# Effects of Transactions on Accounting Equation

Understanding how different transactions impact the accounting equation is critical for keeping the accounting books neat and tidy.

This post explains everything you need to know about the effects of different types of business transactions on the accounting equation using examples and quizzes.

## How Transactions Affect the Accounting Equation

How a transaction impacts the accounting equation depends on the type of the two or more accounts involved (assets, liabilities, or equity). Some transactions don’t affect the accounting equation because they increase and decrease multiple accounts of the same type (e.g., assets).

Whenever a transaction is recorded in the accounting books, it has an equal effect on both sides of the accounting equation.

What that means is that if one side of the accounting equation changes because of a transaction, then the other side of the accounting equation has to change by the same amount so that the totals on both sides of the accounting equation always match.

For example, let’s say a business has assets worth \$50,000. equity of \$50,000 as well, and no liabilities. As you can tell, the accounting equation will show \$50,000 on both sides.

Now, if a business gets a \$10,000 loan from the bank, it will increase both sides of the accounting equation by increasing:

• The cash at bank account on the left side of the equation (assets) by \$10,000;
• The bank loan liability account on the right side of the equation (liabilities + equity) by \$10,000.

So the accounting equation after this transaction will be \$10,000 higher on both sides.

In this example, one account from each side of the accounting equation is changed by the same amount. This isn’t always the case, however.

Many accounting transactions do not change the accounting equation at all because two or more accounts of the same component of the equation (e.g., assets) are changed, which cancels out any effect on the overall equation.

An example of this would be the purchase of a delivery truck worth \$15000 in cash. Let’s continue from the previous example and assume assets of \$60,000, liabilities of \$10,000, and equity of \$50,000 before taking into account the effects of this transaction.

As you can probably tell, this transaction only concerns the left side of the accounting equation (assets).

This transaction will increase one type of asset (delivery truck) by \$15000 and decrease another asset (cash) by the same amount. The overall effect on the total assets is zero because the transaction has only changed the composition of the assets.

In other words, the accounting equation after this transaction is exactly the same as before.

The following sections state the effects of the different types of transactions on the accounting equation.

Notice that in none of the examples below does it happen that one side of the accounting equation changes while the other side remains the same or that one side is increasing while the other is decreasing.

For the accounting equation to work, the effect on both sides needs to always be equal, so you should always expect the changes to be parallel unless two or more accounts of the same side of the equation are affected.

## Transactions that Affect Assets and Liabilities

Type of Transaction Effects on Accounting Equation
Purchase of inventory on credit
Increase Assets, Increase Liabilities
Getting a loan from the bank
Increase Assets, Increase Liabilities
Repayment of a liability
Decrease Assets, Decrease Liabilities

## Transactions that Affect Assets and owner's Equity

Type of Transaction Effects on Accounting Equation
Capital contribution by the owners
Increase Assets, Increase Equity
Payment of dividends to shareholders
Decrease Assets, Decrease Equity
Owner drawings
Decrease Assets, Decrease Equity
Depreciation of assets
Decrease Assets, Decrease Equity
Decrease Assets, Decrease Equity
Sales revenue
Increase Assets, Increase Equity

## Transactions that Affect Liabilities and owner's Equity

Type of Transaction Effects on Accounting Equation
Interest payable on a loan
Increase Liabilities. Decrease Equity
Converting a loan liability into equity
Decrease Liabilities, Increase Equity
Accrued expenses
Increase Liabilities, Decrease Equity

These transactions only impact the right side of the accounting equation so the total assets will remain unchanged.

Unlike transactions listed in previous sections, the effects of these transactions work in opposite directions because the same side of the accounting equation is involved.

## Transactions that don't affect Accounting Equation

Type of Transaction Effects on Accounting Equation
Purchase of a fixed asset for cash
None
Transferring funds from one bank account to another one owned by the same business
None
Transferring the balance of retained earnings account to another equity reserve
None

## Quiz

#### How much do you know about The Effects of Transactions on the Accounting Equation?

Take the free quiz below and find out!

### Question 1

If a transaction decreases the total assets of a business, then the sum of its total liabilities and owner’s equity may or may not decrease depending on the nature of the transaction.

True

Incorrect.

False

Spot on!

If a transaction decreases the total assets of a business, then the right side of the accounting equation MUST reduce as well.

### Question 2

If the sum of liabilities and owner’s equity in the business is equal to \$100,000 after the purchase, what is the value of total assets?

\$90,000

Incorrect.

\$100,000

You're right!

Purchasing the car on credit will increase the total assets and total liabilities by \$10,000 each.

Total assets in the business will equal the sum of liabilities and equity after the transaction (i.e., \$100,000). The addition of the new car is already included in this value.

\$110,000

### Question 3

Which of the following transactions do not affect the accounting equation of a farmer?

A

Not correct.

Depreciation of the farm tractor will reduce the value of total assets and owner's equity.

B

Incorrect.

Although unpaid wages don't affect the total assets, it does impact the right side of the accounting equation by increasing liabilities and lowering the owner's equity.

C

Correct!

This transaction only replaces one asset (cash) with another asset (farm) which means that the total assets, liabilities, and equity should all remain unchanged.

### Question 4

Which of the following transactions will increase both the total assets and the total liabilities of a library?

A

Incorrect.

Preordering books will lower the amount of cash and increase the value of receivables. The total assets and liabilities remain the same as before.

B

Not correct.

Depreciation lowers the value of assets and has no effect on liabilities.

C

You're right!

Receiving advance subscription from customers increases the total assets of the library because of the inflow of cash, while at the same time increases the amount of its liabilities because of unearned revenue.

How many questions did you answer correctly?

4                      Master

3                        Pass