Question

explain what the accounting equation really means beyond the one side should equal the other

Answer 1

The balance sheet of the firm is a statement of assets and liabilities and equity as on a particular date. It is statement which gives details of assets like current assets and long term assets. The current assets are generated out of operations of the business like accounts receivable, inventory, prepaid expenses, etc the long term assets are acquired with an intention to generate revenue to the firm. Overall the assets represent the moneys due to the firm and the assets acquired by the firm as investments.

The liabilities are the money which is owed by the firm to the outsiders. The current liabilities are the liabilities which are generated out of operations of the firm for example: accounts payable, accrued expenses, income tax payable, interest payable etc. The non-current liabilities like long term notes payable or bonds payable are money borrowed on long term basis to meet capital requirements. The equity is the funds invested by shareholders in business and the retained earnings over the period of time.

Balance sheet is important due to following reasons:

· It helps in understanding overall financial position of the firm

· It helps in ascertaining the liquidity of the firm. Liquidity is the ability of the firm to meet short term obligations with current assets. For example: current ratio, quick ratio

· It helps in ascertaining the working capital requirements of the firm. Working capital is the difference between current assets and current liabilities.

· It helps in understating the solvency of the firm. Solvency is ability to meet scheduled repayment of borrowings. For example: Debt to total assets, Debt to equity

· It helps in understanding the net worth of the business. Net worth is the total assets minus total liabilities of the business.

· It gives details of capital invested in the business that is capital invested can be borrowed funds or equity.