Each & every business transactions have an effect on companys financial position whether its a

large MNC or a small retailer shop. The financial position of a company or firm or an entity is
measured by the following items or components of balance sheet:a) Assets: Resources controlled by an entity or things that an entity owns
b) Liabilities: Obligations of an entity or amounts an entity owes to others
c) Owners Equity or Stockholders equity: It shows the amount invested by the owner of an entity
plus the amount of retained earnings by the entity. In simple words, the excess of Assets over
liabilities.
Double entry system of accounting is universally accepted. Loca paciali innovated this system in the
written form double entry system double aspects of each transaction are mentioned. Two accounts
are influenced for each transaction one is debit and the other is credit Modern writers of Accounting
have innovated an arithmetical equation known as accounting equation on the basis of this dual
aspect of transactions. This equation is universally accepted. The basis of this equation is that the
total assets of an organization are equal to the total equity i.e. asset equity.
The Accounting Equation represents the relationship between the Assets, Liabilities & Owners
Equity of an entity. It essentially displays that what an entity owns (Assets) are either financed by
what it owes (liabilities) or the money of the owners equity (shareholders equity). The relationship
is expressed as:Assets= Liabilities + Owners Equity
This Accounting Equation was the foundation for double-entry bookkeeping system*. Every
transaction and all financial reports must have the total debits equal to the total credits. Thus, the
above relationship is always balanced.
For example:1) If a new business is started with $ 1000 introduced by owner, Then the above equation will be:$ 1000= 0+ $ 1000

Assets in terms of cash $ 1000 & Owners Equity $ 1000

2) Further he purchases an office building worth $ 500 for which payment in installments will be
made after 1 year, Then the above equation will be:$ 1500= $ 500+ $ 1000
Assets in terms of cash $ 1000 plus building $ 500 & liabilities $ 500 plus Owners Equity $ 1000
3) After 1 year, he paid $ 200 has 1st installment, Then the above equation will be:$ 1300= $ 300+ $ 1000
Assets in terms of cash $ 800 plus building $ 500 & liabilities $ 300 plus Owners Equity $ 1000
Double-entry bookkeeping is a set of rules for recording financial information which states every
entry to an account requires a corresponding and opposite to a different account or every debit entry
has a corresponding credit entry.
From the above examples, it is apparently clear that every transaction is having two entries. Total
amount of debit is always equal to total amount of credit thereby balancing the equation.
Further analysis/expansion of the accounting equation:

Owners Equity = Capital introduced + retained earnings

Retained Earnings = Net Income Dividends paid/Drawings

Net Income = Revenue Expenses

So the expanded accounting equation will be:-

Assets= Liabilities + Capital Introduced + Revenue Expenses Dividends paid/Drawings

For a newly started business, Liabilities & Retained Earnings will be always 0. So the above
equation will shrink to:-

Assets = Capital Introduced by owner

It's important that accounting equation always balance because, if it does not, financial reports will
not enable to keep correct track of financial transactions.