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Accounting Equation Defination - Overview, Formula, Example With Balance Sheet

Accounting Equation means that in each case the amount of assets is equal to capital and liability. Every transaction changes the assets, liabilities and capital of the business and even after the change the assets of the business remain equal to the business obligations and capital. If a transaction leads to an increase in assets. So by that amount, either the liabilities will increase or the capital will increase.

  • The accounting equation is based on the double entry system.
  • In the accounting equation, the assets of the company / business are equal to the total liabilities and equity shareholder.
  • In the accounting equation, the company's balance sheet remains balanced and every entry made on the debit side is equal to the credit side.
Accounting Equation
Accounting Equation


To understand the accounting equation properly, it is very important to know the balance sheet. A hypothetical position description is created below:

Balance Sheet


Capital & Liabilities
Capital = ($60000)
Liabilities:- 
Creditors = +XXX
Bank Overdraft = +XXX  ($40000)
TOTAL  = $1,00,000

Assets
Cash & Bank = xxx
Debtors = xxx
Stock In Trade = xxx
Furniture = xxx
Machinery = xxx
Building = xxx
TOTAL  = $1,00,000

It is clear from the above that assets are written in the right part of the position statement and capital and liabilities are written in the left part. The sum of the two sides of the balance sheet is always equal because the assets of the business are either purchased from the capital given by the owner to the business or purchased with money received by the other parties. In the above situation statement, the business has total assets of $100000 out of which $60000 properties have been purchased from the capital given by the owner to the business and the remaining $40,000 have been received from the other parties to the business.

Accounting Equation Defination

The accounting equation is based on the double entry system. The double entry system means that every business has 2 transactions which have 2 aspects, one debit second credit, so we can know that the accounting equation is the foundation of the double entry system - which it shows Determines whether the total assets of the company in the balance sheet of the company are equal to the sum of total liabilities and equity of the shareholders.

Basic Accounting Equation Formula


S. No. Transaction Assets Capital Liabilities 
   Name of Assets  Name of Liabilities
1. 1st TransactionAmountAmountAmount
 Total Amount Total Total Total 
2.2nd TransactionAmountAmountAmount
 Total Amount Total Total Total 

This situation can be manifested by the following accounting equations: This Is Based On Balance sheet

Assets = Liabilities + Capital ( OWNER EQUITY)
$100000 = $40000 + $60000

Liabilities = Assets - Capital
$40000 = $100000-$60000

Capital = Assets - Liabilities
$60000 = $100000 - $40000

Accounting Equation Example


Gopal started a business and made the following transactions:

Transactions 1. Gopal started the business with a capital of $75,000. (Gopal started business with 75000 as capital.)

This transaction will have the effect on the business that the business has received assets in the form of $75,000 cash and the business owner owes the business $75,000 as capital. The following accounting equation can be revealed:

Assets = Liabilities + Capital
Cash = Liabilities + Capital
75000 = 0 + 75000

Transaction 2. Gopal purchased furniture of cash of $5,000. (Gopal purchased furniture for Cash 5,000)

The business received furniture from this transaction and the business also makes cash payments for the furniture. Only the property side has been affected by this transaction. The effect of this transaction will be on the accounting equation as follows:-

 Assets = Liabilities + Capital


Transaction 3. Gopal purchased goods worth $20,000. (Gopal purchased goods for Cash (20,000) With this transaction, the business has received the goods in the form of assets and paid the cash, so the accounting equation will be affected by this transaction as follows:-



Assets = Cash     +   Furniture    +   Goods                =     Liabilities + Capital
Old Equation               $70000 +   $5000         +   0                                    0           + $75000
Transaction            (-)  $20000  +   0                +   $20000              =         0            + 0
------------------------------------------------------------------------------------------------------------ 
New Equation              $50000   + $50000      +   $20000               =          0           + $75000

Transaction 4. Gopal purchased a loan of $16,000. (Gopal purchased goods on credit for ₹$16,000)

The business received $16,000 worth of goods as assets from this transaction, and on the other hand, buying borrowed goods also increased the liabilities of the business. Hence the accounting equation will be affected by this transaction as follows:

Assets Equation

Assets               =            Cash          +            Furniture            +            Goods
Old Equation    =            $50000      +            $5000                 +            $20000
Transaction       =            0                +            0                         +            $16000
-----------------------------------------------------------------------------------------------
New Equation   =            $50000      +            $5000                  +            $36000

Liabilities Equation

Liabilities+Capital         =         Creditors          +             Capital
Old Equation                  =         0                       +             $75000
Transaction                     =         $16000             +             $0
------------------------------------------------------------------------------
New Equation                =          $16000             +             $75000

Transaction 5. Sold goods borrowed for $15,000 costing $12,000. Goods costing $12,000 sold on credit for $15,000)

Selling borrowed goods will increase the assets of the business as debtors by $15,000 as future debt is to be received from these debtors. The sale of goods will reduce the merchandise by $12,000, as it is the cost of goods. On the other hand, the owner's capital will be increased by the profit of $3000 made in this deal. Thus the accounting equation will be affected by this transaction as follows:

Assets Equation

Assets               =            Cash          +            Furniture            +            Goods           +         Debtor
Old Equation    =            $50000      +            $5000                 +            $36000         +          0
Transaction       =            0                +            0                         -            $12000          +         $15000 
-----------------------------------------------------------------------------------------------------------------------
New Equation   =            $50000      +            $5000                  +            $24000        +         $15000 

Liabilities Equation

Liabilities+Capital         =         Creditors          +             Capital
Old Equation                  =         $16000            +             $75000
Transaction                     =         $0                    +             $3000   
------------------------------------------------------------------------------
New Equation                =          $16000             +             $78000

Transaction 6. Paid $1,000 for rent

This transaction will reduce assets in the form of cash on one side in the business and on the other side the capital will be reduced by the payment of expenses. Hence the accounting equation will be affected as follows:-

Assets Equation

Assets               =            Cash          +            Furniture            +            Goods           +         Debtor
Old Equation    =            $50000      +            $5000                 +            $24000         +          $15000
Transaction       =            (-)1000      +            0                         +           $0                  +         $0 
-----------------------------------------------------------------------------------------------------------------------
New Equation   =            $49000      +            $5000                  +            $24000        +         $15000 


Liabilities Equation

Liabilities+Capital         =         Creditors          +             Capital
Old Equation                  =         $16000             +             $78000
Transaction                     =         $0                     -             $1000 
------------------------------------------------------------------------------
New Equation                =          $16000             +             $77000

It is clear from the study of the above transactions that each transaction has an impact on two items and. Assets = liability + capital at each stage. Thus we can say that the accounting equation is true in all cases (Accounting Equation is true in all cases). The final balance of the transactions made in Gopal's books can be shown by making a status statement in this way.
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