,000 cash from his friend.
4 10 Bought machinery $200 paid cash.
5 14 Bought goods $3,000 on credit from office supplies Ltd.
6 20 Sold goods $400 in cash.
7 28 Cash sales $2,800 banked immediately.
8 31 Paid wages $900 by cheque.

1- Prepare the General Journal to record the previous transactions.

Date Description Dr. Cr.

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 2- Prepare the ledger accounts to record the previous transactions.

Dr Assets Cr Dr Liabilities Cr Dr Capital Cr

Dr Expenses Cr Dr Revenue Cr Dr Purchases Cr

Example 5:

The following transactions took place during the month of May, 2017.

# Date Transactions
1 May Cash balance $1,000, bought goods on credit $68 from Ali.
1
2 2 Bought goods on credit $77 from Ahmed.
3 5 Sold goods on credit to Amr for $60.
4 6 Sold goods on credit to Karim for $45.
5 10 Returned goods $15 to Aly.
6 12 Goods bought for cash $100.
7 19 Karim returned $16 goods to us.
8 21 Goods sold for cash $150
9 22 Paid cash to Aly $53.
1 30 Amr paid the amount owing by him $60 in cash.
0
1 31 Bought goods on credit $64 from Ahmed.
1

1- Prepare the General Journal to record the previous transactions.

Date Description Dr. Cr.

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 2- Prepare the ledger accounts to record the previous transactions.

Dr Assets Cr Dr Liabilities Cr Dr Capital Cr

Dr Expenses Cr Dr Revenue Cr Dr Purchases Cr

Example 6:

The following transactions took place during the month of May, 2017.

# Date Transactions
1 June 1 Paid for postage stamps by cash $50.
2 2 Paid for electricity by cheque $229.
3 5 Received rent in cash $138.
4 7 Paid insurance by cheque $142.

1- Prepare the General Journal to record the previous transactions.

Date Description Dr. Cr.

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 2- Prepare the ledger accounts to record the previous transactions.

Dr Assets Cr Dr Liabilities Cr Dr Capital Cr

Dr Expenses Cr Dr Revenue Cr Dr Purchases Cr

Example 7:

The following transactions took place during the month of Jan, 2017.

# Date Transactions
1 Jan 1 The owner invested $10,000 cash into the business.
2 5 Bought motor van for $5,000 n credit from Karin.
3 8 Bought equipment for cash amounting to $3,000.
4 12 Sold motor van for $2,500 on credit to Ahmed.
5 17 Withdrew $2,000 cash and deposited them at the bank.
6 21 Paid Karin $5,000 by cheque.
7 28 Ahmed paid us $2,500 cash.

1- Prepare the General Journal to record the previous transactions.

Date Description Dr. Cr.

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 2- Prepare the ledger accounts to record the previous transactions.

Dr Cr Dr Cr Dr Cr

Dr Cr Dr Cr Dr Cr

Example 8:

The following transactions took place during the month of May, 2017.

# Date Transactions
1 July 1 Cash balance $1,000.
2 5 Purchased goods on credit from Ahmed for $100.
3 8 Purchased goods for cash $200.
4 10 Purchased goods from Karim $200 on credit.
5 12 Returned goods to Ahmed for $20.
6 15 Paid Ahmed $80 cash
7 17 Sold goods $300 to Ayman on credit.
8 18 Sold goods for $180 cash.
9 20 Ayman returned goods for $100.
1 30 Received $200 cash from Ayman.
0

1- Prepare the General Journal to record the previous transactions.

Date Description Dr. Cr.

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2- Prepare the ledger accounts to record the previous transactions.

Dr Assets Cr Dr Liabilities Cr Dr Capital Cr

Dr Expenses Cr Dr Revenue Cr Dr Purchases Cr

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