CONCEPT OF ACCOUNTING EQUATION
One of the important features of double-entry book-keeping is that it makes a two-fold or double effect. It implies that every financial transaction has a simultaneous effect on two separate accounts. Such an effect is always of an equal amount. This gives rise to the fundamental principle of the double-entry system. That is, ‘For every debit, there is a corresponding credit or ‘vice versa, or ‘Debit = Credit and Credit = Debit’ With this fundamental principle, a relationship between three basic elements of accounting can be developed. The three basic elements of the accounting equation are assets, capital, and liabilities. The relationship between the elements can be shown in the form of a mathematical equation. This equation is called the accounting equation.
MEANING AND DEFINITIONS OF ACCOUNTING EQUATION
The accounting equation is a mathematical statement showing that two amounts or values accounting statement are equal, such as assets = equities. The accounting equation is also called the balance sheet equation, as it represents a mathematical expression of the relationship between the two balance sheet items of the business. Formally, therefore, the accounting equation is a statement of equality between total assets and total claims or the equities of the business. accounting basic terminologies.
Mathematically,
Assets = Total claims or equities
or, Assets = Owners’ claim or equity + Outsiders’ claim or equity
or, Assets = Capital + Liabilities
or, Capital = Assets – Liabilities
or, Liabilities = Assets – Capital
The above equations are different forms of the accounting or balance sheet equation.
COMPUTATION OF ACCOUNTING EQUATION
The accounting equation shows that at any point in time the total assets of a business are always equal to the total of its capital and liabilities. If by a financial transaction, there is a change in the amount of assets, there must be a corresponding change in the amount of either capital or liabilities or both. Therefore, double-entry book-keeping can also be seen as mainly a set of rules by which an increase in assets is connected with a corresponding decrease or with the balancing increase and/or decrease in equity. The set of rules can be stated in the following manner:
- An increase in the amount of assets with a corresponding decrease in the amount of assets.
- An increase in the amount of assets with a corresponding increase in the amount of capital or liabilities, or both. Basic Accounting Concepts –
- A decrease in the amount of assets with a corresponding increase in the amount of assets.
- A decrease in the amount of assets with a corresponding decrease in the amount of capital or liabilities, or both.
- An increase in the amount of capital with a corresponding increase in the amount of assets.
- An increase in the amount of capital with a corresponding decrease in the amount o liabilities.
- A decrease in the amount of capital with a corresponding decrease in the amount of assets.
- An increase in the amount of liabilities with a corresponding increase in the amount of assets.
- An increase in the amount of -liabilities with a corresponding decrease in the amount of liabilities.
- A decrease in the amount of liabilities with a corresponding decrease in the amount of assets. These rules will be even clearer when they are illustrated with examples in the following section.
