Balance Sheet Equation | PAPER III – ACCOUNTING & FINANCIAL MANAGEMENT FOR BANKERS | MODULE B: FINANCIAL STATEMENTS AND CORE BANKING SYSTEMS

Balance Sheet Equation and Its Computation

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1. Concept of Balance Sheet Equation

The Balance Sheet Equation is a fundamental principle in accounting and banking. It establishes a relationship between the assets owned by a bank and the claims against those assets in the form of liabilities and capital (owner’s equity).

The equation is represented as:

Assets = Liabilities + Capital (Owner’s Equity)

This equation must always balance. It forms the foundation of preparing a balance sheet, which shows the financial position of a bank or business at a given point in time.

2. Explanation of Components

• Assets: Resources owned by the bank (e.g., cash, loans, buildings).
• Liabilities: Obligations to outsiders (e.g., customer deposits, borrowings).
• Capital: The owner’s claim or equity in the business.

3. Example of Balance Sheet Equation

A bank has the following:

• Cash: ₹5,00,000
• Loans given: ₹10,00,000
• Deposits from customers: ₹12,00,000
• Borrowings: ₹2,00,000

Compute the Capital.

Solution:

Total Assets = Cash + Loans = ₹5,00,000 + ₹10,00,000 = ₹15,00,000

Total Liabilities = Deposits + Borrowings = ₹12,00,000 + ₹2,00,000 = ₹14,00,000

Capital = Assets - Liabilities = ₹15,00,000 - ₹14,00,000 = ₹1,00,000

4. Mathematical Illustration

Let: A = Assets, L = Liabilities, C = Capital

If A = ₹20,00,000 and L = ₹17,00,000

Then C = A - L = ₹20,00,000 - ₹17,00,000 = ₹3,00,000

Rewritten equation: ₹20,00,000 = ₹17,00,000 + ₹3,00,000 ✅

5. Importance in Banking

The Balance Sheet Equation is critical in banking for preparing accurate financial statements and assessing the financial health of a bank. Regulators also use this equation to monitor solvency and capital adequacy.

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Multiple Choice Questions (MCQs)

1. What is the correct balance sheet equation?
A) Assets = Capital - Liabilities
B) Assets = Liabilities - Capital
C) Assets = Liabilities + Capital
D) Assets + Liabilities = Capital
Answer: C

2. If a bank has assets worth ₹25 lakh and liabilities worth ₹18 lakh, what is the capital?
A) ₹7 lakh
B) ₹43 lakh
C) ₹18 lakh
D) ₹25 lakh
Answer: A

3. If assets and liabilities are equal, then capital is:
A) Zero
B) Positive
C) Equal to liabilities
D) Cannot be determined
Answer: A

4. The balance sheet equation is also known as:
A) Banking equation
B) Accounting equation
C) Net worth equation
D) Audit equation
Answer: B

5. Which of the following increases both assets and liabilities?
A) Owner investing capital
B) Purchase of goods on credit
C) Repayment of loan
D) Payment of salary
Answer: B

6. If liabilities are ₹50 lakh and capital is ₹10 lakh, what are the assets?
A) ₹60 lakh
B) ₹40 lakh
C) ₹10 lakh
D) ₹50 lakh
Answer: A

7. Which component is considered an obligation to outsiders?
A) Asset
B) Capital
C) Liability
D) Equity
Answer: C

8. A bank lends ₹5 lakh to a customer. What is the effect?
A) Increase in liability
B) Increase in asset
C) Decrease in capital
D) No effect
Answer: B

9. Which of the following would not affect the balance sheet equation?
A) Owner introduces capital
B) Goods purchased on cash
C) Cash withdrawn for personal use
D) Loss due to fire
Answer: B

10. Which of the following is true about the balance sheet?
A) Shows income and expenses
B) Prepared for a specific period
C) Shows financial position on a particular date
D) Only for internal use
Answer: C