What is the basic accounting equation? Define each component of the accounting equation

Q. What is the basic accounting equation? Define each component of the accounting equation (June’13).

Accounting Equation: Dual aspect may be stated as "for every debit, there is a credit." Every transaction should have twofold effect to the extent of the same amount. This concept has resulted in accounting equation which states that at any point of time the assets of any entity must be equal (in monetary terms) to the total of equities. In other words, for every business enterprise, the sum of the rights to the properties is equal to the sum of the properties owned. The properties of the business are called "assets". The rights to the properties are called "equities". Equities may be sub-divided into two principle types: The rights of the creditors and the rights of the owners. The equity of the creditors represents debts of the business and is called liabilities. The equity of the owner is called capital, or proprietorship or owner's equity.

The formula knows as the accounting equation, thus arrived at is as follows:

Assets=Equities

Or

Assets=Liabilities + Proprietorship

Another method of demonstrating the mathematical relationship involves a simple variation in the form of equation. Again it begins with the position that every business owns or has interest in certain assets. It also owes certain amounts to its creditors The difference between what it owns and what it owes represents the owner's capital or proprietorship. Thus the original equation is changed into:

Assets-Liabilities=Proprietorship

Components of the Accounting Equation:

Asset: An asset is a resource controlled by the enterprise as a result of past events and from which future economic benefits are expected to flow to the enterprise.

Equity: In a corporate enterprise equity is classified in the Balance Sheet as Share Capital and Reserve and Surplus. Normally Equity is shown at its paid up value.

Liability: A liability is a present obligation of the enterprise arising from past events the settlement of which is expected to result in an outflow from the enterprise of resources embodying economic benefits. There is a distinction between a present obligation and future commitment. A decision by the management of an enterprise to acquire assets in future does not of itself give the rise to a present obligation.

Proprietorship: The difference between what it owns and what it owes represents the owner's capital or proprietorship.