Accounting Equation|Decrease in Capital and Increase in the Liability, Decrease in Liability and Increase in the Capital and Increase and Decrease in Assets

Every accounting transaction, at a minimum, affects two accounts at the same time, either positively or negatively. Accounting Transaction that causes an increase in capital and decrease in liability, and increase and decrease in assets have been mentioned below:

1. Decrease in Capital and Increase in the Liability:

Some transactions reduce the capital and increase the liability of the business.

Transaction: Rent due not paid ₹1,000.

Solution: This transaction increases the liability of the firm and at the same time decreases the capital by ₹1,000.

	Assets	=	Liabilities	+	Capital
	Cash	=	Outstanding Rent	+	Capital
Transaction	0	=	1,000	+	(1,000)
Equation	0	=	1,000	+	(1,000)

2. Decrease in Liability and Increase in the Capital:

When an owner of the firm uses personal assets to pay off the debt of the firm, then under such circumstances, the liability of the firm is reduced, and the owner’s claim on the capital of the firm(owner’s share) is increased.

Transaction: Mr. A, the owner of the firm, gives away his scooter to the creditor of the firm, as the final settlement of the debt of ₹5,000.

Solution: This transaction reduces the creditor (liability) by ₹5,000 and at the same time increases the share of Mr. A in the capital of the firm (owner’s share) by ₹5,000.

	Assets	=	Liabilities	+	Capital
	Cash	=	Creditors	+	Capital
Transaction	0	=	(5,000)	+	5,000
Equation	0	=	(5,000)	+	5,000

3. Increase and Decrease in Assets:

Some transactions increase and decrease the assets side of the accounting equation simultaneously. Some of such cases include:

(A) Increase in Stock, Decrease in Cash-

Whenever a firm buys a stock for cash, the value of the stock increases, but at the same time, the other asset, i.e., Cash decreases by the same amount. 

Transaction 1: Purchase goods for cash worth ₹50,000.

Solution: This transaction increases the stock (asset), and reduces the cash (asset) by the amount of ₹50,000.

	Asset			=	Liabilities	+	Capital
	Cash	+	Stock	=	0	+	0
Transaction 1	(50,000)	+	50,000	=	0	+	0
Equation	(50,000)	+	50,000	=	0	+	0

(B)  Decrease in Stock, Increase in Debtors- 

When a firm sells the goods on credit, the stock decreases but the new asset i.e. Debtor is created by the same amount.

Transaction 2: Sold goods to Mr. Ram for ₹12,000.

Solution: This transaction decreases the stock (asset) and increases the debtors (assets) by ₹12,000.

	Assets			=	Liabilities	+	Capital
	Stock	+	Debtors	=	0	+	0
Transaction 2	(12,000)	+	12,000	=	0	+	0
Equation	(12,000)	+	12,000	=	0	+	0

(C) Decrease in Stock, Increase in Cash-

When a firm sells the goods for cash, the cash balance is increased and as the stock goes out, the value of a stock is reduced.

Transaction 3: Goods worth ₹10,000 are being sold for cash.

Solution: This transaction decreases the stock (asset) of the firm. On the other hand, increases the cash balance (asset) simultaneously, by the same amount.

	Assets			=	Liabilities	+	Capital
	Cash	+	Stock	=	0	+	0
Transaction 3	10,000	+	(10,000)	=	0	+	0
Equation	10,000	+	(10,000)	=	0	+	0

Sample Question:

Prepare ‘ Accounting Equation’ from the following:

1. Started the business with Cash of ₹1,25,000.
2. Purchased goods for cash of  ₹50,000.
3. Purchased goods on credit from Mr.B worth ₹20,000.
4. Sold goods for Cash ₹40,000.
5. The proprietor paid Mr.B using his personal asset in full settlement.
6. Goods worth ₹10,000 were sold to Guddu.
7. Interest due not paid ₹5,000.

Solution:

No.	Transactions	Assets					=	Liabilities			+	Capital
		Cash	+	Stock	+	Debtors	=	Creditors	+	Outstanding Interest	+	Capital
1.	Started business with cash	1,25,000	+	0	+	0	=	0	+	0	+	1,25,000
	Equation	1,25,000	+	0	+	0	=	0	+	0	+	1,25,000
2.	Cash Purchase	(50,000)	+	50,000	+	0	=	0	+	0	+	0
	New Equation	75,000	+	50,000	+	0	=	0	+	0	+	1,25,000
3.	Credit Purchase	0	+	20,000	+	0	=	20,000	+	0	+	0
	New Equation	75,000	+	70,000	+	0	=	20,000	+	0	+	1,25,000
4.	Cash sale	40,000	+	(40,000)	+	0	=	20,000	+	0	+	0
	New Equation	1,15,000	+	30,000	+	0	=	20,000	+	0	+	1,25,000
5.	Payment made to a creditor using the personal asset	0	+	0	+	0	=	(20,000)	+	0	+	20,000
	New Equation	1,15,000	+	30,000	+	0	=	0	+	0	+	1,45,000
6.	Credit sales	0	+	(10,000)	+	10,000	=	0	+	0	+	0
	New Equation	1,15,000	+	20,000	+	10,000	=	0	+	0	+	1,45,000
7.	Interest due not paid	0	+	0	+	0	=	0	+	5,000	+	(5,000)
	New Equation	1,15,000	+	20,000	+	10,000	=	0	+	5,000	+	1,40,000