Accounting Equation signifies that the assets of a business are always equal to the total of capital and liabilities. A business transaction will result in the change in either of the assets, liabilities or capital of the firm and even after the change the assets will be again equal to the total of capital and liabilities. If a business transactions results in the increase of assets, there will also be a corresponding increase in the amount of either capital or liabilities by the same amount.
The ‘Dual Aspect Concept’ is the basis of accounting equation. It can be expressed as:
An asset is any owned physical object or right, having a money value. These are the economic resources which are owned by a business and from which future economic benefits are expected to flow to the enterprise. The assets may be tangible or intangible like Land and Building, Plant and Machinery, Furniture, Goodwill, Patents, Trademarks and Copyrights etc.
Equities refer to all claims or rights against the assets of an enterprise. These show the sources of the assets. The claims against the assets may be external or internal. External claims are outsiders’ equity and internal claims are owner’s equity. Outsider’s Equity is the liability of the business and owner’s equity is the capital of the business.
The capital is the amount invested by the owner in the business enterprise. It may be invested in cash or kind.
The Liabilities refer to an amount owing by one person to another payable in money, goods or services. The Liabilities may be Long term Liabilities (payable within more than a year) or Short term Liabilities (payable within a year).
The Accounting Equation can be expressed as follows:
ASSETS= LIABILITIES+ CAPITAL
ASSETS= OWNER’S EQUITY+ OUTSIDER’S EQUITY
ASSETS= INTERNAL CLAIMS+ EXTERNAL CLAIMS