Accounting equation
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The basic accounting equation is the foundation for the double-entry book-keeping system.
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[edit] The equation
The equation is as follows:
- Assets = Liabilities + Shareholders equity
It shows how assets were financed: either by borrowing money from someone else (liability) or by paying your own money (shareholder's equity). For example, a student buys a computer for $945. This student borrowed $500 from his best friend and saved another $445 from his part-time job. Now his assets are worth $945, liabilities are $500, and equity $445.
[edit] Re-write
If formula is re-written in this manner:
- Assets − Liabilities = Owners equity
Now it shows that owner's interest is equal to property (assets) minus debts (liabilities). Since in a company owners are shareholders, owner's interest is called shareholder's equity.
[edit] How it works
Every accounting transaction affects at least one element of the equation, but always balances. Simplest transactions also include:
Transaction Shareholders'
Number Assets = Liabilities + equity
----------- ------------- ----------- -------------
1. + 6,000 +6,000
2. +10,000 +10,000
3. + 900 -900
4. + 1,000 -450 + 550
5. + 700 + 700
6. - 200 - 200
7. + 100 - 100
8. - 500 - 500
9. + 200 -200
Explanation of transactions:
- issuing stocks for cash or other assets;
- buying assets by borrowing money (taking a loan from a bank or simply buying on credit);
- buying assets for cash (in essence, it's just an exchange of one asset to another);
- buying assets by paying cash and by borrowing money;
- earning revenues;
- paying expenses (e.g., rent or professional fees) or dividends;
- recording expenses, but not paying them at the moment;
- paying on a debt that you owe;
- received cash for sale of an asset
These are some simple examples, but even the most complicated transactions can be recorded in a similar way. This equation is behind debits, credits, and journal entries.
[edit] Balance sheet
An elaborate form of this equation is presented in a balance sheet which lists all assets, liabilities, and equity and makes sure it balances (thus the name of balance sheet).
[edit] External links
- Accounting Equation Explanation with Examples
