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Accounting · Theoretical Framework

Accounting Equation and Types of Accounts for CA Foundation

Updated 1 October 2026

The accounting equation is Assets = Liabilities + Capital. Every transaction keeps it balanced. Accounts are classed as personal, real or nominal, or as assets, liabilities, capital, income and expenses. To solve questions, classify each account, then debit increases in assets and expenses, and credit increases in liabilities, capital and income.

Understand Accounting Equation and Types of Accounts

Accounting records the money value of what a business owns and owes. What the business owns are assets. What it owes to outsiders are liabilities. What it owes to its owner is capital. Together they give the accounting equation: Assets = Liabilities + Capital.

This equation always balances because every asset is financed either by outsiders or by the owner. Each transaction has two effects, so the equation stays true. If you buy furniture for cash, one asset rises and another falls. If you buy goods on credit, an asset (stock) rises and a liability (creditors) rises by the same amount. This is the dual aspect concept.

To record the two effects, we use accounts. The traditional classification has three types. A personal account relates to a person or entity, such as Ravi, a bank, or a company. It can be natural, artificial or representative (like outstanding rent). A real account relates to things the business owns, such as cash, building or machinery. A nominal account relates to expenses, losses, incomes and gains, such as rent paid or commission received.

The traditional (golden) rules: Personal: debit the receiver, credit the giver. Real: debit what comes in, credit what goes out. Nominal: debit all expenses and losses, credit all incomes and gains.

The modern approach classifies accounts into assets, liabilities, capital, income and expenses. The rules are: debit increases in assets and expenses, credit increases in liabilities, capital and income. Decreases work in reverse. Both approaches give the same entry, so use whichever you find easier, but be consistent.

Key rules to remember

Accounting equation
Assets = Liabilities + Capital
Also written Capital = Assets − Liabilities. Must hold after every transaction.
Expanded equation with profit
Assets = Liabilities + Opening Capital + Additional Capital + Income − Expenses − Drawings
Profit raises capital. Drawings reduce it.
Traditional rule: personal account
Debit the receiver; credit the giver
Applies to persons, firms, companies, banks and representative personal accounts.
Traditional rule: real account
Debit what comes in; credit what goes out
Applies to cash, stock, building, machinery and other assets.
Traditional rule: nominal account
Debit all expenses and losses; credit all incomes and gains
Applies to rent, salaries, interest, discount, commission and similar items.
Modern rules
Assets: Dr increase, Cr decrease | Liabilities and Capital: Cr increase, Dr decrease | Expenses: Dr increase | Income: Cr increase
Total debits always equal total credits for each transaction.

How to solve Accounting Equation and Types of Accounts questions

Use this method for any question on the equation, classification of accounts or the debit-credit rules.

  1. 1Read the transaction and list the two accounts affected. Every transaction has at least two.
  2. 2Classify each account: asset, liability, capital, income or expense. Also note personal, real or nominal if the question asks.
  3. 3Decide whether each account increases or decreases.
  4. 4Apply the rule. Debit increases in assets and expenses and decreases in liabilities, capital and income. Credit the opposite.
  5. 5Check that total debit equals total credit.
  6. 6For equation questions, test: Assets = Liabilities + Capital, after the transaction.
  7. 7Write the answer clearly with the account name, its type and Dr or Cr.

Quickest way: Two-question shortcut

When to use it: Use when you must give the nature of an account or the debit and credit side fast in an exam.

  1. Ask first: is it a person, a thing or an income or expense? That gives personal, real or nominal.
  2. Watch the exception: outstanding and prepaid items and accrued income are representative personal accounts, even though they are also liabilities or assets. Do not class them as real or nominal.
  3. Ask next: did it increase or decrease?
  4. For assets and expenses, increase means debit. For liabilities, capital and income, increase means credit.
  5. Remember outstanding expenses are liabilities, and prepaid expenses and accrued income are assets.
  6. Do a quick equation check: the equation stays balanced because the two effects offset each other. If only one side changes, the other side must change by an equal amount.

Common mistakes in Accounting Equation and Types of Accounts

  • Treating drawings as an expense

    Money leaves the business, so it looks like a cost.

    Fix: Drawings reduce capital. They are not an expense and are not charged to profit.

  • Calling an account personal just because it has a person's name, such as 'Rent paid to Ravi'

    Students look at the name, not the nature.

    Fix: Rent paid is a nominal account. Ravi's account would only appear if rent is owed to him.

  • Reversing debit and credit for the receiver and giver

    Mixing up the rules for personal and real accounts.

    Fix: Say it aloud: personal means debit the receiver; real means debit what comes in.

  • Treating accounts like Outstanding Salary or Prepaid Insurance as nominal

    The words salary and insurance suggest expenses.

    Fix: Both are representative personal accounts, not nominal. Outstanding salary is a liability. Prepaid insurance is an asset.

  • Thinking capital increases only through cash

    Students forget profit and other contributions.

    Fix: Capital rises by fresh investment in cash or assets and by profit. It falls with drawings and losses.

  • Forgetting that the equation still balances after a loss or expense

    Students think expenses break the equation.

    Fix: An expense reduces capital (through profit) and reduces an asset or raises a liability by the same amount.

Worked examples

Example 1

Mohan starts a business with cash ₹5,00,000. He buys furniture for ₹80,000 in cash, buys goods on credit from Sita for ₹1,20,000, and pays rent of ₹10,000 in cash. Show the effect on the accounting equation after each transaction.

Show the solution
  1. Start: Cash ₹5,00,000 = Capital ₹5,00,000.
  2. Furniture for cash: Furniture +₹80,000, Cash −₹80,000. Assets = ₹4,20,000 cash + ₹80,000 furniture = ₹5,00,000. Liabilities nil, Capital ₹5,00,000.
  3. Goods on credit: Stock +₹1,20,000, Creditors +₹1,20,000. Assets = ₹4,20,000 + ₹80,000 + ₹1,20,000 = ₹6,20,000. Liabilities ₹1,20,000 + Capital ₹5,00,000 = ₹6,20,000.
  4. Rent paid: Cash −₹10,000 and Capital −₹10,000 (expense reduces profit). Assets = ₹4,10,000 + ₹80,000 + ₹1,20,000 = ₹6,10,000. Liabilities ₹1,20,000 + Capital ₹4,90,000 = ₹6,10,000.

Answer: Final position: Assets ₹6,10,000 = Liabilities ₹1,20,000 + Capital ₹4,90,000.

Example 2

Classify each account as personal, real or nominal and state which side is debited or credited: (a) goods purchased for cash ₹20,000, (b) commission received ₹5,000 in cash, (c) cash paid to Rekha, a creditor, ₹15,000.

Show the solution
  1. (a) Accounts are Purchases and Cash. Purchases A/c is treated as an expense, so it is a nominal account. Under 'debit all expenses and losses', it is debited. Cash is real and goes out, so it is credited.
  2. (b) Accounts are Cash and Commission Received. Cash is real and comes in, so debit Cash ₹5,000. Commission received is a nominal income account, so credit it.
  3. (c) Accounts are Rekha and Cash. Rekha is personal and is the receiver, so debit Rekha ₹15,000. Cash is real and goes out, so credit Cash. Rekha is a liability and falls, so debit agrees with the modern rule.

Answer: (a) Dr Purchases (nominal) ₹20,000, Cr Cash (real) ₹20,000. (b) Dr Cash (real) ₹5,000, Cr Commission Received (nominal) ₹5,000. (c) Dr Rekha (personal) ₹15,000, Cr Cash (real) ₹15,000.

Exam tips

  • In subjective answers, show each account with its type in brackets, as in 'Cash A/c (real)'. It earns step marks.
  • Learn the equation in both forms and write the figures in a small table after each transaction.
  • Questions often hide traps like outstanding expenses, prepaid items and drawings. Classify these carefully.
  • Check that every entry has equal debits and credits before moving on.
  • If the question asks for the rule, state the rule first and then apply it.

Practice questions from Theoretical Framework

Accounting Equation and Types of Accounts: frequently asked questions

What is the accounting equation in CA Foundation?

It is Assets = Liabilities + Capital. It shows that everything a business owns is financed by outsiders or by the owner. It stays balanced after every transaction.

Do I have to use the golden rules or the modern rules?

Either is accepted, as both give the same entry. Pick the one you find easier and use it consistently. If the question names a method, follow it.

Is drawings a personal, real or nominal account?

Drawings is a deduction from capital. It is not an expense. Under the traditional classification it is generally treated as the owner's personal account, and it is debited when the owner withdraws money or goods.

Are outstanding expenses assets or liabilities?

They are liabilities, because the business owes the amount. Prepaid expenses are assets, because the business has paid in advance for a future benefit.