Accounting Equation

An accounting equation is a mathematical model or expression that shows the relationship between the assets of a firm and its capital and liabilities at a particular period of time. It is also referred to as balance sheet equation and it is expressed as follows;

A= C + L

Where; A is assets of the organization expressed in monetary form

             C is capital or owners contribution which is also termed as equity or owners claim.

             L is the firm debt or liabilities

It should be noted that, the total monetary value of all assets and the total monetary value of capital and liabilities summed up together should always be equal.

Example 1

Assume that the value of A=$100,000,000; C=$100,000,000 and L=$0.000 (ie is zero). This implies that the two sides of balance sheet are balancing or equal. This depicts that the owner used own capital to start the business and did not externally borrow any debt amount. In other words, the owner financed the acquisition of assets (in this case it was cash availed in to the business) using own contribution. Either gotten from own savings.

NB: That with this equation, one can determine the missing value if at least two of its variables are known with certainty.

Case three: If Zack started the business on 2nd/01/2018 with own cash $100,000,000 and $50,000,000 borrowed from a commercial bank, the balance sheet will portray the financial position as follows;

balance-sheet-example-3

The balance sheet shows that Our co. ltd financial position has changed with A=$150,000,000; C=$100,000,000 and L =$50,000,000. This implies that the owner financed his assets (cash) using both own contribution of $100,000,000 and a debt (loan) of $50,000,000.

As mentioned in the three demonstrations presented earlier, it is clear that balance sheet is anchored on the accounting equation and the aspect of dual effect of transactions results to both sides being equal. Also, the balance sheet portrays three main components, namely; assets, capital and liabilities.