How to Learn Accounting by Equation

The accounting equation is the base of all types of book-keeping transactions and records. You have to understand the equation to understand how a financial transaction is affecting the financial position of the business. Further, the various accounting entries are passed based on the basic accounting. The basic accounting equation is: “Assets = Liabilities + Owners’ Equity”. It can further be rearranged as “Owners’ Equity= Assets – Liabilities” or “Liabilities = Assets – Owners’ Equity”. After understanding the basic equation, you can understand how journal entries are passed and the general ledgers are maintained for the normal and recurring business transactions. The knowledge will further help in understanding the income statement and balance sheet of an organization.

Instructions

Before learning accounting by equation, you need to understand the meaning of the components of the basic equation. The term assets refer to all items possesses or owned by the business. You can consider the cash, accounts receivables, plants, equipments and supplies as business assets. On the other hand, the term liabilities stand for whatever a business owed to outsiders including accounts payables, bank accounts and any amount of expenses due but not paid till date. The term owners’ equity refers to the claim of the owner including capital investment, business profits and gains. Based on the definition of the terms, you have to identify the nature of each item and categorize it as asset, liabilities or owners’ equity.
As per the basic accounting equation, whatever a business owns always equals the total amount it owes to the creditors or outsiders and the owners. Further, the profit earned by the business is also owed by the business to the owners in addition to their investment in cash and other assets. When you calculate and sum the total amount owed to the outsiders and owners, you can get the total assets or net worth of the business. Similarly, you can deduct the total amount owed to the outsiders or creditors from the total assets to calculate the amount owed to the owners. The amount owed to the owners is deducted from the total net worth or assets of the business to calculate the amount owed to third party creditors.
Prepare a simple three-column accounting system with column headings Assets, Liabilities and Equity. Try to evaluate a daily transaction based on the nature of the involved items. Each business transaction will have an impact on the total amount of assets, liabilities and owners’ equity. When you notice an increase in assets, you can mark a corresponding increase in liabilities or owner’s equity. Similarly, a decrease in the total assets will result in a decrease in the amount of total liabilities or owner’s equity. Sometimes, a transaction may result in the increase and decrease of the item of similar category. For instance, you can find some transaction simultaneously increasing and decreasing the assets or liabilities.
You can further include some additional components like expenses, revenues and drawings. The revenues will increase the owners’ equity, whereas the expenses will decrease the owners’ equity. At the same time, the revenues and dividends result in increasing the owners’ equity. So you can expand the equation to: “Assets + Expenses + Drawings = Liabilities + Owners’ Equity + Revenues”.