Accounting Equation :

Total Assets = Total Liabilities

Or 

Total Assets = Internal Liabilities + External Liabilities

Or 

Total Assets = Capital + Liabilities

Accounting equation signifies that the assets of a business are always equal to the total of its liabilities and capital (owner’s equity).

A = L + C
Where,
A = Assets
L = Liabilities
C = Capital

Now, 

(i) A – L = C
(ii) A – C = L

The accounting equation depicts the fundamental relationship among
the components of the balance sheet, it is also called the Balance Sheet Equation.

⇒ The balance sheet is a statement of assets, liabilities and capital.

⇒ The claim of the proprietors is called capital and that of the outsides is known as liabilities.

⇒ Each element of the equation is the part of balance sheet, which states the financial position of the business on a particular date.

⇒ When we analyse the transactions, we actually try to know that how balance sheet of a business entity gets affected.

⇒ Asset side of the balance sheet is the list of assets, which the business entity owns.

⇒ The liabilities side of the balance sheet is the list of owner’s claims and outsider’s claims, i.e., what the business entity owes.

⇒ The equality of the assets side and the liabilities side of the balance sheet is an undeniable fact and this justifies the name of accounting equation as balance sheet equation also.

Classification of Transactions:

Following are the nine basic transactions:

(1) Increase in assets with corresponding increase in capital.

(2) Increase in assets with corresponding increase in liabilities.

(3) Decrease in assets with corresponding decrease in capital.

(4) Decrease in assets with corresponding decrease in liabilities.

(5) Increase and decrease in assets.

(6) Increase and decrease in liabilities

(7) Increase and decrease in capital

(8) Increase in liabilities and decrease in capital

(9) Increase in capital and decrease in liabilities. 

Example: Rohit started business with a capital of Rs. 5,00,000.

Solution: 

From the accounting point of view we see:

(i) The resources of this business entity is in the form of cash, i.e., Rs. 5,00,000.

(ii) Sources of this business entity is the contribution by Rohit (Proprietor) Rs. 5,00,000 as Capital .

"In the above balance sheet, the total assets are equal to the liabilities of the business."

 Example 1.
1. Opened a bank account in State Bank of India with an amount of
Rs. 4,80,000.
Analysis of transaction: This transaction increases the cash in hand
(assets) and decreases cash (asset) by Rs. 4,80,000.
2. Bought furniture for Rs. 60,000 and cheque was issued on the same day.
Analysis of transaction: This transaction increases furniture (assets) and
decreases bank (assets) by Rs. 60,000.
3. Bought plant and machinery for the business for Rs. 1,25,000 and an advance of Rs. 10,000 in cash is paid to M/s Ramjee Lal.
Analysis of transaction: This transaction increases plant and machinery
(assets) by Rs. 1,25,000, decreases cash by Rs. 10,000 and increases
liabilities (M/s Ramjee lal as creditor)by Rs. 1,15,000.

4. Goods purchased from M/s Sumit Traders for Rs. 55,000.
Analysis of transaction: This transaction increases goods (assets) and
increases liabilities (M/s Sumit Traders as creditors) by Rs. 55,000.
5. Goods costing Rs. 25,000 sold to Rajani Enterprises for Rs. 35,000.
Analysis of transaction: This transaction decreases stock of goods (assets) by Rs. 25,000 and increases assets (Rajani Enterprises as debtors Rs. 35,000) and capital (with the profit of Rs. 10,000)

Solution: 

In terms of accounting equation
A = L + C
Rs. 6,80,000 = Rs. 1,70,000 + Rs. 5,10,000