0Basic of Accounting Equation
- Before one gets down to analyzing Financial Statements, one needs to know about the accounting equation. It puts things in proper perspective in order to understand the financial statements. (Especially for people with a non-commerce background).
- It can be mathematically expressed as: Assets = Capital + Liabilities.
- Theoretically: it can be said that the amount of owner's equity is the amount of assets minus the amount of liabilities.
- It is the foundation for the double entry system of accounting.
- Thus, the accounting equation essentially shows that what the business owns (its assets), is purchased by, either what it owes (its liabilities), or by what its promoters invest (its shareholders equity or capital).
- Now I’ll give a very simple example: A truck driver buys a second hand truck for Rs 2,00,000. To pay for it he uses his own savings of 50,000 rupees, and borrows 1,50,000 rupees from his brother. Therefore, as per the accounting equation, his assets are worth 2 lacs, his liabilities are Rs 1.5 lacs, and his equity, or capital is Rs 50,000.
