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What is an Accounting Equation?

by Team Goseeko

Accounting Equation is an equation which helps to understand the impact of relationships in financial activities within a company.

Apart this equation is just simplifying breakdown of the values entered in the balance sheet.

It shows the relationship between a company’s assets, its liabilities (the amount payable to others), and its shareholders’ or owner’s capital (the value of the asset minus the liabilities associated with that particular asset).

Accounting Balance

The accounting formula shows the balance of a company’s resources (resources that appear as assets on the balance sheet).

Company assets displays on the left side of the equation, conversely, liabilities and capital (the sum of claims for these assets) on the right side.

This equation shows that all resources (assets) of a company are provided by creditors or owners (through liabilities and capital).

Furthermore, the accounting equation also shows that all economic events which effects the Balance Sheet have a double impact.

We can write the equation as:

Asset = liability + owner’s capital

It is:

Liability = Assets-Owner’s Capital

Owner’s Capital = Assets-Assets

Accounting equations are an easy way to view the relationships of financial activity across your business.

However, the Balance Sheet basically handles the input of each value of the equation. In order so that the equation is not intended for practical use.

For instance, given below are the items that apply to each section.

  • Firstly, Assets: Cash, accounts receivable, inventory, equipment
  • Secondly, Debt: Accounts payable, short-term debt, long-term debt
  • Lastly, Shareholders’ equity: Equity capital, retained earnings

Accounting Equation in Progress

An example of how the three values relate:

Firstly, If a company wants to buy a new asset, such as a computer device that costs £ 300,

Then, Purchase= Cash

OR Owner’s capital (income or funds), or Debt (borrowings, etc.).

Secondly, If the debt is used for purchase,

Likewise, we can use £ 300 for the asset or can use a new debt such as a bank loan.

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