# Accounting Equation Explained – Definition &amp; Examples (2023)

Though Coca-Cola and your local fitness center may be as different as chalk and cheese, they do have one thing in common — and that's their ownaccounting equation.

The accounting equation is the basis ofdouble entry bookkeepingThis is the accounting method used by most businesses, regardless of their size, type or structure. This accounting method ensures that thebalance sheetStatement is always the same in the end.

We'll explain what that means, along with everything else you need to know about the balance sheet equation, as we move on.

In this guide you will learn:

• What is the billing equation?
• What are the three elements in the formula of the accounting equation?
• What is the double-entry bookkeeping method?
• 5+ Examples of Accounting Equations
• What are the limitations of the accounting equation

## What is the billing equation?

The finances of any business consist of two basic elements: what it owns and what it owes.

financial assetsare the total resources owned by a company.ThatEquity capitalis the interest that the owner has in these assets, e.g. B. Personal investments or subscriptions.liabilities, on the other hand, show how much money is owed.

The relationship between these three financial components is expressed bythe balance sheet equation,As shown below:

As mentioned earlier, the accounting equation is the same for all companies. It is extremely important for businesses as it provides the basis for calculating various costsfinancial circumstances, as well as for creatingfinancial statements.

Before we delve into how the balance sheet equation helps eliminate double-entry bookkeeping, let's explain each element of the equation in detail.

Try Deskera Books For Accounting

(Video) Accounting equation explained

## What are the three elements in the formula of the accounting equation?

### financial assets

financial assetsrepresent your company's ability to provide goods and services. Or in other words, it includes all valuables used to carry out activities such as production and sales.

We divide assets into two main categories:short term and long term.

Current assets are expected to be consumed within a year. They include:

• Cash and cash equivalents
• To invent
• accounts obtainable
• Prepaid Expenses

Non-current Assets extend their use for a period of one year. They can be either tangible (physical) or intangible.

### liabilities

Liabilities (or Commitments)are assets owed to creditors. Creditors include people or organizations to whom the company owes money, e.g. B. Employees, government agencies, banks and more.

We classify liabilities the same way as assets, based on current or long-term periods.

Current or short-term liabilities areemployeePayroll,bills, supply and utility costs.coverage of long-term liabilitiesLoans, mortgages and deferred taxes.

### Equity capital

The owner's equityis the value of assets owned by the owner(s). More specifically, it is the amount left over when assets are liquidated and liabilities are paid off.

Let's look at what causes the increases and decreases in owner's equity.

• increase in equity- Two main sources cause an increase in equity:Investments of the owner and income. investmentsare the money that the owner personally invests in his business. These investments are recorded under a category called owner capital.revenues,on the other hand, represent profits made from business activities such as sales, fees, renting a property, lending cash, commissions and more.
• Decrease in equity -Reductions in equity result from drawings and expenses.Drawings are theCash withdrawn by the ownerfrom business accounts. WhileCostare the costs incurred by consumed assets. For example equipment purchase, labor costs, ancillary costs, taxes,etc.

### Extended version of the calculation equation

Well there isextended version of the balancing equationwhich includes all of the elements (described in the section above) that make up equity.

It looks like this:

This wording gives you a full visual representation of the relationship between the company's main accounts.

However, this is not the only type of reorganization you can make to the accounting equation. It can be transformed and interpreted into two other forms:

1.Equity = Assets - Liabilities

(Video) The ACCOUNTING EQUATION For BEGINNERS

At first glance, you probably won't see much of a difference from the basic accounting equation. However, when the owner's equity is shifted to the left, the equation takes on a different meaning.

It tells us that creditors have priority over owners when it comes to getting their claims paid. While the main objective of the basic accounting equation is to present the financial position of the company.

2.Net Worth = Assets - Liabilities

This is another form of the equation that you may come across. It's essentially the same equation because net worth and equity are synonymous. Other equity names you may come across are also net worth or equity (for public corporations).

## What is the double-entry bookkeeping method?

Every business transaction has a double effect on the accounting. For example, when an asset goes up, there is always a corresponding one:

• Decrease of another asset
• increase in a liability
• increase in equity.

Now these changes in the accounting equation are recorded in the company's financial booksdouble entry bookkeeping.

Double-entry bookkeeping is a system in which transactions and their effects are recordedjournal entries, throughdeductan account andcredit amountAnother.

Direct debits are cash going into the business, while loans are cash going out.

An equivalent credit entry must be made for each debit entry. Debits and credits should always balance out in the end.

In order to understand which accounts are debited or credited when you exchange money, we have created a cheat sheet so that you can easily understand it.

Deskera integrates directly with your bank account and automatically posts every purchase and expense made to the correct ledger accounts with the appropriate debit and credit amounts. So you don't have to worry about anything!

And that's not even the best part.

With Deskera you can automate other parts of theaccounting cyclealso, like the management of stocks,send invoices, payroll accounting and much more.

Try Deskera Books For Accounting

(Video) Accounting Equation | Explained with Examples | Accounting Basics

Deskera Booksis a time-saving strategy for managing your work contacts, billing, bills and expenses. You can also import opening balances and set up chart accounts with them.

Deskera Books is aOnline accounting softwarewhich enables you to generate e-invoices for compliance. You can easily create e-invoices by clicking the create e-invoice button.

A short video tour will help you better understand the whole process in a few minutes.

Now that you have Deskera you can easily manage yoursmagazines. A single interface gives you access to all its notable features, including the ability to add products, services, and inventory.

With this accounting software you can create and send invoices automatically. In addition, the preparation of financial statements has become significantly easier thanks to the software that allows you to draft thembalance sheets,income statement,Profit and Loss Accounts andcash flowTestify.

From setting up your organization to inviting your colleagues and your accountant, you can achieve it all with Deskera Books. You can witness the easy implementation of the tool and try it out to gain new experience in dealing with your accounting system.

Get acquainted with a new system that handles accounting, finance, inventory and much more under one roof.

### The balance

The balance sheet is a more detailed reflection of the accounting equation. It records the assets, liabilities and equity of a company at a given point in time. Just like the balance sheet equation, it tells us that total assets equal total liabilities and equity.

The preparation of the balance sheet is one of the last steps in the accounting cycle and is carried out using double-entry bookkeeping.

In order to prepare the balance sheet and other financial statements, you must first decide on onebilling system. The three main systems used in economics are manual,cloud-based accounting softwareand ERP software.

## 5+ Examples of Accounting Equations

To better understand the balance sheet equation, let's take a few practical transactions and analyze their effect.

(Video) accounting overview for students

Suppose the following examples are transactions for company XYZ during their first month of work:

1.The business owner invests \$10,000 in Company XYZ.This transaction will result in an increase in the owner's cash and equity of \$10,000. The equation would look like this:

2.Company XYZ buys \$3,000 worth of equipment.In this case, there is a \$3,000 increase and decrease in wealth. The cash account goes down while the gear account goes up. This is what the entry in the equation would look like:

3.Company XYZ buys \$1,300 worth of goods on credit.This transaction results in a \$1,300 increase in both assets and liabilities from trade payables. Specifically, the accounts concerned are deliveries and payables. This third transaction would appear in the equation as follows:

4.XYZ receives \$800 in cash from clients for services rendered.When receiving cash from services, the two accounts that increase by \$800 are the cash and earnings accounts. The billing equation would look like this:

5.XYZ pays \$400 for employee salaries.The effect of this payment is a \$400 decrease in the cash and expense accounts. This transaction would look like this:

If we add both sides of the equation, they add up to \$27.00 and balance out as shown below:

## What are the limitations of the accounting equation

As helpful as the accounting equation is in accounting for your business, it has its own limitations.

First off, it doesn't provide investors or other interested third parties with an analysis of how well the business is doing.

In addition, it does not completely prevent accounting errors from being made. Even if the balance balances out, there is still the possibility of an error that does not affect the balance equation.

If you want to know more about accounting errors and how to recognize them, we recommend readingCommon accounting mistakes- A practical guide with examples.

## The central theses

And that concludes our accounting equations guide! We hope you found it helpful.

To recap, here are some of the key points we covered:

• The accounting equation is the fundamental tool that enables double-entry bookkeeping for all businesses, regardless of their size or purpose. It represents the relationship between three main entities: assets, liabilities and equity.
• Assets are the business resources, such as B. Cash, inventory, buildings. Payables are liabilities to creditors such as bills, loans, taxes. Owner equity represents assets owned by the owner or shareholders.
• The balance equation can be rearranged in three different ways:
• Assets = Liabilities + Owner's Equity - Owner's Subscriptions + Income - Expenses
• Equity = Assets - Liabilities
• Net Worth = Assets - Liabilities
• Changes in accounting are recorded in double-entry bookkeeping.
• The balance sheet is a financial statement that presents the accounting equation in more detail and expanded.
• The main limitation of the accounting equation is that it provides no analysis of how well the business is doing.

## Related Articles

(Video) The Accounting Equation

## FAQs

### What is accounting equation explain with example? ›

Assets = Liabilities + Shareholder's Equity

For example, an increase in an asset account can be matched by an equal increase to a related liability or shareholder's equity account such that the accounting equation stays in balance.

What is accounting equation answer? ›

The accounting equation states that a company's total assets are equal to the sum of its liabilities and its shareholders' equity. This straightforward relationship between assets, liabilities, and equity is considered to be the foundation of the double-entry accounting system.

How do you solve accounting equations example? ›

The accounting equation can be rearranged into three different ways: Assets = Liabilities + Owner's Capital - Owner's Drawings + Revenues - Expenses. Owner's equity = Assets - Liabilities. Net Worth = Assets - Liabilities.

What are the 3 formulas of accounting equation? ›

Also known as the balance sheet equation, the accounting equation formula is Assets = Liabilities + Equity.

What is the full accounting equation? ›

In the basic accounting equation, liabilities and equity equal the total amount of assets. The accounting formula is: Assets = Liabilities + Equity. Because you make purchases with debt or capital, both sides of the equation must equal.

What are the 11 basic accounting formulas? ›

• Accounting equation formula. Liability + Owner's Equity = Assets. ...
• Break-even point formula. ...
• Cash ratio formula. ...
• Cost of goods sold formula. ...
• Debt-to-equity ratio formula. ...
• Gross profit and gross profit margin formulas. ...
• Inventory shrinkage formula. ...
• Markup percentage formula.
26 Apr 2022

What is accounting simple answer? ›

Accounting, which is often just called "accounting," is the process of measuring, processing, and sharing financial and other information about businesses and corporations.

What are 5 examples of liabilities? ›

Recorded on the right side of the balance sheet, liabilities include loans, accounts payable, mortgages, deferred revenues, bonds, warranties, and accrued expenses.

What are the 4 steps to solving equations? ›

We have 4 ways of solving one-step equations: Adding, Substracting, multiplication and division. If we add the same number to both sides of an equation, both sides will remain equal.

What are the 3 methods for solving equations? ›

There are three methods used to solve systems of equations: graphing, substitution, and elimination. To solve a system by graphing, you simply graph the given equations and find the point(s) where they all intersect. The coordinate of this point will give you the values of the variables that you are solving for.

### What are the two types of assets? ›

If assets are classified based on their physical existence, assets are classified as either tangible assets or intangible assets.
• Tangible Assets. Tangible assets are assets with physical existence (we can touch, feel, and see them). ...
• Intangible Assets. Intangible assets are assets that lack physical existence.
24 Nov 2022

What are the five elements of the accounting equation? ›

This equation contains three of the five so called “accounting elements”—assets, liabilities, equity. The remaining two elements, revenue and expenses, are still important (and you still need to track them) because they indicate how much money you are bringing in and how much you are spending.

What is the basic equation? ›

ASSETS = LIABILITIES + OWNER'S EQUITY. This is the basic accounting equation.

What is the most important accounting equation? ›

What is the Basic Accounting Equation? The basic accounting equation is Assets = Equity + Liability. It is also known as the balance sheet equation. The double-entry bookkeeping system is founded on this very equation, as it represents that the total credit balance equates to a total debt balance.

How many accounting equation are there? ›

There are several accounting formulas used to report the financial health of a person or business. These formulas are used to produce the Balance Sheet and Income Statement.

Why is accounting equation important? ›

The accounting equation is important because it forms the foundation for all financial statements. The income statement, balance sheet, and statement of cash flows can all be derived from this one simple equation. Furthermore, the accounting equation helps to ensure that a company's financial statements are accurate.

What are the 12 accounting concept? ›

: Business Entity, Money Measurement, Going Concern, Accounting Period, Cost Concept, Duality Aspect concept, Realisation Concept, Accrual Concept and Matching Concept.

Who is the father of accounting? ›

But the father of modern accounting is Italian Luca Pacioli, who in 1494 first described the system of double-entry bookkeeping used by Venetian merchants in his Summa de Arithmetica, Geometria, Proportioni et Proportionalita.

What is debit and credit? ›

A debit entry in an account represents a transfer of value to that account, and a credit entry represents a transfer from the account. Each transaction transfers value from credited accounts to debited accounts.

What are the 5 definition of accounting? ›

Definitions of Accounting

Therefore accounting can be defined as” the process of recording, summarising, reporting and analyzing required financial information relating to the economic events of an organization to the interested users for making decisions.”

### What is full accounting? ›

Full Accounting means a compilation of documentation to establish, substantiate and justify the nature and extent of the corrective action costs incurred by an owner or operator.

What are the 4 types of accounting? ›

Discovering the 4 Types of Accounting
• Corporate Accounting. ...
• Public Accounting. ...
• Government Accounting. ...
• Forensic Accounting. ...

What is an asset vs liability? ›

In its simplest form, your balance sheet can be divided into two categories: assets and liabilities. Assets are the items your company owns that can provide future economic benefit. Liabilities are what you owe other parties. In short, assets put money in your pocket, and liabilities take money out!

What are examples of equity? ›

Some of the most common forms of equity include:
• Common stock.
• Preferred stock.
• Treasury stock.
• Accumulated other comprehensive income / loss.
• Retained earnings.

Is cash an asset? ›

Current assets include: Cash and cash equivalents, such as treasury bills and certificates of deposits. Marketable securities, such as stocks, bonds and other types of securities.

What are the 3 types of equations? ›

There are three major forms of linear equations: point-slope form, standard form, and slope-intercept form.

What are the 3 types of system of equations? ›

The types of systems of linear equations are as follows:
• Dependent: The system has infinitely many solutions. The graphs of the equations represent the same lines. ...
• Independent: The system has exactly one solution. The graphs of the equations intersect at a single point. ...
• Inconsistent: The system has no solution.

What are the four types of equations? ›

Different Types of Equations
• Linear Equation.
• Exponential Equation.
• Rational Equation.
1 Oct 2019

What are equations with 3 variables called? ›

A solution to a 3 Variable System of Equations (x,y,z),(x,y,z), is called an ordered triple.

How do you write a system of equations? ›

Writing Systems of Equations: Step 1: Define the variables. Step 2: Write 2 equations from the phrases. Step 3: Use substitution, elimination, or graphing to solve for variables. Step 4: Answer question using proper units.

### What linear equation means? ›

A linear equation is an algebraic equation of the form y=mx+b. involving only a constant and a first-order (linear) term, where m is the slope and b is the y-intercept. Occasionally, the above is called a "linear equation of two variables," where y and x are the variables.

What type of asset is cash? ›

In short, yes—cash is a current asset and is the first line-item on a company's balance sheet. Cash is the most liquid type of asset and can be used to easily purchase other assets. Liquidity is the ease with which an asset can be converted into cash.

What are the types of liabilities? ›

Liabilities can be classified into three categories: current, non-current and contingent.

What are examples of liabilities? ›

Liabilities are any debts your company has, whether it's bank loans, mortgages, unpaid bills, IOUs, or any other sum of money that you owe someone else. If you've promised to pay someone a sum of money in the future and haven't paid them yet, that's a liability.

What are the 6 types of accounts? ›

Types of accounts
• Asset accounts are used to recognize assets. ...
• Liability accounts are used to recognize liabilities. ...
• Equity accounts are used to recognize ownership equity. ...
• Revenue accounts are used to recognize revenue. ...
• Expense accounts are used to recognize expenses. ...
• Gain accounts are used to recognize gains.

What are the 5 types of accounts? ›

The 5 Account Types
• Assets.
• Liabilities.
• Expenses.
• Income (Revenue)
• Equity.
20 Jul 2022

What are the 3 main accounting elements? ›

There are three main elements of the accounting equation:
• Assets. A company's assets could include everything from cash to inventory. ...
• Liabilities. The second component of the accounting equation is liabilities. ...
• Equity.

Why is it called equation? ›

In its simplest form in algebra, the definition of an equation is a mathematical statement that shows that two mathematical expressions are equal. For instance, 3x + 5 = 14 is an equation, in which 3x + 5 and 14 are two expressions separated by an 'equal' sign.

What is called equation? ›

An equation is a mathematical statement that is made up of two expressions connected by an equal sign. For example, 3x – 5 = 16 is an equation. Solving this equation, we get the value of the variable x as x = 7.

What is the first equation? ›

In other words, in any math problem you must start by calculating the parentheses first, then the exponents, then multiplication and division, then addition and subtraction. For operations on the same level, solve from left to right.

### What is the accounting equation briefly explain each of the three parts? ›

It has the following formula: Assets = Liabilities + Owner's Equity. For every transaction in a business, there is a balance that is happening between the three elements of the accounting equation. Assets will always equal the sum of liabilities and owner's equity. Assets are everything that a company owns.

What is accounting equation BCOM? ›

The Accounting Equation is:

Assets = Liabilities + Capital (Owner's Equity)

What is the accounting equation essay? ›

The accounting equation is the foundation or basic of accounting systems. The equation maintain for all transactions and business activities. Every asset that the company hold is always equal to the liabilities and equity. Therefore, the accounting equation is : ASSETS = LIABILITIES + EQUITY.

What are the main elements of accounting equation? ›

There are three main elements of the accounting equation:
• Assets. A company's assets could include everything from cash to inventory. ...
• Liabilities. The second component of the accounting equation is liabilities. ...
• Equity.

What is asset formula? ›

It can also be referred to as a statement of net worth or a statement of financial position. The balance sheet is based on the fundamental equation: Assets = Liabilities + Equity.

What is the main purpose of accounting equation? ›

The accounting equation represents the relationship between the assets, liabilities and capital of a business and it is fundamental to the application of double entry bookkeeping where every transaction has a dual effect on the financial statements.

What is the importance of accounting equation in our daily lives? ›

It can be used in our daily lives because it maintains and expands the financial health of a business. Accounting plays an important role in running a business because it helps you track financial income and expenditures, management, and ensure statutory compliance which can be used in making business decisions.

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