Accounting equation What is the accounting equation?


This basic accounting equation “balances” the company’s balance sheet, showing that a company’s total assets are equal to the sum of its liabilities and shareholders’ equity. This formula, also known as the balance sheet equation, shows that what a company owns is purchased by either what it owes or by what its owners invest . The income statement and balance sheet play a pivotal role when it comes to formulating the accounting equation. An income statement of the company shows the revenues, cost of goods sold, gross profit & net profit.

statement of cash

Both liabilities and shareholders’ equity represent how the assets of a company are financed. If it’s financed through debt, it’ll show as a liability, but if it’s financed through issuing equity shares to investors, it’ll show in shareholders’ equity. Inventory is the cost to acquire or manufacture merchandise for sale to customers.

Accounting Equation Video

The Equation is a vital formula to understand and consider when it comes to the financial health of your business.


As we can see, the assets of $7,500 are equality to the liabilities and equity of $7,500. T Accounts are informal financial records used by a company as part of the double-entry bookkeeping process. For every transaction, at least two classes of accounts are impacted. The accounting equation is fundamental to the double-entry bookkeeping practice. Its applications in accountancy and economics are thus diverse. These additional items under owners’ equity are tracked in temporary accounts until the end of the accounting period, at which time they are closed to owners’ equity.

Accounting Equation Definition

Current liabilities are obligations that the company should settle one year or less. They consist, predominantly, of short-term debt repayments, payments to suppliers, and monthly operational costs that are known in advance. And finally, current liabilities are typically paid with Current assets. The accounting equation is a simple way to view the relationship of financial activities across a business. The equation is a simplified breakdown of the values entered in the balance sheet. It illustrates the relationship between a company’s assets, liabilities , and shareholder or owner equity .

Let’s take a look at certain examples to understand the situation better. The accounting equation is fundamental to the double-entry accounting system and, put simply, it states that the assets of a business must equal its liabilities & owner’s equity.

Recommended explanations on Business-studies Textbooks

At 30 June 2021, the for Wynyard Construction, David Gage, is preparing the financial statements for the year ended on that date. To calculate the annual leave payable, the accountant had gathered the following information on employee annual salary weeks leave outstanding. According to the accounting equation, each transaction will have two effects. There will be a credit for each debit, and vice versa. A transaction is a normal business activity that changes assets, liabilities, or owner’s equity. The sum of the assets and liabilities of a business always equals the investment of the business owner.

Which of the following is an accounting equation Mcq?

Following is the accounting equation: Asset = Liability + Capital. Was this answer helpful?

The amount that is left is returned to stakeholders. Metro collected a total of $5,000 on account from clients who owned money for services previously billed.

Limits of the Accounting Equation

However, note that the Sep 25 transaction affected only the asset side with an increase in cash and an equal but opposite decrease in accounts receivable. The accounting equation is how double-entry bookkeeping is established. The equation represents the relationship between the assets, liabilities, and owner’s equity of a small business. It is necessary to understand the accounting equation to learn how to read a balance sheet.

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