Deriving the Accounting EquationUpdated 3 days ago
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The following explain how we derive the Accounting equation. Whatever a business owns is called an asset. And the only buy, an asset could be owned is when the ownership of the asset is transferred to the business. This could only be done through payment whether an instant payment or instalment. There are two ways in which money to buy asset could be collected i.e. by receiving money from the people or by making a profit. Business can only receive money from two types of people, either investor who have invested money in the business or lender which is called capital and by lenders who have lend money to the business and is called liability. So far we have derived to the following equation: Assets = Capital + Profit + Liability. Now, lets examine the profit which is actually the difference between revenue and expenses. By further simplifying the equation, we derive at: Assets = Capital +(Revenue - Expenses) + Liability. By shifting the liability to the other side, we derive at the Accounting equation that is extensively used throughout Accounting which is: Assets + Expenses = Capital + Revenue + Liability.
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