What is Accounting Equation and Journal?
Accounting is the process of measuring and recording all the financial transactions that happened in a financial year. It includes summarizing, analyzing and recording the data. It helps in getting a clear picture of the financial position of the business by seeing the value of a company’s assets and liabilities.
Accounting consists of some basic terms:
- Summarizing the data: In this step, all the financial transactions are recorded and summarized at one place.
- Analyzing the data: After summarizing the data, different specialists analyze the data.
- Interpreting the data: After the analysis of the data has been completed, the interpretation of the data is done. In this step, all the information collected from the previous steps is forwarded.
- Communicating the information: After the successful completion of the above steps, the information which is required by the different investors and other business entities is communicated to them.
The accounting equation is a fundamental accounting principle and a key component of the balance sheet.
The formula is as follows:
Assets = Liabilities + Shareholder’s Equity.
This equation establishes the cornerstone of double-entry accounting, often called double-entry accounting, and shows the balance sheet structure. Every transaction in double-entry accounting impacts at least one or two accounts.
An increase in an asset account, for example, can be matched by an equivalent rise in a corresponding liability or shareholder’s equity account, ensuring that the accounting equation remains balanced. Alternatively, a rise in one asset account might be offset by a reduction in another. When conducting journal entries, it is critical to remember the accounting equation
- Assets = Liabilities + Capital
- Liabilities = Assets – Capital
- Capital = Assets – Liabilities
This equation is based upon the double-entry bookkeeping method, which implies that all assets in the book of accounts ought to equal all liabilities. A matching credit entry should accompany every item made to the balance sheet’s debit side. As a result, it’s also known as the balance sheet equation. A balance sheet equation can be represented as:
Total Assets = Total Liabilities + Total Shareholder’s Equity
The above relationship is known as ‘Accounting Equation’ or ‘Balance Sheet Equation”. Let us discuss these three elements one by one:
Assets can be described as the value of the things owned by the firm for the purpose of using them in the business. They are not meant for sale. Expenditure that occurred in acquiring these valuable articles is also considered as asset. Assets can be of different types I.e. Fixed, Floating, Fictitious, Intangible, and Liquid. Assets are purchased to increase the earning capacity of the business. The value of these assets keeps on changing from time to time.
Some of the assets are as follows: Cash in Hand, Cash at Bank, Sundry Debtors, Bills Receivables, Investments, Plant & Machinery, Equipment and Tools, Furniture and Fittings, Closing Stock, Prepaid Expenses, Accrued Income, Etc.
Liability can be described as any claim of outsiders against the business or against the assets of the business. It is the amount that the firm is liable to pay to the outside party. The proprietor’s claim against the business is termed as an internal liability. External liabilities are of three types:
Creditors for Goods- Sundry Creditors and Bills Payable.
Creditors for Expenses– Outstanding Salaries, Unpaid Wages, Rent Due.
Other Liabilities- Bank Loan, Bank Overdraft, Partner’s Loan, Etc.
The value of liabilities also keeps on changing from time to time. An increase in the value of liabilities means that the firm has to pay more and a decrease in the value suggests that the firm has to pay less.
The amount invested by owners in the business whether in cash or kind is called capital. The Owner of the business can be a single person in a sole proprietorship, two or more than two in partnership, and many as shareholders in a company. Capital can also be described as the owner’s claim against the assets of the business or the Owner’s Fund. It can be further enumerated as under:
- Reserve, General Reserve, or Reserve Fund
- Profit or Retained Earning and
- Interest on Capital
Journal is a book of accounts in which all day today business transactions are recorded in a chronological order i.e., in the order of their occurrence. Transactions when recorded in a Journal are known as entries. It is the book in which transactions are recorded for the first time. Journal is also known as ‘Book of Original Record’ or ‘Book of Primary Entry’.
Business transactions of financial nature are classified into various categories of accounts such as assets, liabilities, capital, revenue and expenses.
Every business transaction affects two accounts.
Applying the principle of double entry one account is debited and the other account is credited.
Every transaction can be recorded in journal. This process of recording transactions in the journal is known as ‘Journalising’.
A Journal contains the following columns:
3. Ledger folio
4. Debit Amount
5. Credit Amount
Purchase (journal) book is also a book of original entry. This book records only Credit purchase of goods in which the firm deals.
PURCHASE RETURNS JOURNAL/BOOKS
Purchase returns of goods is recorded in this book. Sometimes goods purchased by the supplier are returned for various reasons such as goods are not as per our order, or are defective.
Transactions relating to Sale of goods dealt-in on credit is recorded in the sales journal.
SALE RETURNS JOURNAL/BOOK
Goods returned by the customers are recorded in the Sales return journal/book. The sales returns book does not record the return of goods sold on cash basis.
A Book maintained to record transactions, which do not find place in Special Journals, is known as Journal Proper.