The primary aspect that needs to be understood while dealing with any business institution is its division into Assets, Liabilities, and Capital.
To ensure that business functions in a correct way, it is imperative that each of these details is understood in a specific manner and applied accordingly.
This includes a list of both valuable articles owned by a specific organization as well as that money which is spent in regards to buying of those commodities that help in improving the quality of production in a company.
This improved quality of production at a wider note helps in ensuring increased profit earning capacity of a particular company. Since no business can be carried out without a set of productive assets, it is important that the assets as cash in hand or bank accounts and other aspects as land and buildings are to be taken special care of.
There are times when a certain amount of money that is taken as investment does not match up to standards, and an excess amount is required. In such cases, any particular firm can take loan of a certain amount of money from external sources, and that amount becomes liability for the firm.
Here amount that is represented by both loan and assets are equivalent and funds acquired are contributions of creditors and proprietors. Hence in this regard, double entry system is to be understood clearly.
Capital +Liabilities =Assets
This Accounting Equation needs to be kept in consideration.
As one of the major factors of production, capital is that amount which is used for further production. In regards to this dual entry system, this capital is the primary fund that would be applied for using in areas as gaining of assets.
However, to a certain extent proprietor’s capital becomes liability of the business which has to be paid back with interest after a certain point of time. Since capital is received in the form of cash most of the times, so it includes both proprietor’s claims as well as an asset for business as a whole.
Since both accounts are similar, the equation that is taken into consideration includes:
A segregation of these details is of prime importance, and it is based on this that double entry system is functioning.