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A Brief Understanding of the Accounting Equation

Accounting is one of the most important aspects of any company’s operations. It is really imperative that the accounting is done while keeping in mind the financial health of the company. It is about anybody’s guess that the finances of an organization form the backbone of the company around which almost all the aspects and operations of the company revolve. Accounting is the tool that is used by the accounting professionals in order to take care of the finances of the company. One of the most rudimentary parts of the accounting is the accounting equation that forms the basic elements of almost all the accounting processes.

In the simplest of forms the accounting equation is represented as:

Assets= Liabilities+ (shareholders or owner’s equity)

The equation can be understood with the following example: If a man buys a flat for $5000 for which his own contribution is $3000 and the amount that he borrowed from the market is $2000, then his assets would be $5000, liability would be $2000 and owner’s equity as $3000.

The accounting equation can be restated as:

Assets-Liabilities= shareholder’s or owner’s equity

The balance sheet of a company’s performance uses the accounting equation in an elaborate form. Everytime a transaction is made, atleast one of three elements of the accounting equation is changed. The balancing of the equation occurs when the other factors adjust accordingly.

It doesn’t matter whether you are operating a corner grocery shop or a big multinational company, the accounting books as well as the accounting equation and its balancing would always play an important part in the operations and the accounting equation would be altered with every new transaction. If a company is maintaining accurate records, then the accounting equation would be always balanced. Everytime a transaction takes place atleast two elements of the equation are altered. As a result the system utilizing the accounting equation to keep records is known as the double-entry accounting.