ACC205 Week 1 - DQ 1 Accounting Equation



Week 1 DQ1 Accounting Equation Transcript

 

In this video I'm going to talk about something called the basic accounting Equation. This equation is absolutely fundamental to your understanding of accounting so let's go ahead and write out the equation. We've got on the left-hand side we have assets is the left hand side of our equation. Assets are always equal to liabilities which is otherwise seen as debt borrowing plus equity is the owner share of the assets.  So we've got the right hand side of the equation all this over here and then we've got the assets on the left hand side. This equation will always balances, always, always balances, and in fact this is something you will see on the balance sheet. You'll always see on any balance sheet the assets will be equal to liabilities plus equity.

 

So when we think about conceptually what is going on here well there's a few things. So first of all the assets are things that the company or the business owns, for example cash, to be some accounts receivable, property, plant, equipment, things like buildings, we've got intangible assets like trademarks, investments. All these different things are things that the company owns but although the company owns these things there are different claims on those assets and that's what's represented by the liabilities and equity side. These are claims on the assets of the business but these claims come from two different sources. So we've got the liabilities which is debtors so, for example, you borrow money from a bank. You own this asset but there's a claim against it by a bank so that's the debtor side, and then this equity side is owners so the equity side represents claims by owners and then the debtor side is claims against the assets by debtors.

 

This is a little abstract here so let's go ahead and just think about this in terms of if we actually started a business. So let's say we want to start or you want to start a DJ business. You want to be a DJ at weddings so you start your own DJ business. Eell you're gonna have to buy some equipment so you purchase equipment and let's say it costs five thousand dollars. So you purchase equipment for 5,000 and let's just pretend this to keep things simple here let's pretend that this is the only asset for right now that we're concerned with that you bought. This is the only thing that you own. Make this a very simple world here so that equipment is an asset. So what's going to happen is if we were to look at your balance sheet or to do this accounting equation for your company we're going to have five thousand dollars on the left-hand side and then that five thousand dollars in assets it's just corresponds to this up here is going to be equal to liabilities plus equity. So how do we figure that out? What we have to figure out how are those assets paid for? Well let's say that you went and you took a thousand dollars out of your personal savings which was separate from the business. Just you put a thousand dollars of your own money into the business. Well that's the equity portion. That's your claim against the assets of the business because you are the owner so you've got a thousand dollars here in equity but how else was this purchase of the equipment financed. Well let's say that you borrowed the remaining four thousand dollars from a bank so now we can represent this. In terms of it we've got assets here on our left hand side and then we've got claims against those assets on our right hand side.

 

Okay we've got four thousand dollars in liabilities here and then we've got a thousand dollars in equity. But let's say for a moment that you decide that you want to have an investment, just let's say you want to invest two hundred dollars cash after all this is taking place. You just want to give the company two hundred dollars cash and it will use it at some point in the future. Ok so what's going to happen is this: So now we're going to add that two hundred dollars over here on the asset side and now the company is going to have an asset of five thousand dollars in terms of its equipment plus two hundred dollars of cash. If we were to look at its balance sheet at 5,200 dollars and assets but that has to equal the right hand side if the left-hand side goes up by 200 then the right-hand side must go up by 200 so then we say okay how was that increase in assets financed? Well did we borrow the two hundred dollars? No the owner put it in from his own or her own personal savings so that the debt, the liability side, it's going to stay the same because we didn't borrow to get that but now the owner he or she has an extra two hundred dollars of equity. So if you're the owner now you have twelve hundred dollars in equity, there's four thousand dollars in liabilities, and here's your total assets of five thousand two hundred dollars.

 

Whatever you do to the left hand side or to the right hand side there has to be a corresponding change in the other side of the equation so that both sides are equal to each other. This is the basic accounting equation.

 

 

 
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