the accounting equation

the accounting equation

Understanding the Accounting Equation

1. Introduction to the Accounting Equation

Equating variables not only solves basic equations but helps solve many of the problems you will encounter in accounting. The accounting equation, through its application, is not limited only to the preparation of accounting entries, but is directly related to the solving of problems, by means of identifying significant changes in parts of it. It is also related to the modes of financing used, on the investment funds of the enterprise, or even on the profitability of the operations. This equation can be represented by: Assets = Liabilities + Equity of the Partners. In fact, this is a simplified representation, as there are many components in each member—different things that make up the accounts in the company’s balance sheet. Some of these components are on the asset side, others on the liabilities side and the remaining component in the company’s equity.

Before we talk about accounting, you should understand not only what an “equation” is, but also the types of equations that are used to do accounting. An equation can be mathematically defined as a statement of equality between two expressions. The most common practice in accounting is to use numeric values to represent these expressions. An equation consists of two or more “members.” The number of members in an equation requires the use of the symbol “=” between the members. The next classification is the so-called first and second degree equations (as long as they are linear or first degree), these can be solved by simply performing certain operations, with the purpose of isolating the variable x.

2. Components of the Accounting Equation

The accounting equation would always be in balance, where the equity is positioned as a residual claimant’s position. When the company’s liabilities and obligations are paid, the total value of the company’s assets minus the value of the company’s paid liabilities gives the value of the company’s equity, which is left unclaimed.

Components of the Accounting Equation: The basic elements of the accounting equation are as follows: – Assets: the business owns right now – Liabilities: the business owes right now – Owner’s equity: the owner’s investment in the company – Revenue: the increase in the company’s assets or other criteria of their value from the sale of goods and/or services – Expenses: assets used or decreasing the company’s assets, earned in the relevant accounting period

Accounting equation, also known as the balance sheet equation, approaches the accounting system from the point of accounting notations. In reality, every accounting transaction is meant to fulfill the accounting equation. The accounting equation is the basis of the double-entry bookkeeping system. We can also say that the balance sheet equation is one of the most fundamental equations in accounting.

3. Importance of the Accounting Equation

The accounting equation can easily be related to profitability when it is viewed from a company’s point of view, and there are two other terms that are also often used in replacement for profitable; they are known as “gain” or “earning.” Now you combine the definition of the accounting equation and profitability, and you would get the equation P = L – COE. The equation can really help the business leaders in keeping track of each transaction that has taken place within the company, and at the same time, determine how to form out the decision that will be beneficial to the company. The equation will also be useful when you want to learn about the company’s working capital before making an investment. Always remember this – good knowledge of accounting will never let you down.

It may be hard to understand the ingestion concept at first, but just like other topics, it takes dedication and hard work to get a better understanding of it. Most people will think accounting is a difficult topic or impossible for them to understand, and they will not even give it a try. Only when they are in the working force, then they realize that having a good foundation in accounting is actually very important. They only start to show interest in accounting when they realize that the opportunity will not favor them without a good foundation in accounting.

4. Applications of the Accounting Equation

Many somehow agree with the law firm of Lawyer Watson’s balance sheet that after temporary or unpredicted client-fat litigation. As we reconcile the assets law firm owes by three hundred dollars, the owner remains with nothing belonging to the business. It is a serious case which, if not checked, leads to bankruptcy, attracting the attention of Debts/Accounts payable. An astute business person is required to employ the services of a certified public accountant. From the law firm’s records kept by Accountant Aron in the form of accounts, one can derive the accounting equation and balancing. It becomes clearly difficult for a business to succeed if there is a failure to record transactions properly.

Whatever the case, there is a situation where Lawyer Watson may not be able to pay William as well. This will occur if the law firm of Lawyer Watson incurs debts (liabilities) and at the same time does not earn anything from the legal services rendered (revenue), that is, there is no inflow of assets.

William works for the law firm of Lawyer Watson. William works at a pay of one hundred dollars a day. At the end of the month, William’s cash salary collected is three hundred dollars. Whenever we see William, we always ask ourselves: 1. Does the law firm of Lawyer Watson owe William anything at the end of the month? The answer is yes. 2. Can Lawyer Watson pay William now? The answer is yes.

5. Conclusion

As long as business exists, the accounting equation will remain at the heart of how accountants communicate how business enterprises affect, and are affected by, accounting. But that’s not all. How should an account balance for business transactions or events that don’t involve dollars (or other monetary units)? The accounting equation’s indispensable elements make it tough to communicate and study many sophisticated, and intriguing, concepts. One example is accounting for commodity exchanges; or, for carbon emissions. As businesses, and the world economies, continue to evolve, the nuances and contributions regarding how business impacts the accounting equation will become even more practical. That’s why learning about the accounting equation is an easy – and valuable – way to become better prepared for the many issues accountants face. Throughout history, people have depended on accounting to communicate crucial information. Not everyone can be a Federal Reserve Chairman or the President of a Fortune 50 enterprise, of course. But students can prepare themselves for lives of freedom and opportunities by getting to know the accounting equation.

In his book, Accounting Principles and Practices, J. S. R. Hall, former editor of The Accountant, stated: “Accounting is the science of the mechanics of business.” Effectively measuring a business’ operating results involves business transactions and events that impact a business’ resources, as well as obligations. Accounting’s essential equation represents the foundation for accounting measurement and reporting. That’s why it’s important to learn and understand the accounting equation. That’s why professors teach it and why students study it.