The equation that forms the base of Double entry accounting is called accounting equation. According to the equation, assets of a company are either generated by either taking funds or paying the funds from the company’s shareholders. Accordingly, the equation is –
ASSETS = LIABILITIES + SHAREHOLDER’S EQUITY
There are certain facts as follows, that need to be clear in a student’s mind to have a clear concept of accounting equation. More on the topic can be learned online as well by searching links like accounting equation homework answers.
What is double entry?
Whenever there is any kind of transaction, it involves at least two people, i.e. the buyer, one who buys and the seller, one who sells. The process involves two effects. For example, when someone purchases a packet of bread from a shopkeeper, he pays cash to get it.
So, the transaction will decrease the buyer’s cash by the amount that is equivalent to the cost of the bread whereas, he will get the bread. On the other hand, the seller will be short of one packet of bread, but his cash equivalent to the cost of bread will increase. This is called double entry.
Simplifying the accounting equation
Whenever there is a sale or purchase made through an accounting equity, it affects the equation on both sides. Thus one can also write the equation in the following ways –
LIABILITIES = ASSETS – SHAREHOLDER’S EQUITY
Or
SHAREHOLDER’S EQUITY = ASSETS – LIABILITIES
Shareholder’s Equity
The shareholder’s equity can be obtained by subtracting the firm’s total liabilities from the total assets. This is the simplest part of financial metrics that is used by analysts to understand the financial condition of the company. Shareholder’s equity defines that amount which will be given back to shareholders if all the company’s debts are cleared and its assets liquidated. Thus the formula can also be written as –
SHAREHOLDER’S EQUITY = SHARE CAPITAL + RETAINED EARNINGS – TREASURY SHARES
Liability
The financial obligation that a company faces while executing its business operations is called liability. Settlement of such liabilities is done over the course of time by transferring economic benefits in the form of products, services or money. Links to accounting equation homework answers online can give more ideas on the concept of liability. Liabilities form an important factor for financial operations.
For example, when a garment manufacturer sells a number of garments to a retailer, he might not demand the payment immediately on delivery. Instead he can make an invoice in the name of the retailer which will make payment easier for the retailer. The amount outstanding to be paid by the retailer is his liability. This same amount is an asset for the manufacturer.
Types of Liabilities
- Current liability
An obligation that has to be cleared within twelve months from the company’s balance sheet date is termed as current liability. There are companies whose operating time is more than a year, in that case, the current liability will be due within the company’s operating cycle.
- Limited liability
The form of liability which is lesser than the invested amount in a partnership is called limited liability. Limited liability has a lot of benefits. A shareholder can be a part of the complete growth of a firm, their liability is limited to the invested amount of the company, even if the shareholder is affected by bankruptcy.
- Adjusted liabilities
The liabilities of insurance companies that are different from the firm’s authorized liabilities as a result of adjustments are adjusted liabilities. The adjusted liability is calculated by subtracting the asset valuation reserve and the interest maintenance reserve from the authorized liability.
- Long term liability
The financial debts of companies that have due date over a year or over the operating cycle are called long-term liabilities. Searching topics like accounting equation homework answers online can bring more clarity on the different types of liabilities.
Asset
The valuable things that a firm owns and uses for operational work are its assets. These products are not intended for sale. Instead these are used to enhance the earning ability of the firm. An example of asset could be building, land, machines, furniture, cash,etc. that the company owns.
Difference between liability and expense
The cost involved in operating a company’s business that brings revenue to the firm is expense.Expenseis associated with revenue. There should be no confusion between liability and expense. Expense is listed in the income statement of the company whereas; liability is shown on the balance sheet. Expense is the operational cost of the firm and liabilities are the firm’s debts. The concept of liability and expense should be completely clear in a student’s mind for getting clarity on the accounting equation. Different example on the same can be practiced on searching links like accounting equation homework answers online.
What is balance sheet?
The financial statement which defines an organization’s liabilities, assets and shareholder’s equity for a specific period is termed as a balance sheet. Investors get an idea about the company’s financial condition by studying the balance sheet.
Expansion of the accounting equation
The expanded form of the accounting equation is obtained from the main accounting equation. It details the separate parts of shareholders equity of a firm. The role of equity is expanded in this equation. The expansion is as follows –
ASSETS = LIABILITIES + SHAREHOLDER’S EQUITY
to
ASSETS = LIABILITIES + CONTRIBUTED CAPITAL + BEGINNING RETAINED EARNINGS + REVENUE – EXPENSES – DIVIDENDS
So, as per the expanded equation, the shareholder’s equity is constructed by contributed capital + Beginning retained earnings + revenue – expenses – dividends.
Guide to basic accounting concepts
There are certain accounting concepts that need to be clear for a student to understand accounting equation easily. A complete guide to the same is as follows. Students can also search online for accounting equation homework answers for more clarity.
- Use of monetary unit
All financial transaction in a business should be reported and recorded while accounting should be in monetary units like Canadian dollar, US Dollar, Euro, etc.
- Business is a separate entity
The business should not be confused with the owner’s identity. It should always be considered as a separate entity. The owner’s personal transactions should never be recorded in the company’s accounting book.
- Assumption of continuity
A business is supposed to continue its operation indefinitely. Thus, the assets of a company are generally recorded as per their original cost price, not on its market value.
- Period of accounting
There should be a specific period within which the accounting process of a firm should be completed.
- Clarity of profit
There should be proper record of revenue with expense, so that the net profit for the accounting period can be obtained.
- There should be consistency
The prevailing accounting processes should be continued every year or every accounting period.
- Proper documentation
All recorded transactions should have relevant supporting evidence.
- Materiality
The transactions that affect decisions of users are given importance. Errors in accounting that involve small amounts are not considered important and do not require correction.
- Things should be accurate
All revenue and expense should be noted in the period when it is earned and incurred respectively irrespective of the time when the cash is received or paid.
Knowledge on all these topics can bring clarity to a student on accounting equation. For more information, they can easily log on to different sites and search for accounting equation homework answers.