State the accounting equation explain

Answer 1

The 'basic accounting equation' is the foundation for the double-entry bookkeeping system. For each transaction, the total debits equal the total credits.

[1]

In a corporation, capital represents the stockholders' equity.

Assets - Liabilities = (Shareholders' or Owners' Equity)[1]

Now it shows owners' interest is equal to property (assets) minus debts (liabilities). Since in a corporation owners are shareholders, owner's interest is called shareholders' equity. Every accounting transaction affects at least one element of the equation, but always balances. Simplest transactions also include:[2]

Transaction

Number

Assets

Liabilities

Shareholder's

Equity

Explanation

1

+

6,000

+

6,000

Issuing stocks for cash or other assets

2

+

10,000

+

10,000

Buying assets by borrowing money (taking a loan from a bank or simply buying on credit)

3

�

900

�

900

Selling assets for cash to pay off liabilities: both assets and liabilities are reduced

4

+

1,000

+

400

+

600

Buying assets by paying cash by shareholder's money (600) and by borrowing money (400)

5

+

700

+

700

Earning revenues

6

�

200

�

200

Paying expenses (e.g. rent or professional fees) or dividends

7

+

100

�

100

Recording expenses, but not paying them at the moment

8

�

500

�

500

Paying a debt that you owe

9

0

0

0

Receiving cash for sale of an asset: one asset is exchanged for another; no change in assets or liabilities

These are some simple examples, but even the most complicated transactions can be recorded in a similar way. This equation is behind debits, credits, and journal entries.

This equation is part of the transaction analysis model,[3] for which we also write

Owners equity = Contributed Capital + Retained Earnings

Retained Earnings = Net Income � Dividends

and

Net Income = Income � Expenses

The equation resulting from making these substitutions in the accounting equation may be referred to as the expandedaccounting equation, because it yields the breakdown of the equity component of the equation.[4]

Expanded Accounting Equation

Assets = Liabilities + Stockholders' Equity

Assets = Liabilities + Common Stock + Retained Earnings

Assets = Liabilities + Common Stock + Net Income - Dividends

Assets = Liabilities + Common Stock + Income - Expenses - Dividends

Definition of 'Accounting Equation'

The equation that is the foundation of double entry accounting. The accounting equation displays that all assets are either financed by borrowing money or paying with the money of the company's shareholders. Thus, the accounting equation is: Assets = Liabilities + Shareholder Equity. The balance sheet is a complex display of this equation, showing that the total assets of a company are equal to the total of liabilities and shareholder equity. Any purchase or sale by an accounting equity has an equal effect on both sides of the equation, or offsetting effects on the same side of the equation. The accounting equation is also written as Liabilities = Assets - Shareholder Equity and Shareholder Equity = Assets - Liabilities.

The accounting equation is Assets = Liabilities + Owner's Equity. This is the same format used in a sole proprietorship's balance sheet. (A corporation's balance sheet will use Stockholders' Equity instead of Owner's Equity.)

The accounting equation will always remain in balance if double-entry accounting is followed accurately. For example, if a company borrows $10,000 from its bank, Assets increase by $10,000 and Liabilities increase by $10,000. When a company buys inventory with cash, one Asset (Inventory) increases and one Asset (Cash) decreases. If the owner invests $5,000 of personal assets in the business, the company's Assets increase and Owner's Equity increases. If the owner withdraws $2,000 from the business for her personal use, the company's Assets decrease and Owner's Equity decreases.

Revenues causes Owner's Equity to increase, and expenses cause Owner's Equity to decrease. If the company earns $1,500 in service fees, the company's Assets (Cash or Accounts Receivable) will increase and Owner's Equity will increase. When the company incurs electricity charges, the company's Liabilities increase and Owner's Equity decreases. If the company pays for ads to appear in this week's newspaper, Assets decrease and Owner's Equity decreases.

Bookkeepers and Accountants will be entering amounts into two or more accounts for every transaction. This occurs with business accounting software as well, but the software might be doing part of the entries Behind the Scenes.

From the large, multi-national corporation down to the corner beauty salon, every business transaction will have an effect on a company's financial position. The financial position of a company is measured by the following items:

1. Assets (what it owns)
2. Liabilities (what it owes to others)
3. Owner's Equity (the difference between assets and liabilities)

The accounting equation (or basic accounting equation) offers us a simple way to understand how these three amounts relate to each other. The accounting equation for a sole proprietorship is:

Assets = Liabilities + Owner's Equity

The accounting equation for a corporation is:

Assets = Liabilities + Stockholders' Equity

Assets are a company's resources-things the company owns. Examples of assets include cash, accounts receivable, inventory, prepaid insurance, investments, land, buildings, equipment, and goodwill. From the accounting equation, we see that the amount of assets must equal the combined amount of liabilities plus owner's (or stockholders') equity.

Liabilities are a company's obligations-amounts the company owes. Examples of liabilities include notes or loans payable, Accounts Payable, salaries and wages payable, interest payable, and income taxes payable (if the company is a regular corporation). Liabilities can be viewed in two ways:

(1) as claims by creditors against the company's assets, and

(2) a source-along with owner or stockholder equity-of the company's assets.

Owner's equity or stockholders' equity is the amount left over after liabilities are deducted from assets:

Assets - Liabilities = Owner's (or Stockholders') Equity.

Owner's or stockholders' equity also reports the amounts invested into the company by the owners plus the cumulative net income of the company that has not been withdrawn or distributed to the owners.

If a company keeps accurate records, the accounting equation will always be "in balance," meaning the left side should always equal the right side. The balance is maintained because every business transaction affects at least two of a company's accounts. For example, when a company borrows money from a bank, the company's assets will increase and its liabilities will increase by the same amount. When a company purchases inventory for cash, one asset will increase and one asset will decrease. Because there are two or more accounts affected by every transaction, the accounting system is referred to as double entry accounting.

A company keeps track of all of its transactions by recording them in accounts in the company's general ledger. Each account in the general ledger is designated as to its type: asset, liability, owner's equity, revenue, expense, gain, or loss account.

Balance Sheet and Income Statement

The balance sheet is also known as the statement of financial position and it reflects the accounting equation. The balance sheet reports a company's assets, liabilities, and owner's (or stockholders') equity at a specific point in time. Like the accounting equation, it shows that a company's total amount of assets equals the total amount of liabilities plus owner's (or stockholders') equity.

The income statement is the financial statement that reports a company's revenues and expenses and the resulting net income. While the balance sheet is concerned with one pointin time, the income statement covers a time interval or period of time. The income statement will explain part of the change in the owner's or stockholders' equity during the time interval between two balance sheets.

Definition and Explanation of Accounting Equation:

Dual aspect may be stated as "for every debit, there is a credit." Every transaction should have twofold effect to the extent of the same amount. This concept has resulted in accounting equation which states that at any point of time the assets of any entity must be equal (in monetary terms) to the total of equities. In other words, for every business enterprise, the sum of the rights to the properties is equal to the sum of the properties owned. The properties of the businessare called "assets". The rights to the properties are called "equities". Equities may be sub-divided into two principle types: The rights oft he creditors and the rights of the owners. The equity of the creditors represents debts of the the business and are called liabilities. The equity of the owner is called capital, or proprietorship or owner's equity.

The formula know as the accounting equation, thus arrived at is as follows:

Assets = Equities

OR

Assets = Liabilities + Proprietorship

Another method of demonstrating the mathematical relationship involves a simple variation in the form of equation. Again it begins with the position that every business owns or has interest in certain assets. It also owes certain amounts to its creditors. The difference between what it owns and what it owes represents the owner's capital or proprietorship. Thus the original equation is changed into:

Assets - Liabilities = Proprietorship

Effects of Transactions on the Accounting Equation:

Each and every business transaction affects the elements of accounting equation. The effect is shown by the use of (+) or (-) placed against the elements affected. Note particularly that the equation remains in balance after each transaction.

The three basic fundamentals of bookkeeping are assets, liabilities and owners' equity (capital). The assets represent the things of value that a business owns. The liabilities are the claims of the creditorsadjacent to those assets. The owner's equity (capital) is the claim of the owner against those assets. Whatever is not claimed by the creditors belongs to the owner. As a result, the total claims against the assets are always equal to the total assets, this equality between the assets and the liabilities and the owner's equity expressed by the "accounting equation".

Assets = Liabilities + Owner's Equity.The two sides of the accounting equation must always be equal because the rights to all the assets of a business are owned by someone. The creditors have a claim against the assets of a business until the liabilities have been paid. The owner has a claim against the remaining assets of the business. If no liabilities exist, then the owner's equity will equal to the total assets.

A clear understanding of the accounting equation is essential, because most of accounting systems based on it. The equation actually identifies the claims (or rights) against the assets held by a business. The two sides represent different versions of the same thing. The left side of the equation, assets, consists of the "resources" (properties) held by the business; the right side of the equation, equities (creditor's claim and owner's claim against the assets) consist of the "source".

Resources = Sources

Assets = Claims against assets

It should be remembered that the two sides of the equation are always equal because these two sides are merely two views of the same business resources.

Accounting equation is an accounting term where a relation between assets, liabilities and equity is drawn and these are the main components of accounts as well.In accounting equation we say for every debit there is a credit means for every entry we look at two aspects.Means single entry but it has impact on two of the components of accounting equation.

The equation is as follows.Assets = liabilities + equity.Now here if we look at any business it raises capital by two means either by investing himself or by taking some loan from some bank or another company.If a company takes some loan from a bank then this will also help in building up assets. These assets would be of same amount which the company would borrow and here we can easily understand that liabilities are equal to assets over here.

Similarly if owner invests or injects his capital in the business totally then the assets created would be again equal to the equity side.But normally businesses generate capital from owner capital as well as from loans and both collectively make up the same amount of assets which also explain the accounting equation.

Explaining Accounting Equations

Part of the Accounting Workbook For Dummies Cheat Sheet (UK Edition)

Accounting equations can be tricky to remember, so this handy reference gives you everything you need to do your sums easily and, more importantly, correctly.

Understanding liabilities and owners' equity

Liabilities and owners' equity are the two basic types of claims on the assets of an entity. The two-sided nature of the accounting equation is the basis for double entry accounting that records both sides of the entity's transactions: what's received and what's given in the economic exchange.

Assets = Liabilities + Owners' Equity

Knowing the rules for debits and credits

Here is your handy, at-a-glance table to help you remember the rules for debits and credits in accounting. Keep it by your calculator and never get confused again!

Financial effects of revenues and expenses

As you work your way through your accounting sums, remember the following simple accounting rule when it comes to calculating the financial effects of revenues and expenses:

Revenue = Asset increase (debit) or Liability decrease (debit)

Expense = Asset decrease (credit) or Liability increase (credit)