Essay: THE ACCOUNTING EQUATION

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  • Subject area(s): Accounting essays
  • Reading time: 2 minutes
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  • Published on: November 14, 2017
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  • THE ACCOUNTING EQUATION
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The accounting equation also known as the balance-sheet equation, is the fundamental equation of the double-entry bookkeeping system that displays what is owned and what is owed by the owner or entity (Luthra, n.d.). The accounting equation is generally expressed in the form of ‘Assets = Liability + Owner’s Equity’, but for a corporation the equation is expressed as ‘Assets = Liability + Stockholders’ equity’, and for non-profit organizations, it is ‘Assets = Liability + Net Assets’. Because of double entry accounting, this equation should be balanced on both sides at all times. If at any point the sum of the debits for all accounts does not equal to the sum of the credits for all accounts then an error has occurred, thus this equation serves as an error detection tool. The accounting equation is typically express as a ‘balance sheet’ in the financial statement (Averkamp, n.d.).

In order to more fully grasp an adequate understanding of the development of the accounting equation we have to look to the origin of this equation. Luca Pacioli a Franciscan monk who is often called the ‘father of accounting’, was born in 1446 in Sansepolcro, Italy. He was an Italian mathematician who published a mathematics book titled ‘Summa de arithmetica, geometria and proportioni et proportionalita’ in 1494 which was published in Venice, Italy. It served as the only textbook for accounting up till the 16th century all around the world. within it contained a portion which had detailed descriptions of what we now call the double-entry bookkeeping system that enabled others to study, use and develop what we know today as the ‘accounting equation’ which is based or derived from the double-entry bookkeeping system (User, n.d.).

The accounting equation gives a lot of advantages as it helps accountants, business owners and investors to gain important information on a business and its performance. It helps ascertain the success or failure of a business. Take for example the owner’s equity of a business, if it were to increase if would indicate the success of that particular business and vice-versa (SIDDIQUI, 2013). In addition, the equation also helps identify the third component of the equation provided when the two other components are known. For example, if the assets and the liabilities were known, one need only do a simple mathematical calculation to obtain the owner’s equity (SIDDIQUI, 2013). Besides, the equation also helps accountants easily determine the debits and credits of a business transaction (SIDDIQUI, 2013). Additionally, the accounting equation shows the effect or impact of a business transaction on owner’s equity, liability and assets (Rana, n.d.). Moreover, the equation does help accountants rectify errors, make reversal financial entries or reclassify entries conveniently (SIDDIQUI, 2013). Furthermore, the accounting equation if presented item wise, can help calculate various ratios such as capital to total assets, liability to total assets, current assets to fixed assets, current liability to current assets etc. Which is a big help in making important decisions when running a business (Rana, n.d.).

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