Which parts of the accounting equation do a service rendered on account affect?

The accounting equation illustrates the relationship between a company’s assets and the claims that creditors and investors have on those assets. The equation is the basic structure on which a company’s accounting is based. The collection of cash can affect different parts of the accounting equation, depending on the type of transaction.

About the Accounting Equation

As Accounting Coach explains, the accounting equation offers a simple way to assess how assets, liabilities and equity relate to each other. The formula is: assets equal liabilities plus stockholders’ equity. Assets are a business’ resources. Liabilities are debts a business owes another party. In a sole proprietorship, in which there is one owner, stockholders’ equity is called owner’s equity. This is the claim investors have on a business’ assets. Stockholders’ equity consists of money a company’s owners have invested in the company and profits the company has retained.

A Balanced Accounting Equation

Each account in a company’s accounting records affects one of the three parts of the accounting equation. A business increases or decreases two or more accounts in its records for every business transaction it makes. A transaction may affect accounts on only one side of the equation or on both sides of the equation, but the amounts a business records must keep the accounting equation in balance so that the left side equals the right side.

Collection of Cash from a Sale

When your small business collects cash from a customer at the time of a sale, your cash account increases by the amount collected and your revenue account increases by the same amount. Cash is an asset account. Revenue increases stockholders’ equity. This increases the left side and right side of the accounting equation by the same amount, which keeps it in balance. For example, if you collect cash for a $500 sale, assets and stockholders’ equity each increase by $500.

Collection of Cash from an Account Receivable

Accounts receivable is an asset account and is the money customers owe you for extending them credit on previous sales. When the company receives cash from an accounts receivable, your cash account increases by the amount of the collection and the accounts receivable account decreases by the same amount. Because one asset increases and another decreases by the same amount, the accounting equation remains unchanged and in balance, suggests Principles of Accounting. For example, if you collect $100 from an account receivable, cash increases by $100 and accounts receivable decreases by $100.

The accounting equation is the unifying concept in accounting that shows the relationships between and among the accounting elements: assets, liabilities, and capital.

In this lesson (and the next ones), you will learn about the basic accounting equation and how it stays in balance.

Before taking this lesson, be sure to be familiar with the accounting elements.

Basic Accounting Equation

The basic accounting equation is:

Assets = Liabilities + Capital

When a business is put up, its resources (assets) come from two sources: contributions by owners (capital) and those acquired from creditors or lenders (liabilities). In other words, all assets initially come from liabilities and owners' contributions.

As business transactions take place, the values of the accounting elements change. The accounting equation nonetheless always stays in balance.

Every transaction has a two-fold effect. Meaning, at least two accounts are affected. Let's illustrate all of that through these examples.

Assume the following transactions:

Mr. Alex invested $20,000 to start a printing business,

The company obtained a loan from a bank, $30,000,

The company purchased printers and paid a total of $1,000.

How will the transactions affect the accounting equation?

Let us take a look at transaction #1:

Again, every transaction has a two-fold effect. In the above transaction, Assets increased as a result of the increase in Cash. At the same time, Capital increased due to the owner's contribution. Remember that capital is increased by contribution of owners and income, and is decreased by withdrawals and expenses. No liability is affected hence, stays at zero.

Let's continue with transaction #2:

In transaction #2, the company received cash. Thus, the value of total assets is increased. At the same time, it incurred in an obligation to pay the bank. Therefore, liabilities are increased. The liability in this case is recorded as Loans Payable.

Notice that the accounting equation is still equal (balanced).

Let's add transaction #3:

The company acquired printers, hence, an increase in assets. However, the company used cash to pay for the printers. Thus, it also results in a decrease in assets. Transaction #3 results in an increase in one asset (Service Equipment) and a decrease in another asset (Cash).

For those who are new to accounting format: The parentheses "()" around the 1,000 amount above means "minus" or "less".

Liabilities and capital are not affected. Still, the equation in the third transaction is equal.In this case, it has zero effect on both sides.

At this point, the balance of total assets is $50,000. The combined balance of liabilities and capital is also at $50,000.

The accounting equation is (and should always be) in balance.

To help you better understand how the accounting equation works and stays in balance, here are more sample transactions and their effects to the accounting equation.

In addition to transactions 1, 2 and 3 in the previous lesson, assume the following data:

Rendered services and received the full amount in cash, $500

Rendered services on account (receivable from customer), $750

Purchased office supplies on account (payable to supplier), $200

Had some equipment repaired for $400, to be paid after 15 days

Mr. Alex, the owner, withdrew $5,000 cash for personal use

Paid one-third of the loan obtained in transaction #2

Received customer payment from services in transaction #5

The transactions will result to the following effects:

Examples Explained

The company received cash for services rendered. Cash increased thereby increasing assets. At the same time, capital is increased as a result of the income(Service Revenue). As we've mentioned in the Accounting Elements lesson, income increases capital.

The company rendered services on account. The services have been rendered, hence, already earned. Thus, the $750 worth of services rendered is considered income even if the amount has not yet been collected. Since the amount is still to be collected, it is recorded as Accounts Receivable, an asset account.

Office supplies worth $200 were acquired. This increases the company's Office Supplies, part of the company's assets. The purchase results in an obligation to pay the supplier; thus a $200 increase in liability (Accounts Payable).

The company incurred in $400 Repairs Expense. Expenses decrease capital. The amount has not yet been paid. Thus, it results in an increase in total liabilities.

The owner withdrew $5,000 cash. Cash is decreased thereby decreasing total assets. Withdrawals or drawings decrease capital.

One-third of the $30,000 loan was paid. Therefore, Cash is decreased by $10,000 as a result of the payment. And, liabilities are decreased because part of the obligation has been settled.

The $750 account in a previous transaction has been collected. Therefore, theAccounts Receivable account is decreased and Cash is increased.

Notice that every transaction results in an equal effect to assets and liabilities plus capital. The beginning balances are equal. The changes arising from the transactions are equal. Therefore, the ending balances would still be equal.

The balance of the total assets after considering all of the above transactions amounts to $36,450. It is equal to the combined balance of total liabilities of $20,600 and capital of $15,850 (a total of $36,450).

Assets = Liabilities + Capital is a mathematical equation. Using algebra, the formula can be rewritten to get other versions of the equation.

Liabilities = Assets - Capital

Capital = Assets - Liabilities

How does services rendered affect the accounting equation?

What is the effect of rendered services on account?

What happens in the accounting equation when you provide a service on account?