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Accounting Equation|Sale of Goods and Calculation of Net Worth (Owner’s Equity) Or Capital

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  • Last Updated : 20 Jun, 2022

Every business unit sells goods for cash or on credit and sometimes at a profit or loss accordingly. When a good is sold either at a profit or a loss, along with asset and liability accounts, the capital account is also affected simultaneously. In the case of profit, the amount of profit is added to the capital account and vice versa. This can be understood by the following transactions: 

Sale of Goods:

When a firm sells goods for cash at a profit, three accounts are affected simultaneously, i.e., the stock account is reduced by the cost price of the goods, the cash account is increased by the selling price, and the excess amount of profit is added up to the capital account.

(A) Sale of Goods for Cash at Profit:

Transaction 1: Sold goods for cash (costing ₹10,000) at ₹14,000.

Solution: The stock (asset) is reduced by ₹10,000, the Cash account (asset) is increased by ₹14,000, and the amount of profit ₹4,000 is added to the capital account. 

 

Assets

=

Liabilities

+

Capital

 

Cash

+

Stock

=

0

+

Capital

Transaction 1

14,000

+

(10,000)

=

0

+

4000

Equation

14000

+

(10,000)

=

0

+

4000

(B) Sale of Goods for Cash at Loss:

Whenever goods are sold at price lower than the cost price, the stock is decreased by the amount of the cost price, the cash account is increased by the discounted amount, and the amount of loss is adjusted against the capital account.

Transaction 2: Goods worth ₹15,000, sold for ₹13,000.

Solution: The above transaction reduces the Stock (Asset) by ₹15,000, increases the Cash Account (Asset) by ₹13,000, and the amount of loss, i.e., ₹2,000 is adjusted against the Capital account.

 

Assets

=

Liabilities

+

Capital

 

Cash 

+

Stock

=

0

+

Capital

Transaction 2

13,000

+

(15,000)

=

0

+

(2,000)

Equation

13,000

+

(15,000)

=

0

+

(2,000)

(C) Sale of Goods on Credit at Profit:

When the goods are sold at profit on a credit basis, three accounts namely, the Stock Account, the Debtors Account and the Capital Account are affected.

Transaction 3: Goods worth ₹20,000 sold to Ms. Kaddu at ₹25,000.

Solution: This transaction reduces the Stock Account (asset) by ₹20,000, the Debtors Account (Asset) is increased by ₹25,000, and the amount of profit of ₹5,000 is added up to the Capital Account.

 

Assets

=

Liabilities

+

Capital

 

Stock

+

Debtors

=

0

+

Capital

Transaction 3

(20,000)

+

25,000

=

0

+

5,000

Equation

(20,000)

+

25,000

=

0

+

5,000

(D) Sale of Goods on Credit at a Discount:

When the goods are sold at a discount on a credit basis, the Stock account is reduced by the amount of the cost price, the debtors of the firm are increased by the amount of the selling price, and the amount of discount allowed, is adjusted with the capital account.

Transaction 4: Goods of ₹16,000 is sold to Mr. Golu for ₹14,000.

Solution:  As the effect of the above transaction, Stock (asset) is reduced by ₹16,000, the Debtor’s Account is increased by ₹14,000, and the loss of ₹2,000 is adjusted against the Capital Account.

 

Assets

=

Liabilities

+

Capital

 

Stock

+

Debtors

=

0

+

Capital

Transaction 4

(16,000)

+

14,000

=

0

+

(2,000)

Equation

(16,000)

+

14,000

=

0

+

(2,000)

Sample Question:

Prepare ‘ Accounting Equation’ from the following:

  1. Kaddu started a business with Cash of ₹5,00,000 and Stock of ₹2,00,000.
  2. Purchased goods for Cash ₹50,000.
  3. Sold goods for Cash (costing ₹20,000) for ₹35,000.
  4. Sold goods to Chitra  (costing ₹52,000) for ₹60,000.
  5. Received ₹59,000 from Chitra in full settlement.
  6. Sold goods for Cash worth ₹50,000 at ₹45,000.
  7. Sold goods worth ₹5,000 to Kirti at a discount of 10%.

Solution:

No.

Transactions

Assets

=

Liabilities

+

Capital

 

 

Cash

+

Stock

+

Debtors

=

Liabilities

+

Capital

1.

Started business with cash and stock

5,00,000

+

2,00,000

+

0

=

0

+

7,00,000

 

Equation

5,00,000

+

2,00,000

+

0

=

0

+

7,00,000

2.

Cash purchase

(50,000)

+

50,000

+

0

=

0

+

0

 

New Equation

4,50,000

+

2,50,000

+

0

=

0

+

7,00,000

3.

Cash sale at a profit

35,000

+

(20,000)

+

0

=

0

+

15,000

 

New Equation

4,85,000

+

2,30,000

+

0

=

0

+

7,15,000

4.

Credit sale at a profit 

0

+

(52,000)

+

60,000

=

0

+

8,000

 

New Equation

4,85,000

+

1,78,000

+

60,000

=

0

+

7,23,000

5.

Received cash in full settlement

59,000

+

0

+

(60,000)

=

0

=

(1,000)

 

New Equation

5,44,000

+

1,78,000

+

0

=

0

+

7,22,000

6.

Cash sale at a discount 

45,000

+

(50,000)

+

0

=

0

+

(5,000)

 

New Equation

5,89,000

+

1,28,000

+

0

=

0

+

7,17,000

7.

Credit sale at a discount of 10%

0

+

(5,000)

+

4,500

=

0

+

(500)

 

New Equation

5,89,000

+

1,23,000

+

4,500

=

0

+

7,16,500

Calculation of Net Worth (Owner’s Equity) Or Capital:

The net worth of the firm, also known as Owner’s Equity or the Capital of the firm is the right of the owner over the business. In simple, it is the ownership claim over the assets of the business.

Formula:

Asset = Liability + Capital

Therefore,

Capital = Asset − Liability

 Or

Net Worth = Total Equity − Liability

Case A: When the value of Total Asset and Total Liabilities is given.

Example 1: If the Total Assets of the firm is ₹2,00,000 and the Total Liabilities is ₹80,000. Calculate the Net Worth of the firm.

Solution: 

Capital = Asset − Liability, therefore;

Net Worth = 2,00,000 − 80,000

Net Worth = ₹1,20,000.

Case B: When the Opening Capital, Closing Assets, and Closing Liabilities are given, and the Closing Capital is to be calculated along with the Profit of the given year.

Closing Capital = Closing Assets  − Closing Liability

Or

Closing Capital = Opening Capital + Additional Capital + Profit  − Drawings

Profit = Closing Capital − Opening Capital

Example 2: A business was started on 1st April, 2020 with a capital of ₹5,00,000. On 31st March, 2021, the Assets were valued at ₹8,00,000 and Liabilities stood to be ₹70,000. Find out the closing capital and the profit of the year.

Solution:

Closing Capital = Closing Asset  − Closing Liability, therefore;

Closing Capital = 8,00,000 −70,000

Closing Capital = 7,30,000.

Now,

Profit = Closing Capital − Opening Capital

Profit = 7,30,000 −5,00,000

 Profit = ₹2,30,000.

Case C: Calculation of Closing Capital and Profit when Additional Capital and Drawing are given.

Closing Capital = Closing Asset  − Closing Liability

Profit = Closing Capital + Drawing − Additional Capital −Opening Capital

Example 3: Mohan started a business on 1st April, 2021 with cash ₹10,00,000. He took a loan of ₹2,00,000 during the year and on 31st March, 2022, the Total Asset stood to be ₹15,00,000. He further added ₹2,00,000 as capital on 30th June, 2021, and withdrew ₹10,000 during the year. Calculate Closing Capital and the profit earned during the year.

Solution:

Closing Capital = Closing Asset  − Closing Liability, therefore;

Closing Capital = 15,00,000 −2,00,000

Closing Capital = 13,00,000

Now,

Profit = Closing Capital + Drawing − Additional Capital − Opening Capital, therefore;

Profit = 13,00,000 + 10,000 − 2,00,000 −10,00,000

Profit = ₹1,10,000.


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