Question

Briefly describe each element of the accounting equation. Explain why it is necessary for the equation to remain in balance.

Answer 1

Accounting equation has three elements. Assets on the left-hand side, equal the sum of liabilities and equity on the right-hand side.

• Assets: Resources controlled by the enterprise as a result of past events and from which future economic benefits are expected to flow to the enterprise. Assets are what a company owns.
• Liabilities: Present obligations of an enterprise arising from past events, the settlement of which is expected to result in an outflow of resources embodying economic benefits. Liabilities are what a company owes.
• Equity Assets less liabilities. Equity is the residual interest in the assets after subtracting the liabilities.

Accounting is based on double entry system of bookkeeping. Under double entry system, every transaction or event effects two accounts. These two accounts belong to either assets or liabilities or equity. Hence every transaction influences these elements, increasing on both sides or decreasing on both sides or increasing and decreasing on the same side. Hence, due to these effects, the left-hand side of the equation is always equal to right-hand side of the equation.