The accounting equation has often been referred as the foundation of accounting system with double entry. The accounting equation is shown on the balance sheet of the company whereas the sum of the all the liability and the equity of the shareholders is equal to total asset of the company. The balance sheet remains balanced with the help of this double entry in the accounting equation. All the entry that has been made in the debit side of the balance sheet should also be made in the credit side as well.
Examples of the Accounting Equation:
For the particular year that is going on , let us take example a leading retailer ABC Corporation created such a report on its balance sheet:
- Total liabilities: $120 billion
- Total assets: $170 billion
- Total shareholders’ equity: $50 billion
If the right-hand side of this accounting equation is calculated that is (equity + liabilities), the sum that is concluded is ($50 billion + $120 billion) = $170 billion, and it matches the asset value of the company.
A Mobile Corporation’s balance in September 30, 2018:
- Total liabilities were $157,797
- Total assets were $354,628
- Total equity was $196,831
The accounting equation therefore stands as assets = shareholders’ equity + total liability is calculated like this
Accounting equation = $196,831 (equity) + $157,797 (total liabilities) equals $354,628, and it equals to the total value of the asset of the company
The Accounting Equations and What It Mean?
The equation of Assets= Owner’s Equity + Liability
The balance sheet is the basis of this accounting equation:
- Locating the total asset of the company for a period on the balance sheet.
- The total liability of the company should be present in a separate list.
- Locating the equity of total shareholder and adding the total number of liabilities.
- Total liability and equity should be equal to total assets
No matter how small or big the business is their financial assessment is done basing on two important components in the balance sheet liabilities and assets. Shareholders’ equity, or owner’s equity is present in the balance sheet in the third section. The accounting equation represents how three important factors are related to one another. The accounting equation is also known as the balance sheet equation or basic accounting equation
Assets are used for representing all the assets and other resources which are owned by the company, and all the obligations of the companies are represented by its liabilities. Both of the liabilities and the equity of the shareholders represents how a company finances its assets If the company finances through paying debts then it will be called liability and when financed by issuing shares of the equity to investors, then it will show up in the shareholders’ equity.
The accounting equation is used for assessing whether the company is accurately representing its balances in the accounts sheet
Breaking Down the Basic Accounting Equation Formula:
Assets – Assets in the equation includes in it cash and liquid assets or cash equivalents, which may also include in it deposit certificates and Treasury bills. Account which is received therefore is the sum total of the money which the customers owes it to the company for selling its service and products. Asse may also include in it inventory.
Liabilities – Liabilities is referred to as that money which a company needs to pay or owes for the smooth running of the company. Any kind of debt including those long-term debts is also referred as liabilities besides taxes, rent, salaries, utilities, and wages as well and all the payable dividends and wages.
Shareholders’ Equity – Shareholders’ equity is that amount of money which we get when we subtract from a company’s total assets its total liabilities. If a company liquefy all its debt and pays of all it customers and shareholders, the amount of money which the company will pay is referred to as Shareholder’s equity.
Therefore to conclude accounting equation is the founding of the accounts which is double entry and a precise representation of a concept expanding in to complex, multi-item and expanded display of the balance sheet. The balance sheet is therefore based on the double-entry accounting system and here total assets of a company are equal to and shareholder equity and the total liabilities of the company. Specially, this equation represents all the usage of the assets of the company which are capital along with the sources of these capitals, here the debt capital is leading to liabilities and equity capital is leading to shareholders’ equity.
When a company keeps accurate accounts, each of its business transaction is therefore represented in two of these accounts. For example, if a company takes any loan from any financial institute such as banks, the money that has been borrowed will be raising the assets of the company and the liability of the loan will also be rising by a similar amount. If the company is paying cash for buying raw materials, it leads to an increment in the asset while it reduces the cash capital which is another asset. Two or more than two accounts of the company is supposed to be affected by each transaction that takes place, this accounting system will be referred as double-entry accounting.
The double entry practice therefore is ensuring that the accounting equation is remaining always balanced, therefore indicating that the value on the left side of the equation will always match the value on the right side. Putting it in other way, the total assets will always equal the sum of shareholders’ equity and liability
There is a global adherence to this book-entry double – entry and the general accounting system making the account and it keeps and tallies processes less easy, standardizing and fool-proofing to a large extent. The accounting equation therefore ensures that all the entries in the records and books are vetted, and there is a verified relationship existing between each liability and its relating source, or between each item of income (or asset) and its source.
Smriti Jain is the owner and senior content publisher at Financesmarti. Financesmarti is a website where she shares a lot of useful stuff for the people and business of India. This includes small business ideas and other banking information, as well. Smriti completed her education in science & technology from Delhi University. Smriti usually has interests in digital marketing now, and she has chosen this career for the full-time opportunity. The primary purpose of starting this blog to provide quality information on the banking industry to the people.