Bookkeeping basics

The accounting equation

Assets = capital + liabilities, after every transaction.

Draft: not yet reviewed by a teacher

Why it exists

The equation shows where a business's resources came from. It holds after every transaction, so it checks the bookkeeping, finds a missing figure (such as profit) and shows what each transaction changes.

Key rules

Assets = capital + liabilities; equivalently, capital = assets − liabilities (net assets).
Closing capital = opening capital + capital introduced + profit − drawings.
Every transaction changes at least two figures, and the equation still holds.
The business and its owner are separate for accounting: the owner's money paid in is the business's capital, not its income.
Profit can be found from the change in net assets: profit = increase in net assets − capital introduced + drawings.

Examples

Samira's bakery: capital at 1 January 20,000, capital introduced 3,000, profit 9,500, drawings 4,200. Assets at 31 December 41,750.

Closing capital: 20,000 + 3,000 + 9,500 − 4,200 = 28,300
Liabilities: 41,750 − 28,300 = 13,450

Closing capital and liabilities

A workshop's net assets: 27,900 at the start of the year, 35,600 at the end. Capital introduced 2,000, drawings 6,300.

Increase in net assets: 35,600 − 27,900 = 7,700
Profit: 7,700 − 2,000 + 6,300 = 12,000

Profit from the change in net assets

How it works

Buying equipment for cash only changes the mix of assets. Buying on credit increases assets and liabilities. Income increases capital (through profit); expenses and drawings reduce it. No transaction can change just one side of the equation by one amount.

In the exam, the equation is the quick way to find an unknown: profit, drawings or liabilities.

Traps

Taught in the course

Key rules

Assets = capital + liabilities; equivalently, capital = assets − liabilities (net assets).

Closing capital = opening capital + capital introduced + profit − drawings.

Every transaction changes at least two figures, and the equation still holds.

The business and its owner are separate for accounting: the owner's money paid in is the business's capital, not its income.

Profit can be found from the change in net assets: profit = increase in net assets − capital introduced + drawings.