The Accounting Equation
Introduction to the Accounting Equation
The 'basic accounting equation' is the foundation for the double-entry bookkeeping system. For each transaction, the total debits equal the total credits.
The accounting equation used in business must always be kept in balance — the assets on one side of the equation must equal the claims against the assets on the other side: Assets = Liabilities + Owners’ equity. Everything falls under these three elements in a business transaction.
In other words accounting equation is a mathematical expression of the relationship of property and property rights. The equation may be expressed in three forms:
· Abbreviated or Simple Version:
Property = Property Rights
· Expanded Version:
Assets = Liabilities + Owner's Equity (Capital)
· Fully Expanded Version:
Assets = Liabilities + Beginning Owner's Equity (Capital) + Additional Owner Investments + Revenues - Expenses - Draws
On the left-hand-side of the Accounting Basics equation are the resources (assets) of the business. Or more correctly, the term assets "represents" the value of the resources of the business. On the other side of the equation are claims of ownership on those assets. Liabilities are the claims of creditors (those "outside" the business). The equity, or owner’s equity, is the claim of the owners of the business (those "inside" the business).
These claims arise from credit extended to the business (liabilities) and capital invested by owners in the business (owners’ equity). The claims of liabilities are significantly different than the claims of owners; liabilities have seniority and priority for payment over the claims of owners.
Understanding liabilities and owners’ equity is important. Liabilities and owners’ equity are the two basic types of claims on the assets of an entity. The two-sided nature of the accounting equation is the basis for double entry accounting that records both sides of the entity’s transactions: what’s received and what’s given in the economic exchange.
Well this equation is what double entry is all about. For every business transaction there are two entries. These entries represent increases or decreases in property (assets) and/or property rights (liabilities and owner's equity). In other words the double entry system based on the Accounting Equation allows to track:
| (1) What We Got and What Went (Property) |
| and |
| (2) From Whom and To Whom (Property Rights) |
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