As we saw in Section 3.2, the accounting equation, extended to include income and expenses, can be expressed as follows:
A – L= C+ (I – E)
This equation can be rearranged as A+ E =C+ L+ I according to the rules of mathematics.
The next activity should help you to understand the importance of both forms of the accounting equation.
Activity 21
A business has assets of £110,000, liabilities of £30,000, income in the year of £20,000 against expenses incurred of £10,000 and capital at the beginning of the year of £70,000. Using the two forms of the accounting equation, insert these figures into each equation to show that the equation holds true in both cases.
Answer
Each form of the equation is correct as both sides of the equal sign in each case would have the same figure.
In the first form of the accounting equation, A – L= C+ (I – E), the answer would be:
£80,000 (£110,000 – £30,000) = £80,000 (£70,000 + (£20,000 – £10,000))
In the second form, A+ E =C+ L + I, it would be:
£120,000 (£110,000 + £10,000) = £120,000 (£70,000 + £30,000 + £20,000)
What is the point of knowing the second form of the accounting equation?
This second form of the equation, i.e. A + E =C + L + I, is very useful to remember as it gives you all the rules of double-entry bookkeeping, including the ones for income and expense accounts.
Assets (A) and expenses (E) are on the left side of the equation representing debit balances. The double-entry rule is thus: if a transaction increases an asset or expense account, then the value of this increase must be recorded on the debit or left side of these accounts.
Likewise in the equation, capital (C), liabilities (L) and income (I) are on the right side of the equation representing credit balances. The double-entry rule is thus: if a transaction increases a capital, liability or income account, then the value of this increase must be recorded on the credit or right side of these accounts.
The following T-accounts may help you to learn these ‘golden rules’ of double-entry bookkeeping.
In the final activity of this section, you will need to apply your knowledge of the double-entry rules, the P&L account, the balance sheet and the accounting equation.
Activity 22
Jane Michaela, trading as Michaela Enterprises, has the following closing balances in ledger accounts for her first year in business, the financial year just ended on 31 December 20X7:
- Opening capital £5,000
- Cash and bank £2,853
- Furniture £3,200
- Computers and equipment £2,010
- Debtors £790
- Creditors £1,100
- Bank loan £2,000
- Sales £33,230
- Purchases £21,565
- Rent £6,053
- Heating and lighting £1,256
- Insurance £988
- Office expenses £2,615
- Using the template below, complete the trial balance for the year.
- Using the formula I – E (Income – Expenses), calculate the net profit for the year ended 31/12/20X7 if the closing stock was £200.
- Using the formula C+ (I – E) (Capital + (Income – Expenses)), calculate the capital as at 31/12/20X7.
- Using the formula A – L (Assets – Liabilities), calculate the net assets as at 31/12/20X7.
- What do you notice about your answers to 3 and 4?
Answer
- £33,230 – (£21,565 – £200 closing stock) + £6,053 + £1,256 + £988 + £2,615 = £33,230 – £32,277 = £953 net profit for the year ended 31/12/20X7.
- £5,000 + £953 net profit = £5,953 capital as at 31/12/20X7.
- (£2,853 + £3,200 + £2,010 + £790 + £200 closing stock not included in trial balance) – (£1,100 + £2,000) = £9,053 – £3,100 = £5,953 net assets as at 31/12/20X7.
- The answers to 3 and 4 are exactly the same. This again demonstrates that the accounting equation in the form A – L = C + (I – E) is always true.
Information point
Closing stock is not included in the trial balance as it does not reflect a transaction that has a dual aspect – it is merely the purchases that have not been sold in the year. If there is any opening stock it is included in the trial balance at the year end.
FAQs
Bookkeeping is generally termed as a task of recording financial transactions and is a part of accounts in business and other organizations. This plays a vital role in keeping track of documents related to transactions, operations, and other events of a business.
What is the basic concept of bookkeeping and accounting? ›
While bookkeeping is all about recording of financial transactions, accounting deals with the interpretation, analysis, classification, reporting and summarization of the financial data of a business.
Can I teach myself bookkeeping? ›
Self-taught bookkeepers use a variety of courses, seminars, books, and other online resources to learn about bookkeeping and accounting. You can also learn how to use accounting software, like QuickBooks, which can teach you about the basics of bookkeeping as well as the technology used by many businesses.
How do I start bookkeeping for beginners? ›
- Step 1: Separate your business and personal expenses. ...
- Step 2: Choose a bookkeeping system. ...
- Step 3: Choose an accounting method: Cash or Accrual. ...
- Step 4: Choose the right tools. ...
- Step 5: Make sure your transactions are categorized. ...
- Step 6: Choose a system for storing your documents. ...
- Step 7: Organize your deductions.
To learn these skills and others, new bookkeepers often receive around six months of on-the-job training to learn how to use bookkeeping software, databases, and spreadsheets. Though bookkeepers don't need to hold college degrees, some may see their salaries increase after completing an undergraduate degree.
Is accounting and bookkeeping hard? ›
Is studying bookkeeping hard? While accounting does require a complex set of skills and abilities, as well as excellent attention to detail, it really isn't any more difficult than many of the other popular fields of study that lead to excellent lifelong career opportunities.
What is the first step in bookkeeping? ›
Step 1: Identify Transactions
The first step in the accounting cycle is identifying transactions. Companies will have many transactions throughout the accounting cycle. Each one needs to be properly recorded on the company's books.
What are the golden rules of accounting? ›
What are the Golden Rules of Accounting? 1) Debit what comes in - credit what goes out. 2) Credit the giver and Debit the Receiver. 3) Credit all income and debit all expenses.
Is being a bookkeeper hard? ›
Bookkeeping is not hard as long as you have the skills and resources needed to maintain accurate and up-to-date books. Take online courses and training programs and read books about bookkeeping to continually hone your skills and increase your chances of success.
What is the fastest way to learn bookkeeping? ›
Use a Bookkeeping App: The best way to learn is to get hands-on in your own time and use a bookkeeping app that's both easy to use and understand. No formal degrees, no qualifications. Just look for one that has useful features you'll need and not packed full of ones you'll probably never use.
The OHSC's free online bookkeeping course is a 20-hour program that covers the fundamentals of bookkeeping, including basic terminology, essential financial records, double-entry bookkeeping, ledger preparation, and more.
Is bookkeeping a lot of math? ›
Do you have to be really good at math to be a bookkeeper? Not necessarily but it helps. With current technology (and calculators) most of the math is done for you but at least a grasp of arithmetic is helpful to be able to identify things that are wrong and being able to fix them quickly.
What is the basic rule in bookkeeping? ›
The three golden rules of accounting are (1) debit all expenses and losses, credit all incomes and gains, (2) debit the receiver, credit the giver, and (3) debit what comes in, credit what goes out.
What is the simplest form of bookkeeping? ›
Single-entry bookkeeping is a simple and straightforward method of bookkeeping in which each transaction is recorded as a single-entry in a journal.
What should every bookkeeper know? ›
Components of Bookkeeping
Documenting every financial transaction (payments and expenses) Recording all debits and credits. Sending invoices and processing payments. Preparing financial statements (balance sheet, income and cash flow)
Is introduction to accounting hard? ›
How Hard is Basic Accounting? Accounting is a complex field with a lot of intricacies, but the foundational concepts should be fairly easy to pick up for most students. Again, it takes a good eye for detail to become an accountant and even your Introduction to Accounting class shouldn't be a walk in the park.
What is the difference between bookkeeping and accounting and accountancy? ›
Bookkeepers and accountants sometimes do the same work, but have a different skill set. In general, a bookkeeper's role is to record transactions and keep you financially organized, while accountants provide consultation, analysis, and are more qualified to advise on tax matters.
What is the basic introduction of accountancy? ›
Accounting can be defined as a process of reporting, recording, interpreting and summarising economic data. The introduction of accounting helps the decision-makers of a company to make effective choices, by providing information on the financial status of the business.
What is the main objective of bookkeeping and accounting? ›
The main objective of book-keeping is to keep a complete and accurate record of all the financial transactions in a systematic orderly, logical manner. This ensures that the financial effects of these transactions are reflected in the books of accounts.
