The Accounting Equation is the mathematical representation of the equality present in the patrimonial confirmation of the company, where what is owed is equal to what is had.
The accounting equation or equity equation consists of three variables: assets, liabilities, and equity. Definition of assets, liabilities, and equity
The definition of the three elements that are part of the accounting equation can be found in the technical-regulatory frameworks currently in force for the convergence groups into which the country’s entities have been divided.
The Accounting Equation Is The Pillar Of Modern Accounting?
As we already pointed out, it is the pillar of modern accounting, complemented by double entry, where what comes out is equal to what comes in, and what you have is equivalent to what you owe.
Therefore, the accounting equation is equality, which allows for determining a company’s balance.
Therefore, the accounting equation helps us identify and build that balance in the company’s equity, a ratio representing the company’s assets and the corresponding liabilities and equity.
Any company’s balance sheet is nothing more than applying the accounting equation since the balance sheet shows precisely the company’s assets, liabilities, and equity.
Accounting Equation Example.
The equation is characterize because it allows knowing an unknown variable call unknown from two know variables.
These variables can be exchange like any equation, and their value varies. We will always arrive at the same equality since double-entry is also incorporate into it, which allows equality to be maintain to the extent that every entry has a counterpart of the same value, thus preventing a difference from occurring that could affect the balance of the accounting equation.
What Does The Accounting Equation Mean?
Most of the time, the company does not fully own its assets. That is why rights over the company’s assets form the second part of the accounting equation. There are claims on these assets. For example, the company might have a loan on the company car, a mortgage on the building, or even owe money to its shareholders. All these claims on the company’s assets are divide into liabilities and equity.
A Bank Loan Or Mortgage Is A Good Example of Accounting Equation
Liabilities are claims on the company’s assets by other companies or individuals. It is the amount of money owed to other people in other arguments. A bank loan or mortgage is a good example. The bank has the right to the commercial building or the mortgage land.
On the other hand, equity is the shareholders’ rights to the company’s assets. This is the number of money shareholders has contributed to the company for an ownership interest. Equity also includes retained earnings. Equity is usually show after liability in the accounting equation because liabilities must be pay before owners’ claims. You may also notice that is the same order as the balance sheet.
When accounting records have been made, they leave a balance in each account that is ultimately add to determine how much the company has of total assets, how much of total liabilities, and finally, how much equity. one of the use given to the accounting equation is to be able to show that the accounts were classify correctly,
Analysis Of The Values In The Accounting Equation
The equity equation is not only use to corroborate the classification of the accounts. But it is also possible to carry out some analyzes of the financial situation of the company:
Favorable Positive Net Position
When the value of the assets is greater than that of the liabilities, there is a favorable equity position; this indicates a typical situation for the company since the assets and rights exceed the obligations.
The same happens when the value of the goods is equal to the net worth, and this means that the value of the obligations is equal to zero; that is, the company has no obligations with third parties. Generally, this situation occurs at the time of the company opening.
Companies Do Not Arise Created
so their resources were contribute by the partners and the third parties that financed them. That is why the assets are equal to the sum of the liabilities plus the heritage.
The concept of the accounting equation is based on the fact that the value of the asset must be finance 100%, 100% of which can finance in part with debts and amount with equity, with debts being liabilities and equity capital, or that it can be fund in its entirety by equity or contribution of the partners.
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