Page 19 - DEBK-XI(2020)

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C H A P T E R

Accounting Equation

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.