Accounting equation also known as balance sheet equation shows the relationship between the total assets and total of liabilities and owner’s equity.
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Here,
Total Assets = resources owned by enterprise which can generate economic benefit, e.g., cash, furniture, building, machinery, inventory etc.
Total Liabilities are categorized into two parts- liability towards owners and liabilities towards outsiders i.e.
1. Owner’s equity / Capital = amount invested by owner/proprietor in business. It is written as shareholders equity in case of companies.
2. Outsiders Liabilities = amount repayable to outsiders, e.g. creditors, bank loan etc.
Some key points to remember :
- This equation is considered as a foundation of the double entry system of book keeping.
- The main thing to remember here is that whenever any transaction is conducted it affects at least two items and the accounting equation is always balanced.
1. Suppose B started business with cash Rs. 3,00,000.
Here in this case entity will receive cash worth Rs. 3,00,000 in form of capital/ equity from B . So its effect will be :
Assets | = | Owner’s Equity | Liabilities |
Cash | = | B's Capital |
|
300,000 | = | 300,000 |
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Hence our equation is balanced.
2. Purchased inventory of Rs. 10,000 from Ram on credit.
In this case goods worth Rs. 10,000 were purchased from Ram on credit . So this led to increase in the balance of inventory and also of our liability to pay Rs. 10,000 to Ram
Assets | = | Owner’s Equity | Liabilities |
Inventory | = | Ram's A/c | |
10,000 | = | 10,000 |
3. Took loan of Rs. 20,000 from bank
In this case on taking loan we received Rs.20,000 from bank and also it becomes entity's liability to repay back that amount to bank in future.
Assets | = | Owner’s Equity | Liabilities |
Cash | = |
| Bank Loan |
20,000 | = |
| 20,000 |
From the above examples we can see that after each and every transaction the accounting equation is balanced. Above we have discussed the concept of accounting equation for the commerce students. To know more stay tuned with Ace Your Grades.
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