Key Components in the Accounting Equation

1. Assets

Assets can be described as the value of the things owned by the firm for the purpose of using them in the business. They are not meant for sale. Expenditure that occurred in acquiring these valuable articles is also considered as asset.  Assets can be of different types I.e. Fixed, Floating, Fictitious, Intangible, and Liquid. Assets are purchased to increase the earning capacity of the business. The value of these assets keeps on changing from time to time.

Some of the assets are as follows: Cash in Hand, Cash at Bank, Sundry Debtors, Bills Receivables, Investments, Plant & Machinery, Equipment and Tools, Furniture and Fittings, Closing Stock, Prepaid Expenses, Accrued Income, Etc. 

2. Liabilities

Liability can be described as any claim of outsiders against the business or against the assets of the business. It is the amount that the firm is liable to pay to the outside party. The proprietor’s claim against the business is termed as an internal liability.  External liabilities are of three types:

• Creditors for Goods- Sundry Creditors and Bills Payable.
• Creditors for Expenses– Outstanding Salaries, Unpaid Wages, Rent Due.
• Other Liabilities- Bank Loan, Bank Overdraft, Partner’s Loan, Etc. 

The value of liabilities also keeps on changing from time to time. An increase in the value of liabilities means that the firm has to pay more and a decrease in the value suggests that the firm has to pay less.

3. Equity

The amount invested by owners in the business whether in cash or kind is called Equity or capital. The Owner of the business can be a single person in a sole proprietorship, two or more than two in partnership, and many as shareholders in a company. Equity can also be described as the owner’s claim against the assets of the business or the Owner’s Fund. It can be further enumerated as under:

• Capital
• Reserve, General Reserve, or Reserve Fund
• Profit or Retained Earning and
• Interest on Capital

The interrelationship between assets, liabilities, and Equity results in the transactions that show that a change in one element forces a change in another.

The accounting equation is the foundation of double-entry accounting, representing the relationship between a company’s assets, liabilities, and equity. Business is run through transactions. Transactions are financial in nature and they affect the financial position of any business. Every transaction increases or decreases Assets, Liabilities, or Equity. The entire accounting structure is based on these three items. A business receives its fund from proprietors & creditors and invests those funds to acquire assets. This shows that the amount of capital and liabilities will be equal to the total amount of assets.