The Accounting Equation

Question 1

The accounting equation is correctly expressed as:
A) Assets + profits - drawings - liabilities = closing capital
B) Assets - liabilities - drawings = opening capital + profit
C) Assets - liabilities - opening capital + drawings = profit
D) Opening capital + profit - drawings - liabilities = assets

Answer 1

C) Assets - liabilities - opening capital + drawings = profit

The accounting equation is most commonly expressed as assets = capital + liabilities.
Capital can be expanded to Opening capital + profit - drawings. This can then be rearranged as Assets - liabilities - opening capital + drawings = profit.

Question 1

The capital of a sole trader would change as a results of:
A) a credit customer paying by bank transfer
B) raw materials being purchased on credit
C) non-current assets being purchased on credit
D) personal petrol being paid for out of the business’s petty cash

Answer 1

D) personal petrol being paid for out of the business’s petty cash

Personal petrol is a drawing rather than an expense of the business. The petrol costs being paid in petty cash means assets decrease and drawings increase, which decreases capital. Option A is a transaction that involves assets only, while options B & C increase assets and increase liabilities.

Question 2

A business can make a profit and yet have a decreased bank balance. Which of the following might cause this to happen?
A) The sale of non-current assets at a loss
B) The charging of depreciation in the statement of profit or loss
C) The lengthening of the period of credit given to customers
D) The lengthening of the period of credit taken from suppliers

Answer 2

C) The lengthening of the period of credit given to customers

Extending the credit period given to customers means that while there are increased profits as the level of sales increases, it takes longer to collect cash from those customers.

Question 3

The purpose of the financial statement that lists an entity’s total assets and total capital and liabilities is to show:
A) the financial performance of the entity over a period of time
B) the amount the entity could be sold for in liquidation
C) the amount the entity could be sold for as a going concern
D) the financial position of the entity at a particular time

Answer 3

D) the financial position of the entity at a particular time

A defines the statement of profit or loss, B 7 C suggest that the statement of financial position represents a valuation which is incorrect, while D is correct in that it is the definition of a statement of financial position’s purpose.

Question 4

A sole trader is £5,000 overdrawn at their bank and receives £1,000 from a credit customer in respect of its account. Which element(s) of the accounting equation will change due to this transaction?
A) Assets and liabilities only
B) Liabilities only
C) Assets only
D) Assets, liabilities and capital

Answer 4

A) Assets and liabilities only

The overdraft (liability) will decrease and receivables (assets) will decrease by an equal amount.

Question 5

A soler trader purchases goods on credit. Which element(s) of the accounting equation will change due to this transaction?
A) Assets and liabilities
B) Assets and capital
C) Capital and liabilities
D) Assets only

Answer 5

A) Assets and liabilities

Assets will increase as the sole trader has acquired inventory (asset), and payables (liability) will increase as the goods were purchased on credit.

Question 6

A sole trader borrows £10,000 from a bank. Which element(s) of the accounting equation will change due to this transaction?
A) Assets and liabilities
B) Assets and capital
C) Capital and liabilities
D) Assets only

Answer 6

A) Assets and liabilities

The bank account (asset) will increase on receipt of the loan funds, and liabilities will increase as the loan is a liability.

Question 7

A sole trader sells goods for cash for £500 which had cost of £300. Which element(s) of the accounting equation will change due to this transaction?
A) Assets and liabilities
B) Assets and capital
C) Capital and liabilities
D) Assets only

Answer 7

B) Assets and capital

Assets will increase as there is an increase in the cash of £500 and a decrease in the inventory of only £300, and capital will increase due to the profit of £200.

Question 8

A sole trader increases the business’s number of motor vehicles by adding their own car to the business’s fleet. Which element(s) of the accounting equation will change due to this transaction?
A) Assets only
B) Capital only
C) Assets and capital
D) Assets and liabilities

Answer 8

C) Assets and capital

The car increases assets and it is treated as capital introduced to the business by its proprietor.

Question 9

Which three of the following are elements of financial statements as identified by the Conceptual Framework for Financial Reporting?
A) Income
B) Expenses
C) Profits
D) Losses
E) Obligations
F) Resources
G) Equity

Answer 9

A) Income + B) Expenses + G) Equity

According to the Conceptual Framework for Financial Reporting, income, expenses and equity are elements of financial statements. The Conceptual Framework for Financial Reporting also identifies assets and liabilities as elements of financial statements.