Accounting Equation and define its components briefly.

 

What is accounting equation?

The two basic elements of a business are what it owns and what it owes. The father of modern accounting is Italian Luca Pacioli, who in 1494 first described the system of double-entry in his own book Summa de arithmetica, geometria, proportioni et proportionalita . From this book we can know that the accounting equation is,

A=L+OE

Where,

A=Assets

L=liabilities

OE=Owners Equity

Assets: Assets are resources a business owns. The business uses its assets in carrying out such activities as production and sales. The common characteristic possessed by all assets is the capacity to provide future services or benefits.

Liabilities: Liabilities are claims against assets that is existing debts and obligations. Businesses of all sizes usually borrow money and purchase merchandise on credit.

Owners Equity: The ownership claim on total assets is owners equity.It is equal to total assets minus total liabilities.

In expanded equations we can see,

A=L+OE-D+R-E

Where,

D - is the short form of Owners Drawing.

R - is the indicators of Revenue.

E - shows Expenses.

Drawings: Drawings an owners may withdraw cash or others assets for personal use.

Revenue: Revenue are the gross increase in owners equity resulting from business activities entered into for the purpose of earning income.

Expenses: Expenses are the cost of assets consumed or services used in the process of earning revenue. They are decreases in owners equity that result from operating the business.