Venn diagrams (named after John Venn’s 1880 paper ‘On the Diagrammatic and Mechanical Representation of Propositions and Reasonings’ in the Philosophical Magazine and Journal of Science) are used to describe logical relationship between two or more finite sets. Sounds good but Accounting Equation and Venn diagram! Is everything fine here?
Let me elaborate. Soon after I completed my this year’s introductory class of accounting, a girl comes over to my office to share an interesting observation about the classic accounting equation [Assets = Capital + Liabilities] discussed by us in the class. “I’m an engineer. I think your accounting equation can easily be represented by using a Venn diagram.” She pulled out her notebook and scribbled something in a geeky fashion, which looked like this –
She said, “If the value of Assets is equal to the value of Capital and Liabilities put together, the set of Assets must include the subsets of Capital and Liabilities.”
It took me a while to understand what she was trying to say. This was my first encounter with accounting equation drawn in a Venn diagram. This was one of those ‘mein kaha hu‘ moments of my life! As I gathered courage to give my reaction on this petrified occasion, a divine force kindled a random thought inside my head. So, here is what I said. “I think your logic is wrong. Assets and Liabilities are equal and opposite forces. One cannot encompass the other. In my opinion, a better analogy would be that of a coin. Assets and Liabilities are two sides of the same coin. Infact, as in the case of a coin, we don’t measure worth of a company as a sum of Assets + Liabilities. Just like the coin which has two sides but one value, we measure only a single unified aspect (Networth) as the eventual worth of assets and liabilities.”
To my utter surprise, without any further confrontation, she extended my analogy (another shock!) and said, “That sounds good. In case of a coin, diameters of both the sides are perfectly equal. Hence Assets = Liabilities. One side of the coin cannot be larger than the other.”
Well, this was a new learning for me in my 15 years of accounting education. Balance Sheet is like a coin with two sides having equal diameters but one value. But when you toss this coin the probability of not getting head or tail of it is very high!