Characteristics of Equity Equation

Characteristics of Equity Equation

In this article we would explain some important characteristics of equity equation. These characteristics have been explained in terms of relationship between asset , liabilities and shareholder equity, dual aspect of the accounting.

Important Characteristics of Equity Equation

Some important characteristics of equity equation have been described below

1.   Relationship between Asset & Liability and Equity:

Equity explains or describe an important relationship between asset & liabilities and equity i.e. asset is always equal to liabilities Plus equity. It is important to note that shareholder equity is also a kind of liability for business. 

2.   All Time Valid:

Equity equation is all time valid and can be calculated at any point of time. Different transactions changes this equation differently, however, for all transactions the basic outcome does not change i.e. asset = equity + liabilities.

In some transaction one asset is increased and other decreased like cash purchases. In other transaction asset and liability both increases like credit purchases.

3.   Equity Equation Formula:

Equity equation has simple formula

Asset = Equity + Liabilities

The formula can also be presented in following manner

Equity = Asset- Liabilities (This is known as net asset formula).

4.   Dual Concept of Accounting

Equity equation effectively explains the dual concept of the book keeping or accrual system. In accounting we study that each debit has a credit of equal amount and vice versa. In equity equation the assets are equal to liabilities.

5.   Performance Analyses:

Equity equation reflects the performance of the organization.

	Asset	Liabilities	Equity
2015	10,000	5,000	5,000
2016	15,000	6,000	9,000

Above example shows that equity has increased to 9000. It means that organization has earned a profit of 4,000. Thus equity equation can be used to calculate the profit. 

Thus We can say that equity equation provides some basic information about the financial position and performance.

6.   List of important characteristics of equity equation

Some important characteristics of equity equation are listed below

a.    It is simple & easy equation.

b.    It reflects the status of asset, liabilities and equity at first glance.

c.   It can be used for performance analyses.

7.   Equation Changes

The concept of accounting equation has been explained with following three transactions.

1.    Introduce capital 50,000.

2.    Taken a loan of 50,000

3.    Purchases made on credit 30,000.

Assets	Capital	Liabilities
50,000	50,000
50,000		50,000
30,000		30,000

In first transaction on one side the asset increase, while on other side the shareholder increases. The result of this transaction is asset and shareholder equity increases with same amount.

In second transaction the asset (cash) increase, and on other hand liabilities (loan) increases. The result of this transaction asset and liability both increases with same amount.

In third transaction the asset (inventory) increase, and on other hand liabilities (trade payable) increases. The result of this transaction asset and liability both increases with same amount.

There may be a transaction , where an asset would be increasing and other asset would be decreasing like purchase of plant on cash.

All of above four transaction shows that despite the different nature of transactions the equity equation remained valid.