The philosophy behind the accounting equation is a fascinating subject that most students of accounting will be asked about in exams.
In the paragraph below, I try to explain it in the simplest terms possible. Please comment with feedback.
The philosophy and concept behind the accounting equation is an important part of understanding accountancy, and can be explained in the following way:
Here's a video I created with a colleague to help explain this process in a little more detail. Please have a watch and let me know what you think (I mainly scripted the video btw)
"The assets of an entity can be financed in two different ways: Firstly, through external borrowing (which are also known as liabilities) or from the various forms of internal financing that are available - the ones we call "equity". The general principle of the accounting theory is that the total of assets will always be equal to the sum of both the liabilities and equity as described above."
I would also add that all accounting transactions fall into one of the 4 main types as listed below. This will help you understand the philosophy behind the accounting equation, as it shows how balance can be achieved between the two sides of the equation, by taking into account the necessary elements:
- Transactions that only affect Assets of the entity
- Transactions that affect Assets and Liabilities of the entity
- Transactions that affect Assets and Equity of the entity
- Transactions that affect Liabilities and Equity of the entity