When it comes to the financial world, accounting is a crucial aspect of every business, irrespective of industry, structure, fund, and size. In case you’re studying accounting and are stuck at accounting equations, this blog will help you understand everything about them. Besides, if you need help even after reading this, we are here to assist you in every possible way.
Before we get straight to examples, let us first understand what an accounting equation really is.
Commonly known as the balance sheet equation, the fundamental equation measures the relationship between the owner’s equity, liabilities, and assets. The basic equation examines the financial reports of a company and analyzes its financial condition.
The base of the double-entry accounting system, this equation is used by several organizations to make sure that the balance sheet equals consistently. The sheet’s left side demonstrates the resources and must match the right side, which is the source.
Everything a company owns is called an asset and everything it owes is known as a liability. The owner’s share of the total assets is referred to as the owner’s equity. Thus, an accounting equation represents the relationship between a business’s liabilities, assets, and the owner’s equity.
The left column of the balance sheet represents liabilities while the right represents assets. When the two are equal, the company’s owner is at his best.
The formula for the accounting equation is as follows:
Assets - Liabilities = Owner’s Equity
Now, let us understand each term in depth.
The resources that a business owns are called assets. These are utilized for sales and production. Common instances of tangible assets are accounts receivable, inventory of product assets, and cash.
Some of the most common examples of material assets are collection systems, billing, buildings, furniture, land, computer appliances, dishes, office supplies, and customer supplies. Lastly, intangible assets include patents, trademarks, and copyrights. The business’s lenders or investors hold rights to the assets.
What businesses owe to third parties and lenders are called liabilities. Creditors are entities a company owes money to, such as government agencies, banks, and employees. Similar to assets, liabilities are categorized as current and fixed. Current liabilities include supply charges, invoices, utility, and employee payroll. Long-term liabilities include bank loans, deferred taxes, and mortgages.
The owner’s equity is the total amount left after the liabilities are paid off and the assets are liquidated. Thus, it is the value of assets that a company’s owner owns. There are several factors that increase or decrease the owner’s equity. These are explained below.
Based on these factors, the extended version of the accounting equation consists of further elements:
Hence, the formula for this equation is:
Assets = Liabilities + Owner’s Funds - Owner’s Drawings + Revenues - Charges
Let us understand these better through the help of some solved examples.
Find the missing factor with the use of the accounting equation transaction formula.
Assets = $200,000
Liabilities = $40,000
Equity = ?
Solution
Equity = Assets - Liabilities
Equity = $200,000 - $40,000 = $160,000
Find the missing factor with the use of the accounting equation transaction formula.
Assets = $200,000
Liabilities = ?
Equity = $80,000
Solution
Liabilities = Assets - Equity
Liabilities = $200,000 - $80,000 = $120,000
Accounting problems are the issues that lead to material financial statement errors and undetected mistakes because of regulatory non-compliance, cybersecurity breaches, wrong application of GAAP accounting standards, and poor internal control.
Thus, accounting issues that remain unchecked may lead to adverse cash flow along with misstatement of the company’s profitability. Some of the most popular accounting challenges that businesses usually face are:
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