Accounting Equation - The Importance of Accounting Equation

What is the Importance of Accounting Equation?

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The accounting equation aids the professionals greatly in making sure that the whole process is being done in an effective and efficient manner. Lets discuss in detail some other benefits of accounting equation.

The accounting equation is of a great value and relevance in the process of accounting as a whole. As such, it is necessary to make analysis accordingly on the basis of accounting equation.

The accounting equation aids the professionals greatly in making sure that the whole process is being done in an effective and efficient manner.

The accounting equation encompasses these components, Assets, liabilities and owner’s equity, while it represents the relationship between them.

The basic accounting equation, which is also known as balance sheet equation is formed in this way: Assets = Liabilities + owner’s equity.

In order to make interpretation and analysis of financial information, basic understanding of the accounting equation and the conceptual knowledge is important. Also, it's appropriate to mention that the financial reports are prepared on the basis of the accounting equation, which shows the importance of debits and the corresponding credits being associated with the innumerable business transactions, while representing the relevance of the components.

It is worth mentioning that the double entry book keeping system on which the accounting system is based, is clearly understood through this equation. It is thus set up in such a way that if two components are known, the third one can be easily determined.

As regards the relation between balance sheet and the income statement, it is through the expanded equation – that includes the components of the income statement, the link between these two financial statements can be asertained. So, the expanded accounting equation goes this way:

Assets = Liabilities + Owner's Equity + Revenue - Expenses – Drawings – Dividends

It is helpful to make use of the accounting equation at the time of preparing financial statements, as it would not only help you to maintain the accuracy, but also enable you to track the debits and credits, so that you can balance the equation accordingly.

The importance of accounting equation should not be underestimated, as it's very much helpful to serve as a basis for all the accounting transactions.

Representing the relationship with the components of the balance sheet, it reveals the financial standing of a business entity.

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FAREED SIDDIQUI

I am an Individual Member of Institute of Management Consultants of India. I am a Professional with a high creative capability based on Business, Management, Financial Accounting, Management Accounting, Finance and Management Consulting Field. I impart part time training and development programs. I write professional articles on business & management, business English and Software Engineering.

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