The Accounting Equation (Cambridge (CIE) IGCSE Accounting)

Revision Note

The Accounting Equation

What is the formula for the accounting equation?

  • The formula for the accounting equation is: Assets = Liabilities + Capital

  • The equation states that the assets of a business are always equal to the liabilities and capital of the business 

  • You can rearrange the equation so that you can find one of the three values if the other two are known

    • Liabilities = Assets - Capital

    • Capital = Assets - Liabilities

The accounting equation: Assets equal liabilities plus capital
The accounting equation

Examiner Tips and Tricks

You may be given examples of assets and liabilities and asked to calculate the missing figure for capital.

Worked Example

The assets and liabilities are listed below for a business.

$

Premises

8 500

Equipment

7 000

Inventory

1 000

Trade receivables

5 000

Trade payables

4 500

Bank overdraft

1 200

Calculate the capital of the business.

Answer

Firstly, calculate the total assets:

$

Premises

8 500

Equipment

7 000

Inventory

1 000

Trade receivables

5 000

Total assets

21 500

Secondly, calculate the total liabilities:

$

Trade payables

4 500

Bank overdraft

1 200

Total liabilities

5 700

Finally, apply the formula Capital = Assets - Liabilities

$21 500 - $5 700 = $15 800

Why is the accounting equation important?

  • The accounting equation may be shown in the form of a statement of financial position 

  • The statement of financial position will be affected every time the business makes changes to the assets, liabilities and capital 

  • Every single transaction will result in at least two changes which balance out

    • Both sides of the equation could increase by the same amount

    • Both sides of the equation could decrease by the same amount

    • Both sides of the equation could stay the same

Case Study

Hannah is the owner of a business. Some of her transactions are listed below. After each transaction, the accounting equation still balances.

Transaction

Effects on assets

Effects on liabilities or capital

A credit customer, Peter, pays the amount owed to Hannah by cheque for $1 120

Assets increase by $1 120

The money in the bank increases

Assets decrease by $1 120

The amount owed by Peter decreases

Overall no change to assets

No change in liabilities or capital

Hannah pays the amount owed to a credit supplier, Rizwan, by cheque for $4 200

Assets decrease by $4 200

The money in the bank decreases

Liabilities decrease by $4 200

The amount owed to Rizwan decreases

Hannah buys additional fixtures and fittings for $5 500 on credit from FixFit Ltd

Assets increase by $5 500

The value of Hannah's assets increases

Liabilities increase by $5 500

The amount owed to FixFit Ltd increases

Hannah takes goods worth $500 from the business for personal use

Assets decrease by $500

The amount of inventory decreases

Capital decreases by $500

Hannah takes drawings from the business

Hannah transfers $1 000 from her personal bank account into the business bank account

Assets increase by $1 000

The money in the bank increases

Capital increases by $1 000

Hannah invests $1 000 into the business

Hannah makes $20 profit by selling goods which cost $30 for $50 cash

Assets increase by $50

The amount of cash increases

Assets decrease by $30

The amount of inventory decreases

Overall assets increase by $20

Capital increases by $20

A profit has been made

Worked Example

A business pays one of its trade payables by cheque. Identify the effects on the business' assets and liabilities.

 

Effect on assets 

Effect on liabilities 

Reduce bank 

Reduce trade payables 

Increase bank 

Increase trade payables 

Reduce trade payables 

Reduce bank 

D

Increase trade payables 

Increase bank 

Answer

Money in the bank is an asset and trade payables is a liability. A payment made by cheque would reduce the money in the bank, therefore reducing the asset.  Trade payable is a liability.  The business debt would be reduced when payment is made.

The answer is A.

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Donna Simpson

Author: Donna Simpson

Expertise: Accounting Content Creator

Donna is a classroom practitioner with over 25 years experience in teaching accounting and business studies at GCSE A-Levels and undergraduate levels, both in the UK and abroad. She currently works for a Multi-Academy Trust (MAT) as a teacher, instructional coach and mentor to other teachers. Donna is also an AQA A Level Accounting examiner as well as the content creator of resources used by all accounting teachers across the Trust. She enjoys designing and creating resources that provides students with deeper understanding of the subject content. Donna has a Bachelor of Science Degree in Business Administration with major in Accounting and Finance (BSc Hons) and ACCA certified to Level 2.

Dan Finlay

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Dan graduated from the University of Oxford with a First class degree in mathematics. As well as teaching maths for over 8 years, Dan has marked a range of exams for Edexcel, tutored students and taught A Level Accounting. Dan has a keen interest in statistics and probability and their real-life applications.