The value of the assets owned by the concern is equal to the claims on these assets.
The fundamental accounting equation is the formal expression of the dual aspect concept. All accounting procedures that we will discuss later are derived from this equation. The equation is written as
|Assets = Liabilities + Owner’s Equity
Economic events, which are recorded in the accounting system, are called transactions. Every transaction that an organization undertakes has a dual impact on the accounting records i.e. it will have an impact on two (or more) accounts simultaneously. This is why accounting is also called a double-entry system.
To illustrate suppose that Ms. Rozystarts a dry-cleaning business and her first act is to buy an industrial washing machine for $ 0.1 million with her own money. The dual aspect of this transaction would be that a proprietorship business now has an asset, an industrial washing machine, of $ 0.1 million and Ms. Sharda, the owner, has a claim of $ 0.1 million against this asset. Putting this in the above equation, we get
Assets (Industrial Washing Machine), $ 0.1 million = Liabilities + Owner’s Equity, $ 0.1 million.
Ms. Rozyborrows another $ 0.3 million from the bank for buying a shop. This will change her accounting records in two ways:
- It would show $ 0.3 million increase in cash on the asset side, and
- On the right hand side, it would show a liability of $ 0.3 million, which is the bank’s claim against the asset.
Cash = $ 0.3 million Owner’s equity = $ 0.1 million
There is no conceivable way that a transaction can result in only a single change in the accounts. There is another system where only a single entry is maintained for every transaction but companies cannot use this system, as the Companies Act does not allow it.
The Accounting Period Concept
Accounting measures activity for a specific interval of time, usually a year.
Net Income is easy to measure if you are only dealing once but the company deals constantly and we expect the company to continue forever (remember going concern principle). Therefore, it becomes difficult to find out whether the business is earning anything or not. Both the managers and external users are unwilling to wait for the closure of the business to know how the business has fared. They need to know how things are going in the business at frequent intervals. This leads to the accounting period concept. The first author of a known accounting text, Pacioli, wrote in 1994; “Books should be closed each year, especially in a partnership, because frequent accounting makes for long friendship”. So the books of the organization are closed at regular intervals (usually a year) and the financial statements prepared for reporting purposes. The Companies Act also requires that a report should be prepared for reporting purposes. The Companies Act also requires that a report should be prepared annually for reporting purposes and income tax reporting is also on an annual basis.
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