Accounting Equation

Accounting equation is a basic concept of agreement between left-hand and right-hand site and starting pint of double entry. Double entry bookkeeping states that for every debit entry there should be pass a credit entry. Every transaction has twofold effect; this concept has a result of Balance Sheet Equation or Fundamental Equation. At any point of time total assets must be equal to equities. In other words we can say that left hand side which is resource side must be equal to right hand side which is of course source side.

The two basic elements of a business are what it owns and what it owes. Assets are the resources a business owns. For example, ABC Ltd. has total assets of approximately Rs. 50.5 billion. Liabilities and owner’s equity are the rights or claims against these resources. Thus, ABC Ltd. has Rs. 50.5 billion of claims against its Rs. 50.5 billion of assets. Claims of those to whom the company owes money (creditors) are called liabilities. Claims of owners are called owner’s equity. ABC Ltd. has liabilities of Rs. 20 billion and owners’ equity of Rs. 30.5 billion. We can express the relationship of assets, liabilities, and owner’s equity as an equation, as shown:

 Asset =  Liabilities + Owner Equity

Or

Assets = Equities / Claims

Or

Resources = Sources

Or

 Left hand side = Right hand side

This relationship is the basic accounting equation. Assets must equal the sum of liabilities and owner’s equity. Liabilities appear before owner’s equity in the basic accounting equation because they are paid first if a business is liquidated. The accounting equation applies to all economic entities regardless of size, nature of business, or form of business organization. The equation provides the underlying framework for recording and summarizing economic events.

Different Presentation of Accounting Equation

There are different style of presentation mention below for balance sheet equation:

The accounting equation as a statement of financial position may be expressed as:

Assets minus Liabilities equal Ownership interest; the ownership interest is the residual claim after liabilities to third parties have been satisfied. The equation expressed in this form emphasizes that residual aspect. Another way of thinking about an equation is to imagine a balance with a bucket on each end. In one bucket are the assets (A) minus liabilities (L). In the other is the ownership interest (OI). If anything happens to disturb the assets then the balance will tip unevenly unless some matching disturbance is applied to the ownership interest. If anything happens to disturb the liabilities then the balance will tip unevenly unless some matching disturbance is applied to the ownership interest. If a disturbance applied to an asset is applied equally to a liability, then the balance will remain level.

Four Effects of Transactions

Accounting Transaction is broadly classified into four categories:

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Accounting Equation Examples

Example # 1:

For each of the following transactions indicate the effects i.e. (Increase, Decrease, Conversion or No Effect)?

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Example # 2:

From the list of accounts below, determine which assets are and which equities are.  List the assets under the Asset Column and the equities under the equities Column.  Then add each column and complete the Fundamental Accounting Equation?

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Example # 3:

For each of the following equations, a figure is missing.  In the space provided, please supply the missing figure that will balance the equation.

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Expanded Accounting Equation

The Expanded Accounting Equation of sole proprietorship and partnership is Accounting Equation (Assets = Liabilities + Owner’s Equity) – Expenses + Revenue – Drawings Account.

In case of company business the expanded accounting equation in the balance sheet equation (Assets = Liabilities + Stockholders’ Equity) with replacement of Stockholders’ Equity with Paid-in Capital – Expenses + Revenues – Treasury Stock – Dividends.

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