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CHAPTER             Accounting Equation
                      CHAPTER

                            5







                                  MEANING OF KEY TERMS USED IN THE CHAPTER

                       1.  Accounting Equation    Accounting Equation shows the relationship between capital, liabilities
                                                  and assets. Total assets are equal to the sum of capital and liabilities.
                                                  Mathematical Expression of Accounting Equation:
                                                   (i)  Assets = Liabilities + Capital; or
                                                   (ii)  Capital = Assets – Liabilities; or
                                                  (iii)  Liabilities = Assets – Capital.
                       2.  Assets                 Assets are the resources that the business owns. They refer to property
                                                  or legal rights owned by the business, which can be measured in terms
                                                  of money.
                       3.  Liabilities            Liabilities are the financial obligations of an enterprise other than owner’s
                                                  fund or capital.
                       4.  Capital                Capital is the amount invested by the owner in the business.
                                                                            Or
                                                  Capital is the excess of assets over external liabilities.

                                                  CHAPTER SUMMARY

                     •  Accounting Equation is the basis for Double Entry System of Book Keeping. Total assets
                       of the business firm are provided by the creditors/lenders and the owners. Therefore, at any
                       point of time, the total assets of a business are equal to its total liabilities (those of outsiders
                       and of the proprietors). Liabilities to the outsiders are known as ‘liabilities’ but liability to
                       the owners, in accounting is referred to as ‘capital’.
                       We can express the relationship that exists among assets, liabilities and capital in the form
                       of an accounting equation as follows:
                                             Total Assets = Total Liabilities
                                                             Or
                                             Total Assets = Liabilities + Capital
                                                             Or
                                                  Capital = Total Assets – Liabilities
                     •  A transaction may affect either both sides of the equation by the same amount or on one side
                       of the equation only, by both increasing or decreasing it by the equal amounts.
                     •  An increase in an asset, without a corresponding increase in liability or corresponding decrease
                       in another asset, must represent an increase in capital.
                       Conversely, an increase in liability without a corresponding increase in asset or a corresponding
                       decrease in another liability, will indicate a decrease in capital.
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