The accounting equation for a double entry system is a basic, basic formula. The formula of the equation includes your business obligations, tools, and equity as well as how these three elements are related to each other. The formula says that business assets or net assets can be calculated by deducting the value of a business from the value of its assets.
The accounting equation is the most widespread equation of scales, and the equation must be understood to properly evaluate and understand the balance.
With the basic understanding of expressions related to the equation, it is easy to understand the formula and how it works. The value of the business obligations is the total amount of money or resources that a company pays for its paid assets. The value of a business asset is the total amount of money or products owned by the business owner. The accounting equation is as follows: value of assets = liabilities = total equity.
We look at the accounting equation of ABC Cellular Phones. Last month, the following transactions occurred:
- the owner invested $ 3000 in his business
- paid $ 500 for his account
- for $ 1000 for customer purchases.
The equation will look like this:
wealth ($ 3,000 + $ 1,000) – liabilities ($ 500) = $ 3,500 total equity.
It is important to understand that this illustration is very basic and does not take into account factors that affect the value of business assets and liabilities, such as depreciation, which may fluctuate over time.
The accounting equation serves not just to give an accurate assessment of an enterprise's capital, but also to warn the business of calculating its equity. If the equation is properly used and the liabilities are accurately deducted for the assets, the calculated capital must be equal to the actual capital. If there is a discrepancy between the accounting equation and the equity of the company and the actual capital, then obviously there is a problem to be found. Or if the amount of liabilities and the equity value is not equal to the value of the assets, there is an accounting error. Thus, the discrepancy warns businesses of their balance problem.
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