Making Sense of Accounting Equations - Part I Articles | Accounting

The financial condition of a company depicts the total resources at its disposal and in addition the claims against these valuable assets at any given time. Claims are also known as equities. Therefore, a company can actually be called a blend of economic resources as well as equities. Economic Resources = Equities. Whatever be the kind of business you run, every kind of company normally has two different kinds of equities. These are the owner’s equity and the creditor’s equity. Put differently, Economic Resources = Owners Equity + Creditors Equities.

In accounting terms, a company’s assets refer to the financial resources a company possesses at a certain period of time. Conversely, a company’s liabilities refer to the amount of a creditor’s equity that a company has. Therefore, the common accounting formula or what is popularly called the accounting equation is depicted as follows: Assets = Owner’s Equity + Liabilities. Just like an algebraic equation, it is necessary that both sides of this equation need to be balanced. This equation is very useful when studying the financial outcomes of your daily business activities.

Now let us address an extremely vital concept of all businesses. Assets are called the financial resources of a business and these are expected to create wealth for the business in the future. Examples of this are real estate as well as any other property owned by the business in order that it can lease it out to people. In case it is an owned business, then the money enters what is referred to as accounts receivable and these are monetary items. But, there are quite a few assets, which are not physical in nature. A few examples of such assets are patents, trademarks, and copyrights but then they too are considered very precious to a business.

Liabilities refer to the commitments of a business like reassigning assets to some other entity, paying cash, or supplying future services to customers. These are called the debts of a business venture or the money owed by them sometime in the future. Now all such items are meticulously noted down in accounts payable. You must be aware that it is not a wise thing to have plenty of debt and debt/liabilities are considered to be claims in the eyes of the law.

Well, the law grants creditors (people to whom the business owes money) the right to demand selling of the company’s assets in case the company fails to clear their debts on schedule. Creditors have loads of rights over the business owners and it is mandatory that they be settled in full much before the owners get anything. Now it is quite probable for debts to make inroads into all of a company’s resources. Then, owner’s equity pertains to the claim of the business owners with relation to the assets possessed by them. This is the interest available or the remaining resources of a business after subtracting the sum of entity liabilities. This is the formula for calculating owner’s equity. Owner’s Equity = Assets-Liabilities.

Now the owner’s equity in a certain company is called as the stockholders equity, and therefore the equation then appears something such as this: Assets = Liabilities +Stockholder’s Equity. This stockholders equity comprises of two separate parts and these are the retained earnings and the contributed capital. Stockholder’s Equity = Contributed Capital + Retained Earnings.

Contributed capital refers to the amount, which each individual stockholder invests in the business. Generally, contributed capital is segregated into two discrete parts called as the “par value” and the “additional paid in capital.” Now, retained earnings refer to the equity amount, which stockholders earn by way of the income producing activities of the business and that are retained for future use by the business.