Balance Sheet Equation Concept

The Historical Cost Concept needs support of two other concepts for practical purposes
viz. (i) the Money Measurement Concept (ii) the Balance Sheet Equation Concepts. Accounting
processes, however, conforms to an algebric equation which, in other words is involved in
two laws of nature, i.e., the law of constancy of matter and the law that every effect originates
from a case.
In relation to the former, it may be deduced that all that has been received by us must be
equal to (=) all that has been given to us (In accounts, receipts are classified as debits and
giving or sacrifices are classified as credits). Here, the equation comes
Debit = Credit
(That is, in other words, every debit must have a corresponding equal credit or viceversa).
All receipts (referred to above) may again be classified into (i) benefits/services received
and totally consumed (which are known as expenses), (ii) benefits or services received but not
used properly or misused (which are known as losses) and (iii) benefits or services received
but kept to be used in future (which are known as assets). Similarly, in the opposite case, all
that have been given by others may also be classified into (i) What has been given to us but are
not to be repaid (which are known as incomes or gains) and (ii) What has been given by others
but has to be repaid at a later date (which are known as liabilities).
Therefore, the above equation may again be re-written as under :
Expenses + Loss + Assets = Income + Gains + Liabilities
Or, Asset = Net Profit (-) Net Loss + Liabilities
Liabilities become due either to outsider or to the owner, viz. The proprietors, in the case :
Assets = Net Profit or (-) Net Loss + External liabilities + Dues to Proprietors.
We know that proprietors due increases with the amount of net profit whereas decreases
with the amount of net loss. The same is known as equity in the business. So, the above equation
comes down to :
Assets = Equity + External Liabilities
Again, from the proprietor’s point of view, the equation can also be re-written as under :
Proprietor’s Fund or Equity = Asset – Liabilities
E = A - L
From the above, it may be said that the entire accounting process depends on the above
accounting equation.