The accounting equation summarizes the essential nature of doubleentry system of accounting. Under which, the debit always equal to credit, and assets always equal to the sum of equities and liabilities. Accounting equation can be simply defined as a relationship between assets, liabilities and owner’s equity in the business.
The accounting equation connotes two equations that are basic and core to accrual accounting and doubleentry accounting system.
The following are two basic rules of accounting equation that distinguishes the accrual system of accounting from cash basis accounting, and singleentry system from the doubleentry system:
It derives its status only from the accrual system of accounting and thereby, it does not apply in a cashbased, singleentry accounting system.
It is pertinent to note that the term basic accounting equation is another name for the ‘Balance Sheet Equation’. The reason balance sheet always balances is because of the following equation:
Assets = Liabilities + Owners Equities
The ingredients of this equation  Assets, Liabilities, and Owner's equities are the three major sections of the Balance sheet. By using the above equation, the bookkeepers and accountants ensure that the "balance" always holds i.e., both sides of the equation are always equal.
The accounting equation represents an extension of the ‘Basic Equation’ to include another fundamental rule that applies to every accounting transaction when a doubleentry system of bookkeeping is used by the businesses.
Debits = Credits
This Accounting Equation summarizes the following:
This equation serves to provide an essential form of builtin error checking mechanism for accountants while preparing the financial statements.
The entire financial accounting depends on the accounting equation which is also known as the ‘Balance Sheet Equation’. The following are the different types of basic accounting equation:
This balance sheet equation tells you that all the assets owned by the business are either sponsored using the owners’ equity or the amount which company should owe others like suppliers or borrowings like Loans
The difference of assets and owner’s investment into business is your liabilities which you owe others in the form of payables to suppliers, banks etc.
This equation reveals the value of assets owned purely by owner equity.
While trying to do this correlation, we can note that incomes or gains will increase owner’s equity and expenses, or losses will reduce it.
Let us understand the accounting equation with the help of an example.
Mr Ram, a sole proprietor has the following transactions in his books of accounts for the year 2019.
Amount ( in Indonesian Rupiah)
Date 
Transactions 
Assets = 
Liabilities + 
Owner’s Equity (Capital) 
01.01.19 
Capital brought into the business 20,000 
20,000 
 
20,000 
02.01.19 
Purchased goods on credit from Dad & Co., 2,000 
+ 2000 
+ 2,000 
 

Revised equation 
22,000 = 
2000 + 
20,000 
04.01.19 
Bought plant and machinery for cash 8,000 
+8,000 
  
  

Revised equation 
22,000 = 
2000 + 
20,000 
08.01.19 
Purchased goods for cash 4000 
+4,000 
  
  

Revised equation 
22,000 = 
2000 + 
20,000 
12.01.19 
Sold goods for cash (cost of inventory 4,000 + Profit 2,000) 6000 
+6,000 
  
+2,000 

Revised equation 
24,000 = 
2000 + 
22,000 
18.01.19 
Paid to Das and Co., in cash 1,000 
1,000 
1,000 
 

Revised equation 
23,000 = 
1000 + 
22,000 
22.01.19 
Received from Mr Y 300 (being a debtor) 
300 
  
  

Revised equation 
23,000 = 
1000 + 
22,000 
25.01.19 
Paid salary 6,000 
6,000 
 
6,000 

Revised equation 
17,000 = 
1000 + 
16,000 
30.01.19 
Received interest 5,000 
+5,000 
 
+ 5,000 

Revised equation 
22,000 = 
1000 + 
21,000 
31.01.19 
Paid wages 3,000 
3,000 
 
3,000 

Revised equation 
19,000 = 
1000 + 
18,000 
The extended accounting equation is the following: Assets = Liabilities + Contributed Capital + Beginning Retained Earnings + Revenue  Expenses  Dividends
Accounting equation comes with its own limitations. To begin with, it doesn’t provide an analysis of how the business is operating.
Furthermore, it doesn't totally keep accounting mistakes from being made. In any event, when the balance sheet report adjusts itself, there is still a chance of a mistake that doesn't include the accounting equation.
The basic accounting equation formula is:
Asset = Liabilities + Equity
The three components of the accounting equation are assets, liabilities, and equity.
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