Some business owners may be quite familiar with the basic accounting equation, which states that the assets that a company owns are equal to the sum of its liabilities and equity. However, when the accountants in an accounting firm in Johor Bahru are dealing with different kinds of company, they may expand this equation based on the business form that the company has chosen. The accounting equation will be slightly different in the case of sole proprietorships, partnerships and companies.
When calculating the assets that a sole proprietorship owns, the accountant will sum up the liabilities as well as the owner’s capital, that is the amount the owner has invested in the business, then minus any withdrawals (Also see Understanding Drawing Accounts) that the company has made. Then, he will add the income generated to the resulting amount before subtracting the expenses incurred.
The calculation for partnerships is quite similar to that of the sole proprietorships. To calculate the assets, the accountant will add liabilities to partner’s capital instead of the owner’s capital, less the distributions given to the partners, instead of the withdrawals as in the case of sole proprietorships. Then, similar to that of in the sole proprietorship, he will add the income generated to the resulting amount before subtracting the expenses incurred.
The calculation for companies (Also see What is Meant by the Term “Company”?) may be a bit more complicated when compared to that of the sole proprietorships and partnerships. To calculate the assets owned by a company, the accountant should include the liabilities and the paid-in capital, less any treasury stock (the stocks that the shareholders of the issuing company have repurchased). Next, the accountant will then add the income that the company have earned to the resulting amount, and minus expenses incurred by the company as well as the dividends.
In accounting, this equation is crucial as it shows the financial health of the business. Besides providing the information included in the balance sheet, the accounting equation also present information related to the profit and loss statement (Also see What is the Relationship between the Profit and Loss Statement and the Balance Sheet?). As we can see from the explanation above, the assets that an organisation owns are equivalent to the net impact of liabilities, stockholder’s equity as well as its net income.
By using this equation, business owners will be able to understand the financial position and performance of the business that the financial statements have presented to them. The professionals also rely on this equation to determine the efficiency of the accounting policies that the organisation is following.