Question

Please share your insights and thoughts about this discussion post.

the relationship between economic resources and claims to economic resources is that the assets of the entity are the economic resources owned by the entity and the claims to economic resources are the liabilities and the owner's equity. Therefore, the equation must balance because any transaction done by the entity has either same effect on both sides of the equation or opposite effect on either one side of equation. Net income increases owner equity and net loss decreases owners equity.Transactions that increase owner's equity include issue of common stock and net income for the period, transactions that decrease owner's equity include net loss for the period and payment of dividends. For example: issue of loan payable for $20,000 has same result on both sides on the equation i.e. increase of $20,000 in assets and increase of $20,000 in liabilities.

Answer 1

The objection of accounting is to gather financial information to make better decisions. For obtaining financial information, all the financial and economic transactions of the organisations are recorded. This brings us to the concept of accounting equation which states that

ASSETS = LIABILITIES + SHAREHOLDER’S EQUITY

This implies that all the economic assets – tangible (such as land, machinery, inventory, debtors etc.) and intangible assets (such as goodwill, patents, copyrights, etc. ) can be bifurcated into liabilities ( what business owes to creditors) and owner’s equity (claims of the owners).

This means all the assets acquired by the business are acquired by the funds that are obtained either from the creditors or from the owners of the business.

If there is any change in total amount of economic assets then that change will be reflected either in liabilities of the business or the owner’s equity.

For example – Amount invested by the business owner in the business. This will lead to increase in the Cash Balance of the business. Thus, increase in total assets of the business. Also, this will increase the capital of the business owner. Thus, increase in Owner’s equity.

Every financial transaction impacts the accounting equation but the equation always remains balanced.

There can be financial transactions that may impact only the one side of the equation.

For example – Purchase of Machinery by making cash payment. This will lead to reduction in Cash Balance. Thus, decreasing the total assets of the business. But there will be corresponding increase in the Long term assets of the business due to addition of new machinery. Thus, increasing the total assets of the business.

Therefore, as a whole there will be no change in the total assets of the business as there was increase and decrease of the same amount.

Therefore, the accounting equation always remains balanced.