What is accounting equation?
80Before journaling any transaction, you need to know accounting equation.This equation help you to keep from right track. Any accounting who serve for multi national company, large company even small business should understand the accounting equation.
The accounting equation contain three elements:
1. Asset (the company own)
2. Liabilities (the company owe it from others)
3. Owner's equity (the difference between asset and liability)
The example of asset is : cash, deposit, receivables, inventory, prepaid, advance payment, prepaid insurance, investments, land, buildings, equipment, vehicle, and goodwill.
The example of liabilities are: notes, short term loan,account payable, interest payable, incomes tax payable, bond, preferred stock, and long term loan.
The owner equity is the difference amount of asset to liability.In a company, the shareholder is the company owner. Therefore, the corporate name owner equity as shareholder equity. Owner's equity or shareholder's equity reports the amount invested and retained eraning ( the income which is not distributed to owner or shareholder).
The accounting equation for a sole propriethorship is :
Asset = Liabilities + Owner's Equity
If the company has some ownership, the equation is :
Asset = Liabilities + Shareholder's Equity
The left side and the ridgh side should be balance. If you find unbalance equation, you should check the journal. You may be wrong to record the journal or forget to journal some transactions.Therefore, you need recheck until the left side and right side is equal. If the equation is not equal, you could not make balance sheet. Balance sheet is representation of accounting equation.
As I explain in my other hub, the accounting use double entry accounting. Every transaction effects two different account i.e. debit and credit.
If you use accounting software, the equation must be balance. When entry a journal, the software will warn you if the journal is not balance. You may edit the journal and save it.
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