The accounting equation says assets = liabilities + capital. A transaction is correctly recorded when it keeps this equation balanced, which means it must change at least two items.
This lesson is part of tracing a transaction through the whole accounting cycle.
How do you describe the effect of a transaction?
Use one sentence with two changes: “Item A goes up or down by RM___ and item B goes up or down by RM___.” If the two changes are on opposite sides of the equation, both sides move together. If they are on the same side, one goes up while the other goes down.
Worked example: five transactions in a row
A trader starts with RM5 000 cash as capital. Amounts are in RM.
| Step | Transaction | Cash | Equipment | Stock | Creditors | Capital |
|---|---|---|---|---|---|---|
| Start | Owner invests | 5 000 | 5 000 | |||
| 1 | Buys equipment for cash, 2 000 | 3 000 | 2 000 | 5 000 | ||
| 2 | Buys stock on credit, 1 500 | 3 000 | 2 000 | 1 500 | 1 500 | 5 000 |
| 3 | Pays creditors, 1 000 | 2 000 | 2 000 | 1 500 | 500 | 5 000 |
| 4 | Sells stock (bought at 600) for 900 cash | 2 900 | 2 000 | 900 | 500 | 5 300 |
| 5 | Drawings in cash, 200 | 2 700 | 2 000 | 900 | 500 | 5 100 |
Check after step 5. Assets = 2 700 + 2 000 + 900 = 5 600. Liabilities plus capital = 500 + 5 100 = 5 600. The equation balances.
Step 4 changes three items: cash up 900, stock down 600, and capital up 300. The capital rise is the profit on the sale, which is sales 900 minus the goods given up at 600.
What each step shows
- Step 1 swaps one asset for another. Total assets do not change.
- Step 2 raises assets and liabilities together.
- Step 3 lowers assets and liabilities together.
- Step 4 is the only one that raises capital.
- Step 5 lowers assets and capital together.
The mistake that costs marks
The common slip is to raise capital by the full sale, 900, instead of the profit of 300. The 600 of stock that left the shop is a real reduction of an asset.
| Step 4 | Wrong | Right |
|---|---|---|
| Cash | +900 | +900 |
| Stock | unchanged | −600 |
| Capital | +900 | +300 |
| Equation after step 4 | 6 400 = 6 400 | 5 800 = 5 800 |
The wrong version still balances: assets are 2 900 + 2 000 + 1 500 = 6 400 and liabilities plus capital are 500 + 5 900 = 6 400. Yet stock and capital are both overstated by 600. A balanced equation is necessary, but it does not prove each figure is right.
Check yourself
The trader buys office furniture for RM800 on credit. State the effect on the equation.
Answer
Furniture (an asset) rises by 800 and creditors (a liability) rise by 800. Assets and liabilities plus capital both rise by 800. Capital does not change, because no profit or owner’s money is involved.
What to study next
Go to tracing a returned item without reversing unrelated entries, or test yourself on the integrated practice.
If you want a teacher to hear you state each effect, see online one-to-one Accounting tuition.