Today in this free accounting training tutorial blog we will discuss Accounting Equations.’ This discussion will help you to understand:
- What is Accounting Equation
- Definition of Accounting Equation Concept
- Example of Accounting Equation
- Meaning of Financial Accounting Equation
- Expanded Accounting Equation
The two fundamental elements of business are what it owns and what it owes. Assets represent the resources of a business that a business owns. For example, Patrick & Sons company has total assets of approximately $ 34.6 billion. And liabilities and owner’s equity are the rights and claims against the resources that a business owes. Likewise, Patrick & Sons company has 34.6 billion claims against its 34.6 billion assets. Liabilities are called creditors’ claims on total assets and the ownership claim on total assets is called owner’s equity. Thus Patrick & Sons company has a liability of billion and owners™ equity of billion.
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It means Assets = Liabilities + (Owner’s Capital + Revenues “ Expenses “Owners withdraws). This equation is known as Expanded Accounting Equation. We can combine these elements by relating them with an equation which is a basic accounting equation:
A=L+P
The accounting equation used in business describes an organization’s financial position. An asset always equals the sum of liabilities and owners™ equity. As liabilities are paid first so it appears before owner™s equity. The accounting equation is implemented in all economic entities regardless of the form and nature and also the shape of the business. Let’s take a close look at the accounting equation:
Assets: assets are the economic resources that a business uses to carry out organizational activity to get benefits in the future such as production, and sales. Examples of assets are furniture, land, office supplies, merchandise, cash, etc. The service possessed by assets will eventually affect cash inflows. For example, The pastry house owns a delivery van that provides financial support for delivering pastries. Other assets of the pastry house are a table, chairs, jukebox, cash register, oven, tableware, and of course cash.
Liabilities: Claims against assets come from two sources, liabilities are outsider claims which are called creditors are existing economic obligations debt. All form of business either big or small generally borrows money and purchase merchandise on credit. These kinds of transactions lead to payable of various sorts:
For example, the pastry house purchases cream, butter, flour, egg, sugar, etc., and all beverages from suppliers on credit. These obligations are called accounts payable. The pastry house could have a note payable to the Bank for the transactions of borrowing money for buying a delivery van. The pastry house may have salaries payable to workers and takes and sales payable to the local government. If any business is liquidated then liabilities pay first.
Owners™ Equity: Owner™s equity is insider claims on total assets. This owners™ equity is measured by subtracting total assets from total liabilities. It means:
OE=TA-TC, here OE= Owner™s Equity, TA= Total Assets and TC=Total Claims
Claims on assets can come from either creditors or owners as liabilities paid firsts so to find out what belongs to the owner, the total assets are subtracted from total liabilities. The remainder is the ownership claim. For this reason, owner’s equity is often referred to as net assets.
In the accounting equation ownership claim to business assets is residual as it calculates from remain after liabilities are paid off. In proprietorship owner™s investment and revenues increase owner™s equity and owner™s withdrawal and express decreases owner™s equity. For instance the owner of the pastry house invested in the business which increase the owner™s equity. Revenues resulting in gross increases come from business transactions for the purpose of carrying income. For example, the pastry house can earn revenues by selling pastry, and beverages.
Withdrawals: It is the opposite of investment. Withdrawals are measured by those amounts for assets that are withdrawn by the owner for the personal case.
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