purchase of goods from a supplier, sales of goods to customers, borrowing money from a bank. B: Internal transactions:such as the expiration or transfer of cost within the enterprise. E.g. Depreciation of plant assets, transfer of production costs from work in process inventory to the finished goods inventory The Accounting Equation The properties owned by business enterprise referred as assetsand the right or claim to the properties are referred as equities. If the assets owned by a business are Br.50,000, the equity in the assets is also Br. 50,000, i.e., Assets = Equities Equities may be subdivided in to two: the rights of creditors and the right of owners. The rights of creditors represent debtof the business and are called as liabilities. The rights of owner are called owner’s equity. Thus, we get the following accounting equation: Assets = Liabilities + Owner’sEquity NB: Liabilities should always be placed before owner’s equity in the accounting equation since creditors have preferential rights or claims against the assets. All business transactions from the simplest to the most complex can be stated in terms of the resulting change in the three basic elements of the accounting equation. The following illustration demonstrates types of transaction and the accounting equation: Assume Mr. X establishes sole proprietorship business known as XYZ Taxi. Transaction -A-Mr. X deposited Br.10,000 in a bank account in the name of XYZ Taxi. The effect of this transaction is to increase the assets (cash), left side of equation and to increase the owner’s equity on the right side by the same amount.Assets = Liabilities + Owner’s EquityCash Mr. X Capital (a)10,000 10,000 Investment
13 Transaction -B-Mr. X purchased land, which costs Br.7,500 paying in cash. This transaction changes the composition of the assets but not the total amount. Assets = Liabilities + Owner’s EquityCash + Land Mr. X Capital (A) 10,000 7,500 10,000 Investment (B) - 7,500 Bal. 2,500 7,500 10,000 Transaction -C- Mr. X purchased Br.850 of gasoline, oil, and other supplies and agreed to pay in the near future. This type of transaction is called purchase on accountand liability (account payable)is created. The transaction’s effect is increasing both the assets and liability amounts. Assets = Liabilities + Owner’s EquityCash + Supplies + Land Account Payable Mr. X Capital Bal. 2,500 7,500 10,000 (C) 850 850 Bal. 2,500 850 7,500 850 10,000 Transaction –D- Mr. X paid for creditor Br.400, the effect is decreasing the assets and liabilities. Assets = Liabilities + Owner’s EquityCash + Supplies + Land Account Payable Mr. X Capital Bal. 2,500 850 7,500 850 10,000 (D) -400 -400 Bal. 2,100 850 7,500 450 10,000 Transaction -E- Mr. X taxi earned fares of Br. 4,500, receiving the amount in cash. In general the amount charged to customers for goods or services sold is called revenue.Instead of requiring the payment of cash at the time goods or services are sold, a business may make sales on account, allowing the customers to pay latter. In such cases, the firm acquires an account receivable, which is a claim against the customers. Accounts receivable is as much as an asset as cash and revenue is realized. The effect of this transaction is increasing both the assets and owners equity.