Accounting Equation- MBA TOPIC

 Accounting Equation

MEANING OF ACCOUNTING EQUATION

All About MBA TOPIC| In simple words, accounting equation, is an equation of equality between the assets and the claims of the business. In literal terms, we can define accounting equation as, 

Source- accountants-day.info

‘An accounting formula expressing the equivalence of the two expressions of Assets &
Liabilities.’(Accounting equation concept)

An accounting equation is an equation of equality between the assets and the liabilities + Capital of the business. Since the accounting equation states the fundamental relations among the components of the Balance Sheet, it is also called the Balance Sheet Equation.  So, before understanding an accounting equation, it is essential to know about a Balance Sheet. An example of a simple Balance Sheet in 'T' form is given below which shall help in better understanding about accounting equation.

BALANCE SHEET

Liabilities                                           Rs                                                        Assets Rs

Capital                                     1,20,000                                  Cash and Bank            80,000

Liabilities                                                                                           Debtors                         5 000

Creditors                     30,000                                                             Stock in Trade   5,000

Bank Loan                  50,000                80,000                                  Furniture                     10,000

                                                                                                            Machinery                  30.000

                                                                                                            Building                      70 000

                                                            2,00,000                                                                   2,00,000

In a Balance Sheet, assets are recorded on the right hand side and liabilities including proprietors capital are recorded on the left hand side. The total of the both sides of the Balance Sheet is always equal at any point of time, the reason is that the assets of a business are purchased either from the funds (capital) supplied by the proprietor or from the funds provided by external parties.

The entire system of recording business transaction is based on accounting equation. A transaction may affect either both sides of the equation by the same amount or one side of the equation only, by both increasing or decreasing it by equal amounts.

Important Steps to prepare Accounting Equation:

•        After passing any transaction, both side of balance sheet should be equal.

•        All expenses are the causes of losses and all incomes are the causes of Profits.

•        According to business entity concept all profits should be added in the capital account and all expenses should be deducted from the capital account.

•        Interest on capital : Business provides interest on the capital contribution by the proprietor, It will be treated as an expenses of the business and capital account of the business man will also be increases. In the accounting equation  firstly it will be added in the Capital Account and then being expenses of the business it should be deducted from the Capital account.

•        Interest on Drawing : Business charged Interest on drawing from the business man on drawings withdrawn by proprietor during the year. In the accounting equation,  firstly It will be deducted from the Capital account and then being income of the business it should be added in the Capital account.

•        Drawing : When business man withdraws any cash or goods from the business for personal use, we open separate account for business man known as Drawing account. In the accounting equation, It will be deducted from the capital account and also deducted from cash / goods account in  the asset side.

•         Outstanding Expenses: Outstanding Expenses are such expenses which are due but not paid. Being current year operating expenses these will be deducted from the Capital and shown separately in the liabilities side of accounting equation.

•        Prepaid expenses: Prepaid expenses are such expenses which are paid in advance but not due, these will be deducted from the cash account and shown separately in the assets side of accounting equation.

•        Accrued Income: Accrued Income is an income of current year which is earned but not received. In the accounting equation,  it will be added in the capital account being current year’s profit and shown separately in the assets side.

•         Unearned Income: Unearned Income is an income which is received but not earned. In the accounting equation, it will be added in the cash account and shown separately in the liabilities side of accounting equation.

•         Depreciation: It will be treated as operating expenses so In the accounting equation,  it  

will be deducted from the capital account as well as from the concerning asset account.

We hope you like this article(Accounting equation concept) & also help you to know about MBA TOPIC.