All modern accounting systems make use of the double entry bookkeeping method. The double entry bookkeeping method is based on the nature of a transaction. As there are two values involved in a transaction there should be also be two parts for the recording of a transaction, a left side and a right ride(debit/credit).
The Accounting Equation
The basic accounting equation is : ASSETS = EQUITIES
What is Assets?
It includes anything owned or possessed by the business which is capable of being expressed in terms of money or possessing monetary values, and which consequently, is available for the payment of the debts or obligations of the business.
What is Equities?
It includes all the vested rights of persons in the assets of the business. Equities include all the amounts owned by the business to all persons which may be classified as : liabilities and owners' equty
To update our accounting equation, we may say that :
ASSETS = LIABILITIES + PROPRIETORSHIP or
ASSETS - LIABILITEIS = PROPRIETORSHIP
To summarize the equation we may concludes that:
-Increase in Assets = Increase in Proprietorship
-Increase in Assets = Increase in Liabilities
-Increase in some forms of Assets = Decrease in other forms of Assets
- Decrease in Assets = Decrease in Proprietorship
-Decrease in Assets = Decrease in Liabilities
-Increase in Liabilities = Decrease in Proprietorship
- Increase in some form of Liabilities = Decrease in other forms of Liabilities
- Increase in Proprietorship = Decrease in Liabilities
- Increase in some forms of Proprietorship = Decrease in other forms of Proprietorship
What other factors affect Proprietorship?
Let us decompose the Proprietorship section of the accounting equation into the following parts:
- Capital originally invested of amount originally placed into the business
- Additional investment or amount added to the capital originally invested (increase capital)
- Withdrawal or taking away of capital from business (decrease capital)
- Incomes or earnings of the business (sale of merchandise or services)
- Deductions from income such as cost of merchandise bought and sold, expenses, losses incident to the operations of the business.
From the original equation of Assets = Liabilities + Proprietorship we may expand our equation into
Assets = Liabilities + Original capital + Additional investment - Withdrawals +Income- Deductions from Income