The Accounting Equation: Assets = Liabilities + Equity


In any case, there is still a possibility of an error that does not involve the accounting equation when the balance sheet report automatically updates. In other words, the sum would be left over after the firm sold all of its assets and settled all of its debts. A liability is a monetary obligation that your company must fulfil. While some liabilities include debt, others are often a necessary component of your core business activities.

Accounts receivableslist the amounts of money owed to the company by its customers for the sale of its products. Is a factor in almost every aspect of your business accounting. Unearned revenue from the money you have yet to receive for services or products that you have not yet delivered is considered a liability.

What is the Basic Accounting Equation?

The last component of the equation is owner's equity. Initial start-up cost of a company that comes from the owner's own pocket - that's a good example of owner's equity. Understand what the accounting equation is, learn the elements of the basic accounting equation, and see examples. 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.


These are in a class with other items worth owning like land or buildings. Leases can’t make it on this list because they’re not technically owned by the Similarly, when a company takes out a business loan, the borrowed money leads to an increase in assets. At the same time, this increases the company’s liability in the form of debt. As you can see from the examples above, double-entry accounting keeps the books balanced.

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On the side of the basic accounting equation, an increase of $250 is balanced by an increase of $250 on the right side of the equation for liabilities . We calculate the expanded accounting equation using 2021 financial statements for this example. Balance Sheets shown above and the Income Statement and detailed Statement of Stockholder’s Equity in this section. The basic accounting equation is less detailed than the expanded accounting equation. The expanded accounting equation shows more shareholders’ equity components in the calculation. In this form, it is easier to highlight the relationship between shareholder’s equity and debt . As you can see, shareholder’s equity is the remainder after liabilities have been subtracted from assets.

Assets refer to items like cash, inventory, accounts receivable, buildings, land, or equipment. Buying something with the cash the company has on hand doesn't affect the accounting formula, because it's just converting one type of asset into another type of asset .

The Balance Sheet Always Balances

Let’s consider a company whose total assets are valued at $1,000. In this example, the owner’s value in the assets is $100, representing the company’s equity. Beginning retained earnings are the retained earnings from the prior accounting period .

  • It shows what the company owns , how much debt there is and the components of owners’ equity—how much have the owners invested and how much did the company add to the owners’ wealth.
  • The residual value of assets is also what an owner can claim after all the liabilities are paid off if the company has to shut down.
  • That’s the case for each business transaction and journal entry.
  • This business transaction increases company cash and increases equity by the same amount.
  • Thus, all of the company’s assets stem from either creditors or investors i.e. liabilities and equity.

The accounting equation is a fundamental principle of accounting that states that the total value of an entity's assets must equal the total value of its liabilities plus its equity. This equation is used to ensure that companies' financial statements are accurate. To understand this equation better we need to understand the different components of this accounting equation.

The accounting equation in action

Whereas a high profit margin generally indicates a healthy company. The breakeven point is the point at which the total cost to run your business and the revenue it generates are equal. In other words, there is no loss or gain for your small business because it’s not earning profits, but it’s not losing money either. As we can see, the assets of $7,500 are equality to the liabilities and equity of $7,500. Make a trial balance to ensure that debit balances equal credit balances.

X employs someone to operate its new equipment and start production. Economic analysts can get a clearer idea of how to use profits for various things like dividends which are reinvested into the firm or kept as cash by breaking down equity into smaller parts. You can start learning these accounting skills today with Forage’s accounting and finance virtual experience programs. Additionally, you can use your cover letter to detail other experiences you have using the equation. For example, you can talk about how you checked that the books were balanced for a friend or family member’s small business. Barbara is currently a financial writer working with successful B2B businesses, including SaaS companies. She is a former CFO for fast-growing tech companies and has Deloitte audit experience.

The rationale is that the assets belonging to a company must have been funded somehow, i.e. the money used to purchase the assets did not just appear out of thin air to state the obvious. The difference between the assets and the owner’s investment in the business is what the firm owes to its lenders and others.

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