What is the Accounting Equation?
The accounting equation is the foundation of double-entry bookkeeping: it states that everything a business owns (assets) is financed either by debt (liabilities) or by the owners (equity). Every transaction keeps this equation in balance.
The accounting equation states that Assets = Liabilities + Equity — a company's resources always equal what it owes plus what belongs to its owners.
- •Cash
- •Inventory
- •Equipment
- •Accounts receivable
- •Loans payable
- •Accounts payable
- •Owner's capital
- •Retained earnings
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Step-by-step worked examples
A bakery has $80,000 in liabilities and $45,000 in owner's equity. What are its total assets?
Assets = Liabilities + Equity Assets = 80,000 + 45,000 Assets = $125,000
A store owns $150,000 in assets and owes $90,000 in liabilities. Find the owner's equity.
Equity = Assets − Liabilities Equity = 150,000 − 90,000 Equity = $60,000
A company has $200,000 in assets and $70,000 in equity. What are its liabilities?
Liabilities = Assets − Equity Liabilities = 200,000 − 70,000 Liabilities = $130,000
Flashcards
Quick quiz
Q1.A company has $50,000 in liabilities and $30,000 in equity. What are total assets?
Q2.Which equation is correct?
Q3.A firm's assets are $300,000 and equity is $120,000. Liabilities?
Q4.Buying equipment with cash affects the equation how?
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Common mistakes
Thinking equity is just cash in the bank. — Correct: Equity is a residual claim (assets minus liabilities), not a specific cash balance.
Believing the equation only applies at year-end. — Correct: It must hold true after every single transaction, not just at reporting dates.
Mixing up liabilities and expenses. — Correct: Liabilities are debts owed; expenses are costs that reduce equity through the income statement.
Assuming assets = liabilities alone. — Correct: Assets equal liabilities PLUS equity — leaving out equity breaks the equation.
FAQ
What is the accounting equation?
It's Assets = Liabilities + Equity, the rule that keeps a company's balance sheet balanced at all times.
What is the accounting equation formula?
Assets = Liabilities + Equity. Rearranged: Equity = Assets − Liabilities.
How do you calculate the accounting equation?
Add liabilities and equity to get total assets, or subtract liabilities from assets to find equity.
Can you give an example of the accounting equation?
A shop with $100,000 in assets and $60,000 in liabilities has $40,000 in equity, since 100,000 = 60,000 + 40,000.