Accounting is the measurement, elaboration, and provision of certainty about information that will help investors, managers, tax authorities or other decision makers to make the allocation of decision resources within organizations, companies, and government agencies.
Nowadays, the field of Accounting is a popular field of work and major. If you are an accountant or a student who is in the study period of an accountant must understand what is the basic element of Accounting, which is the Basic Accounting Equation. The Basic Accounting Equation is a relationship between debt, assets, and capital of a company because each business transaction affects at least two company accounts.
Basic Accounting Equations: Fundamental Elements of Accounting
In fact, all accounting concepts and frameworks are based on the Basic Accounting Equation. The Basic Accounting Equation equates a company’s assets with its liabilities and equity. This shows all the assets of the company obtained from either debt or equity funding. For example when a new company is built, the first asset purchased comes from funds received from investors or from loans (debt). Thus all company assets that come from creditors or investors are called liabilities and equity. If described by the formula, the formulation is as follows:
Assets = Liabilities + Equity
As you can see, the asset side is equivalent to the number of liabilities and owner’s equity. This makes sense if the mindset is liability and equity is basically just a source of funding for companies to buy assets.
This equation is generally written with the liability position placed first before owner’s equity. Because debts to creditors must be paid off before investors when the company goes bankrupt. In other words, liabilities are considered more current or liquid than equity. This has proven to be consistent with the example of financial reporting where current assets (Current Assets) and current liabilities (Current Liabilities) are always reported before fixed assets (PPE) and long-term liabilities (Long-Term Debt).
This equation applies to all business activities and transactions. Assets will always be equivalent to liabilities and owner’s equity. If assets increase, both liabilities or owner’s equity must increase to balance the equation. Vice versa, if assets decline, liabilities and owner’s equity also decline.
Components in the Basic Accounting Equation
Now that we have a basic understanding of the equation, let’s look at each component of the accounting equation that starts with assets.
Assets are resources that are owned or controlled by a company for future use. Some assets are tangible such as cash and some are intangible or intangible such as goodwill or copyright. Here are some examples of asset accounts:
Current assets: Cash, Receivables, Prepaid Expenses.
Fixed Assets: Vehicles, Buildings.
Intangible Assets: Goodwill, Copyright, Patents
Liability or Liability
Obligations or commonly referred to as liabilities are a number of funds that the company borrows from other parties (creditors) and must be paid in accordance with the agreed time. A common form of obligation is debt. Debt is the opposite of receivables. When a company buys goods or services from another company on credit, debt is recorded to show that the company promises to pay later. Here are a few examples of the most common liability accounts.
Short-term Debt: Trade Debt, Bank Debt, Salary Debt, Tax Debt.
Long-term Debt: Bond Debt
Equity is part of company assets owned by shareholders or third parties. Owners can increase their share of ownership by investing funds in the company or reducing equity by withdrawing company funds (prive). Likewise, income increases the equity side while costs decrease equity. Some general equity accounts such as Owner’s Capital, Owner’s Withdrawal (prive), Retained Earnings, Common Stock, Paid-in Capital.
Example of Application of Basic Accounting Equations
The following is an example of the case for applying the Basic Accounting Equation:
Gus is a businessman who wants to start a company that sells musical instruments. After saving money for a year, Gus decided to officially start his business. He formed Guitars, Inc. and invested IDR 100,000,000 in his new company. This business transaction increases the company’s cash and increases equity by the same amount.