UAE Accounting Equation: Key Concepts
Unlock the essence of the Accounting Equation for UAE businesses. Dive into fundamental concepts that will empower your financial decision-making. Gain insights for sound financial management.
Accounting Equation
What is an accounting equation? The accounting equation also called the basic accounting equation, forms the basis for all kinds of accounting systems. The entire double-entry accounting key concept is based on the basic accounting equation. This simple equation illustrates two facts about a company: what it owns and owes.
The accounting equation is equal to a company’s assets to its obligations and equity. This shows that either debt or equity financing acquires all company assets. For example, when a company is started, its assets are first purchased with either money from banks or other creditors in the form of loans or money the company receives from investors. Thus, all of the company’s assets originate from creditors or investors, liabilities, and equity.
Assets are equal to the total of liabilities and Owner’s equity. This is logical because liabilities and equity are just funding sources for companies to purchase assets.
The equation is generally written with liabilities before the holder’s equity because creditors usually have to be repaid before investors in case of bankruptcy. In this sense, the obligations are considered more present than the equity. This is in line with financial reporting, where present assets and obligations are always reported before long-term assets and liabilities.
Following a double-entry accounting system, this equation holds for all business activities and transactions. Assets will always balance and be equal to liabilities and Owner’s equity. If assets increase, liabilities or Owner’s equity must increase to balance the equation. The vice versa is true if liabilities or equity increase.
Accounting Equation Formula
Are you looking for an accounting equation formula? Read the paragraph mentioned below, and it will clear all your doubts.
Here, Assets means Liabilities + Owner’s possession.
- You must first enlist all the company’s assets on a balance sheet for a particular period to get the accounting equation.
- Take a new balance sheet and list the company’s total liabilities.
- Now, find the equity of the total shareholders. Add the figure with the total liabilities.
- The total asset is equivalent to the sum of total equity and liability.
Now that you understand the equation let’s look at each accounting equation part, starting with the assets.
Assets
How do you define an asset? In a UAE business sense, an asset is a monetary value owned or controlled by the company for future benefits. Some assets, like cash, vehicles, machinery, land, etc., may be tangible, while others are theoretical or intangible, like patent rights, design registration, goodwill copyrights, etc.
Another common asset that is worth mentioning is the account receivables. This is a classic example of crude accounting. This is another party’s promise that they will pay us. Receivables arise when a company offers a service or sells it to someone on credit.
These assets are things that a company can utilize for future benefits. Here are some common examples of assets:
- Cash
- Land
- Machinery
- Accounts Receivable
- Prepaid Expenses
- Vehicles
- Buildings
- Goodwill
- Copyrights
- Patents
- Supplier Advance
- Bank Guarantee
Liabilities
Simply put, a liability is money owed to another person or organization. Alternatively, liabilities are creditors’ claims on company assets because these are the assets creditors would own if the business is liquidated.
A common form of liability is accounts payable. Accounts payable are the opposite of accounts receivable. When a company buys goods or services from various companies on credit, a payable is recorded to show that it promises to pay the other companies for their assets.
Here are some instances of the most common liabilities:
- Accounts payable
- Bank loans
- Lines of Credit
- Fixed deposits received
- Bank guarantees received
- Material advance received
- Unearned income
Equity
Equity represents the proportion of company assets owned by the Owner, shareholders, or partners. In other words, the shareholders or partners own the remainder of the assets once all liabilities are paid off.
Owners can increase their ownership stake by contributing money to the business or decrease equity by withdrawing company funds through drawing accounts or selling shares. Likewise, revenues increase equity, while expenses decrease it.
Here are some common equity accounts:
- Owner’s Capital
- Owner’s Withdrawals
- Revenues
- Expenses
- Common stock
- Paid-In Capital
Example
Let us look at a company’s formation to illustrate how the accounting equation works in the UAE business.
Vicky is an entrepreneur who wants to start a design consultancy in civil engineering projects. After saving up money for a year, he officially started his business. He forms Dynamic Consultants, Inc. and contributes $200,000 to the company in exchange for all of its latest issued shares. This business transaction betters company cash and increases equity by the same amount.
After the company’s formation, Dynamic Consultants, Inc. needed to buy some computers and software for designing, so it purchased $20,000 from different vendors by issuing checks. In this case, Speakers, Inc. uses its bank balance to buy another asset, so the asset account is decreased by the disbursement of funds and increased by the addition of installation equipment and software.
After twelve months, Dynamic Consultants, Inc. is growing rapidly and has to find a new place of business. Vicky decides that it makes the most financial sense for the company to buy an office space. Since the company needs more funds to pay for a building, it must take out a loan. This company purchases a $600,000 building by paying $100,000 in cash and taking out a $500,000 mortgage. This business transaction reduces assets by the $100,000 of cash given. These things increase assets by the new $600,000 building and liabilities by the new $500,000 mortgage.
As can be seen, these transactions always balance the accounting equation. This is one of the fundamental rules of accounting. The accounting equation can always be in balance. Assets will always equal liabilities and Owner’s equity.
How can you use the accounting equation to make better UAE business decisions?
The basic accounting equation, the balance sheet equation, is Assets = Liabilities + Equity. This equation is the basis of double-entry bookkeeping, which all UAE businesses use to keep track of their money and funds.
This equation is critical because it shows how the three major components of a business’s financial statement are similar. Assets are everything an entity owns and can use to earn revenue. Liabilities are what a company owes to others. Equity is stakeholders’ leftover claim on assets after liabilities are paid.
A business can utilize the accounting equation to make good decisions:
- They can use it to track where their money is going and ensure that their assets are being used most efficiently.
- They can use it to check whether they have the required resources to meet their obligations.
- They can use it to check opportunities to generate more equity or reduce liabilities.
By understanding how the accounting equation works, UAE businesses can make informed decisions about using their resources best.
What Do You Understand by Fundamental Accounting Equation
There are many aspiring professionals to whom the fundamental accounting equation is not clear. As a result, they need to apply the formula in their work. If you are among them, let me tell you the fundamental accounting equation. This is an equation in which you must explain the relationship between the assets used to form the business and the funds used to make purchases. It is also loved for the name balance sheet equation.
The fundamental accounting equation is made up of three variables. These are assets, liabilities, and the Owner’s or shareholders’ equity.
The fundamental accounting equation indicates that the company’s total asset must equal the sum of the Owner’s fund or the money that the business has borrowed from various sources. If you are given any different variables, then by calculating the total, you can easily get the wanted result. Based on it, you can see the profit and loss of the company in a particular time or financial year. But to get the result, you must know the three variables.
Conclusion
The accounting equation is essential for understanding the relationships between any business’s assets, liabilities, and equity. It is a key concept that every accountant should deeply understand and apply when evaluating a company’s financial position. Using this equation to analyze transactions, you can effectively manage your finances and make good decisions about investments or other business operations.