Accounting students are well-versed with accounting equations. This is one of the basic needs for the students if they want to excel in accounting. The accounting equation is a fundamental principle of accounting and a key element of the balance sheet. Typically, an accounting equation is the sign of the assets of the firm are equal to the total of the liabilities and equity or not. The equity of the organisation should be the same as the assets whereby the liabilities are not included. The critical importance of the accounting equation is due to three key components of the balance sheet, including assets, liabilities, and shareholder’s equity. The accounting equation has a lot of uses in double-entry accounting.
A typical accounting equation is explained as follows.
Assets = Liabilities + Equity of Shareholders
Double-entry accounting is extremely common and accounting equations are effectively used in it. The accounting equation illustrated above provides the basis of double-entry accounting. This highlights the structure of the balance sheet. In this accounting system, every transaction influence both sides of the accounting equation. There should be an equal chance to the liability or equity account of the shareholders. It is required to consider the accounting equation, especially when journal entries are being done. In the basic accounting equation, there are three key things by OnlineAssignmentsHelp.com Assets, Liabilities and Shareholder’s Equity.
- Assets: The first key element of a basic accounting equation is assets. Assets can comprise cash and liquid assets. For instance, treasury bills and deposit certificates are crucial examples of assets. In assets, accounts receivables are the amount of money to be owed by the organisation from its customers for proper product sales. Inventory is a crucial asset for the organisation.
- Liabilities: Another important element of a basic accounting equation is liabilities. These are the things that are owned by the organisation. These should be needed to ensure that the organisation is operating effectively. As far as debt is concerned, it can be rent, utilities, wages, dividends, etc.
- Shareholders’ equity: the equity is the total assets of the company which do not include the liabilities. Shareholders’ equity shows the money which would be given back to the shareholders when all the assets are transformed into liquid or cash. This typically happens when the management pays off the debts of the company. Keep earnings are a crucial part of the shareholders’ equity. These are equal to the total of earnings that were not paid to shareholders. It can be considered as savings also in certain cases since these are often put to be used in the future.
When understanding an accounting equation, it is extremely crucial that you understand these key elements of the equation. It is when these elements are clear then only the accounting students can solve different accounting equations appropriately.
It is also needed to understand that there are certain limitations to an accounting equation as well. The accounting equation does not offer any information to the investors about the financial status of the organisation. There is a need for the investors to analyse other information as well so that it can be known if the organisation is performing well or not. There is a need for the investors to analyse the numbers and decide for them whether or not the organisation has liabilities. They must refer to different financial documents to understand if they have enough assets or not. So, it should be noted that accounting equations cannot help in determining whether.