The three primary elements of any business transaction are- assets, liabilities and capital. This relation between them in Accounting Equation remains unchanged no matter how worse or good the situation of a company is. It has even been justified by mathematical data.
Inter-relationship of these three accounting terminologies- assets, liabilities and capital, results into nine transactions. These transactions depict that a change in one element will automatically lead to a corresponding change in all other elements. These nine business transactions are as follows-
- Increase and decrease in liabilities
- Increase in assets with a corresponding increase in liabilities
- Decrease in assets with a corresponding decrease in liabilities
- Increase in capital and decrease in liabilities
- Increase and decrease in capital
- Increase in assets with a corresponding increase in capital
- Decrease in assets with a corresponding decrease in capital
- Increase in liabilities and decrease in capital
- Increase and decrease in assets
Each of these transactions can be further explained as-
- Increase and decrease in liabilities
Various creditors of goods at times draw a bill of exchange in the company. This is based on the arrangement of payment. Once this bill is accepted, this payment becomes due for payment after a specific period’s expiry. The acceptance of this bill diminishes a creditor’s liability and creates another liability. The bill on which this payment needs to be made is known as bills payable.
- Increase in assets with a corresponding increase in liabilities
For example, if a business is started with an amount of $20,000, it will not only increase the assets, but even the capital of a firm will also be affected.
The financial position of a business will be affected by this transaction. This can be further explained as-
- Decrease in assets with a corresponding decrease in liabilities
If a payment of $30,000 is made to the creditors, it will decrease creditors, liabilities of that company and even the value of assets will decrease. This decrease in assets and liabilities together at a time with the same amount will prove the Accounting equation to be true.
- Increase in capital and decrease in liabilities
When a loan is converted into capital, on the one hand, it lowers the liability of a business and on the other hand; it increases the business capital.
- Increase and decrease in capital
There are some business transactions which involve capital like transfer of company’s share from one shareholder to another. During such a time, a company’s capital will increase and even decrease with the same amount and this will be left unchanged. With the amount of interest allowed, the owner’s capital will increase.
- Increase in assets with a corresponding increase in capital
For instance, if goods are purchased on credit for an amount of $ 7,000, it will lead to an increase in the stock of goods with $7000. Further, it will even increase the liabilities of creditors. The financial position of this company will be affected as-
- Decrease in assets with a corresponding decrease in capital
The amount withdrawn by an owner for his personal use will automatically lead to a decrease in cash and capital.
- Increase in liabilities and decrease in capital
There are times when capital can be easily converted into a loan in the form of a liability. Such transactions occur when associate retires from a company and the capital which was refundable to him get transferred to his loan account. In such cases, instead of his capital, the company will show its partner’s loan as a liability. This leads to an increase in liabilities and an automatic decrease in capital.
- Increase and decrease in assets
A purchase of furniture involves both the assets- cash and furniture. This will lead to a transaction where furniture will increase as an asset and then get decreased as cash. Even an increase in an asset with the same value will not affect the accounting equation.