What is the Accounting Equation?
The accounting equation is the foundation of double-entry bookkeeping: it states that everything a business owns is financed either by what it owes to others or by the owner's investment. Every journal entry must keep this equation in balance.
The accounting equation states that Assets = Liabilities + Equity — a company's resources always equal the claims against them from creditors and owners.
- •Cash
- •Accounts receivable
- •Inventory
- •Equipment
- •Accounts payable
- •Bank loans
- •Owner's capital
- •Retained earnings
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Step-by-step worked examples
A bakery has $45,000 in cash, $15,000 in equipment, and owes $20,000 to a supplier. Find the owner's equity.
A = 45,000 + 15,000 = 60,000 L = 20,000 E = A − L = 60,000 − 20,000 = 40,000
A startup has $80,000 in liabilities and $120,000 in equity. What are its total assets?
A = L + E A = 80,000 + 120,000 = 200,000
A shop's assets are $150,000 and liabilities are $55,000. Find equity.
E = A − L E = 150,000 − 55,000 = 95,000
Flashcards
Quick quiz
Q1.If Assets = $200,000 and Liabilities = $75,000, what is Equity?
Q2.The accounting equation is the basis for which financial statement?
Q3.A company takes out a $10,000 loan to buy equipment. What happens?
Q4.If Liabilities = $50,000 and Equity = $150,000, Assets = ?
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Common mistakes
Thinking equity is just cash in the bank. — Correct: Equity is the owner's residual claim (Assets − Liabilities), not a cash balance.
Believing the equation only applies at year-end. — Correct: It must balance after every single transaction, not just at reporting dates.
Confusing liabilities with expenses. — Correct: Liabilities are what a company owes (debts); expenses are costs incurred to earn revenue.
Assuming assets minus equity gives liabilities in the wrong order. — Correct: Rearranged correctly: L = A − E.
FAQ
What is the formula for the accounting equation?
Assets = Liabilities + Equity (A = L + E). It must hold true after every transaction.
How do you calculate the accounting equation?
Add total liabilities and total equity to get total assets, or rearrange to solve for any one variable.
What are examples of the accounting equation in use?
Buying equipment with a loan, paying off debt with cash, or an owner investing capital — each keeps A = L + E balanced.
Why is the accounting equation important?
It's the basis of double-entry bookkeeping and the balance sheet, ensuring a company's books always balance.