The Accounting Equation Demystified Lesson III

By Michael Onuorah | 1 min read
11th June 2017
The Accounting Equation Demystified Lesson III

Good Morning Class and welcome back to the Accounting Equation, Professor Matthew chants.

It gives me great pleasure to introduce you to the last class on the Accounting Equation, which is focused on Equity.

According to the IASB Framework, Equity is the residual interest in the assets of the entity after deducting all the liabilities, Professor Matthew continues.

Equity is the livewire of every enterprise particularly at the startup phase, because it is required before you get the business off the ground, Professor Matthew exclaims.

Professor, are you saying that before a business starts, you must have equity or startup capital Abdul quizzes.

I now understand why Standard Chartered Bank specifically asked me what percentage was my equity contribution Chimezie chips in.

Let me explain this further Professor Matthew replies.

Equity is what the owners of an entity have invested in an enterprise.

Equity represents what the business owes to its owners.

Equity is also a reflection of the capital left in the business after assets of the entity are used to pay off any outstanding liabilities.

Equity includes share capital contributed by the shareholders along with any profits or surpluses retained in the entity.

Equity is what the owners take home in the event of liquidation of the entity.

Some examples of Equity recognized in a financial statement include the following:

  • Ordinary Share Capital
  • Preference Share Capital (irredeemable)
  • Retained Earnings (profit carried over from the previous year)
  • Revaluation Surpluses

Finally, Professor recaps, Equity is required to demonstrate commitment on the part of the entrepreneur and to answer Abdul's question earlier on, yes, you need to have your own equity contribution at least 20% of the total funds you need before approaching a bank or an investor for the remaining 80%.

The Accounting Equation may further explain the meaning of equity:

Assets - Liabilities = Equity

This further illustrates the fact that equity is what remains after liquidation because your assets pay off all your liabilities. So always endeavor to pay your debts.

The whole class laughs.

Rearranging the above equation, we have

Assets = Liabilities + Equity

Let me also add that if you pick up any balance sheet, you will notice that they are arranged in this format: Assets, Liabilities and owners' equity.

The Asset of a company has to be financed in some way.

They can be financed either by debt (Liability) or by share capital and retained profits (Equity).

Hence, equity must be viewed as a type of liability a company has towards its owners in respect of the assets they financed.

I hope with these few points of mine, I have clearly demystified the Accounting Equation.

Thank you very much class for your time, it was indeed a great learning experience for all of us, the professor says.

The class ends with clapping and a standing ovation for Professor Matthew.

 

Michael Onuorah
My name is Michael Onuorah. I am first and foremost a teacher, problem solver and a servant leader. I want to honestly state that what drives me in life is helping people to start their journey to self-discovery. I believe that is my primary purpose. My secondary purpose is to be a teacher that demystifies various areas of learning ranging from Database Administration, Entrepreneurship, Information Technology, Business Administration, Marketing, Logic and Problem Solving. And My tertiary purpose is to be a problem solver. I want to teach people how to solve problems relating to what we encounter every day.
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