Accounting Equation Overview, Formula, and Examples


The balance sheet is one of the primary statements used in accounting. Its purpose is to document the financial condition of a company at a point in time. It highlights what the company owns , what the company owes , and the effectiveness of the operation over time .

  • The accounting equation will always remain in balance if the double entry system of accounting is followed accurately.
  • As we can deduce from the equation itself, liabilities and capital finance the whole of the organisation’s assets.
  • With the information that is given in the example, we see that Ed has a store that is valued at $40,000 and equipment that is valued at $10,000.
  • Ted decides it makes the most financial sense for Speakers, Inc. to buy a building.

The accounting equation ensures that the balance sheet remains balanced. That is, each entry made on the debit side has a corresponding entry on the credit side. If you understand all of the above, then you are well on your way to understanding the three-statement model framework.

Stay up to date on the latest accounting tips and training equation describes that the total value of assets of a business entity is always equal to its liabilities plus owner’s equity. This equation is the foundation of modern double entry system of accounting being used by small proprietors to large multinational corporations.

  • On January 1st, 2020, Sherry took out the money from her savings for $100,000 to start her skincare business.
  • We’ll review how each transaction affects the basic accounting equation.
  • Merely placing an order for goods is not a recordable transaction because no exchange has taken place.
  • The accounting equation is a simple but very important concept in accounts to move forward with other concepts and to understand them better.
  • When you use the accounting equation, you can see if you use business funds for your assets or finance them through debt.
  • The accounting equation is the first concept you need to master to build on this skill set.
  • The expanded accounting equation shows the various units of stockholder equity in greater detail.

The balance sheet equation answers important financial questions for your business. Use the balance sheet equation when setting your budget or when making financial decisions. After the company formation, Speakers, Inc. needs to buy some equipment for installing speakers, so it purchases $20,000 of installation equipment from a manufacturer for cash. A liability, in its simplest terms, is an amount of money owed to another person or organization. Said a different way, liabilities are creditors’ claims on company assets because this is the amount of assets creditors would own if the company liquidated.

6 The accounting equation and the double-entry rules for income and expenses

Accounting equation is also called balance sheet equation and fundamental accounting equation. For every transaction, both sides of this equation must have an equal net effect. Below are some examples of transactions and how they affect the accounting equation. Journal entries often use the language of debits and credits .

  • Retained earnings are the sums of money that came from the company’s profit that was not given back to the shareholders.
  • On the liabilities and equity side of the equation, there is also an increase of $20,000, keeping the equation balanced.
  • Therefore, it can be seen that the above transaction impacts both sides of the balance sheet.
  • We show formulas for how to calculate it as a basic accounting equation and an expanded accounting equation.

The double-entry practice ensures that the accounting equation always remains balanced, meaning that the left side value of the equation will always match the right side value. Locate the company’s total assets on the balance sheet for the period. Assets represent the valuable resources controlled by the company, while liabilities represent its obligations.

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Metro issued a check to Commerce, Inc. for $1,800 to pay for office rent in advance for the months of February and March. Assets are the items of worth that the business controls and liabilities show you what the business owes to others. Get answers to the most common queries related to the CBSE 11th Examination Preparation. Debt is a liability, whether it is a long-term loan or a bill that is due to be paid.

When a purchases goods or services from other companies on credit, a payable is recorded to show that the company promises to pay the other companies for their assets. The equation remains balanced, as assets and liabilities increase. The balance sheet would experience an increase in assets and an increase in liabilities. Share repurchases are called treasury stock if the shares are not retired. Treasury stock transactions and cancellations are recorded in retained earnings and paid-in-capital.

Financial Accounting

The two have absolutely no correlation except for the word equation. Coming to the accounting equation, if you have a basic idea of assets, liabilities, shareholders equity, double-entry, and simple plus and minus, you are good to go. Just keep adding or removing items as per the transactions in this simple equation and keep it balanced at all times to know that you are going well. Here are the different ways the basic accounting equation is used in real-life situations. The following examples also show the double entry practice that maintains the balance of the equation. Assets will always equal the sum of liabilities and owner’s equity. Every transaction demonstrates the relationship of the elements and shows how balance is maintained.


Author: Steffy Alen