FUNDAMENTAL ACCOUNTING EQUATION

FUNDAMENTAL ACCOUNTING EQUATION

The properties owned by a business are called ASSETS.
The rights to these properties are called EQUITIES.
Accounting deals with property and rights to property.

For every business enterprise, the sum of rights to the properties is equal to the sum of the properties owned by it.

This relationship can be expressed in form of an Accounting Equation.

ASSETS = EQUITIES

Or in simple words, if the business enterprise is not borrowing from outside sources and it is doing all its business in cash (no credit), then there will be no Liabilities and the above equation will stand true.

However, generally the business has to be carried out on credit basis and also sometimes the business enterprise may have to borrow funds from other sources. In that case the rights to properties (Equities) are divided into two principal types, which are The Rights of Creditors (Liabilities) and The Rights of Owners (Owner’s Equity).

So more logical Accounting Equation, which recognizes both types of Equities can be stated as follows.

ASSETS = LIABILITIES + OWNER’S EQUITY

Consequently, we may also express this equation as follows.

ASSETS – LIABILITIES = OWNER’S EQUITY

Here it is also notable that every business transaction can be stated in terms of its effect on the three basic elements of the accounting equation – Assets, Liabilities and Owner’s Equity.

Assets are resources (things that are owned by business).
Liabilities are obligations of the business (amounts that are owed by business).
Owner’s Equity is the amount left over after deduction of Liabilities from Assets