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Assets, liabilities and capital are constituents of business transactions. Let us discuss these elements:

(a) Assets. The acceptable meaning of assets is the valuable things owned by the firm. Expenditure for acquiring these valuable articles for use in the business is also termed as assets. The assets are acquired for constant future use. They are not meant for sale. These assets increase the profit earning capacity of the business. Some of the assets are listed as under : 

(i) Cash in hand                                                  (ii) Cash at bank

(iii) Sundry debtors or Book debts             (iv) Bills receivables

(v) Investments                                                  (vi) Closing stock

(vii) Land and building                                     (viii) Plant and machinery

(ix) Equipments and tools                               (x) Furniture and fittings

(xi) Patents, trade marks, etc.                         (xii) Goodwill

(xiii) Prepaid expenses                                       (xiv) Accrued income

(b) Liabilities. Creditors’ and proprietors’ claim against the assets of business is termed as its liability. Proprietor’s claim is termed as capital, which we shall be discussing later on. Liabilities are also known as equities or claims. The term liability means the claim_of outsiders against the business such as creditors for goods and expenses. Liability is the account for which the firm is indebted to outside parties. Certain external liabilities are mentioned as under :

(i) Creditors for goods–:-sundry creditors and bills payable

(ii) Creditors for expenses :

(a) Outstanding salaries

(b) Unpaid wages

(c) Rent due but not paid. 

(iit) Other liabilities :

(a) Bank loan or overdraft

(b) Partner’s loan

(c) Loan from Financial Institution, i.e., IFC, IDBI, etc.

(d) Debentures

(e) Employees Provident Fund

(f) Workmen’s Compensation Fund, etc.

Liabilities also go on changing. Their value either increases or decreases. In case of increase the business will have to pay more and in case of decrease the business will have to pay lesser.

(c) Capital. It is the proprietor’s claim against the assets of the business. In case of one man business the capital is contributed by the proprietor himself. In case of partnership, capital is contributed by partners and in case of companies. shareholders contribute for capital. Owners of the business are the contributors of the capital. Owners are the entrepreneurs of the business. They get profit of the business for the risk taken by them. If certain amount of profit remains undistributed or retained as reserve and funds, it is also known as proprietor’s claim. Proprietor’s claim can be enumerated as under :

(i) Capital

(ii) Reserve, general reserve or reserve fund

(iii) Profit or retained earning

(iv) Interest on capital. 

Explanation of Accounting Equation. Business transactions are financial in nature and so every transaction affects the financial position of the business. These transactions increase or decrease the assets, liabilities or capital. Every business has certain assets. These assets are purchased with the funds supplied to the business by its proprietors or creditors. Proprietors’ and creditors’ funds, in whatever form they are, create assets. For example, if the business receives $1,00,00 as capital from the proprietor and retains that in the firm, it will create an asset i.e., cash in hand. If $ 80,000 are deposited into the bank, the total capital will be represented by two assets i.e., cash $ 20,000 (due to deposit into the bank of $ 80,000 out of a cash balance of $ 1,00,000) and cash at bank $ 80,000. If furniture, worth $ 20,000 are purchased and payment is made out of bank deposit, the assets will now consist of cash in hand $ 20,000, cash at bank $ 60,000 (due to purchase of furniture, bank balance has reduced by $ 20,000) and furniture $ 20,000. As such accounting equation is a statement of equality between debits and credits. These above facts can also be presented in this way :

The above facts are technically known as Accounting Equations in simple form and reveal that capital which is always equal to assets.

Increase in capital will generally result in the corresponding increase in the assets and in the same way, decrease in capital will result in the decrease of assets. If the proprietor introduces $ 40,000 as additional capital there will be corresponding increase in cash balance. As both capital and assets are increasing simultaneously with $ 40,000, the capital will remain equal to assets. Amount withdrawn by the proprietor for personal use will decrease capital and there will be decrease in the cash, an asset at the same time. If drawings are worth $ 10,000 both the capital and assets will decrease simultaneously with $ 10,000.

INTRODUCTION OF CREDITORS’ LIABILITY IN ACCOUNTING EQUATIONS

It has been accepted fact that business does not possess anything of its own. The business receives funds from proprietors and creditors and retains all of them in the form of various assets. This shows that capital + liabilities are always equal to assets. The fact can be presented in terms of accounting equation as under: