Accounting Equation : Definition, Formula, Example etc.

What is Accounting Equation?

Accounting Equation which is also called as balance sheet equation. This equation is considered as the base of “Double Entry Book Keeping system” that indicates the relationship between means owned and resources owned by the company. Accounting Equation represents the relationship between the assets, liabilities, and owner’s equity of a person of business. Actually, Accounting Equation shows how total debits equal to total credit of the company.

Formula of Accounting Equation

The formulation of Accounting Equation is:

i) Assets = Liabilities + Owner’s Equity

ii) Assets – Liabilities = Owners’ Equity.

Assets: The assets of the company represents the total property owned by the company

Liabilities: Liabilities of the company represents all of the obligations currently owned by the business.

Owners’ Equity: The company’s ownership interest in its assets, after all of its debts have been repaid i.e. the difference between assets and liabilities.

Liabilities + Owners’ Equity represent how the assets of a company are financed.

Components of Assets, Liabilities & Owners’ Equity

The detail clarification of assets, liabilities and expenses are presented as follow:

Assets:

Normally Assets include Cash and Cash Equivalent, Accounts Receivable, Inventory and Equipment of the company. Cash and Cash Equivalent includes all the liquid assets which may include Treasury bills, Certificate of deposits. Accounts Receivables are the amount that the customers are owed to the company. Inventory includes the raw materials, finished goods etc. which is also considered as asset. Equipment also treated as assets of the company.

Liabilities:

Liabilities are the obligations of the company typically owes by the company to pay to the third party. Liabilities include Accounts Payable, Rent payable, Tax Payable, Utilities payable, Salaries & Wages Payable as well as dividends payable.

Shareholders’ Equity:

Shareholders’ Equity is the total assets minus its total liabilities of the company. Shareholders’ equity is the amount of money that the company owed to its shareholders. Assets less liabilities equals the shareholders’ equity. Retained earnings are the part of shareholders’ equity.

Example of Accounting Equation

XYZ Ltd. Purchased Equipment’s @ RS. 30,00,000. To pay for the equipment, the company borrows RS. 13,00,000 and Mr. X brings RS.10,00,000 and Mr. Y brings RS.700,000.

Applying the Accounting Equation of XYZ Ltd. is :

Assets = Liabilities + Owners’ Equity

RS. 30,00,000 = RS. 13,00,000 + Rs. 17,00,000 (10,00,000+700,000).

Owners’ Equity = Assets – Liabilities

RS.17,00,000 = RS. 30,00,000 – RS. 13,00,000

Here, Assets increased by RS. 30,00,000 as well as Liabilities increased by RS. 13,00,000 and Owners’ equity increased by RS. 17,00,000

Again, if subsequently company paid @ RS.10,00,000 of borrowed amount, the new accounting equation will be stand at :

Assets = Liabilities + Owners Equity

RS. 30,00,000 = RS. 300,000 + RS. 27,00,000

Because of liabilities gone down by RS. 10,00,000 and assets have not changed , the owners equity has, by default, increased by RS.10,00,000

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