- Learn Basic Accounting in Less than 1 Hour!
- Accounting Basics
- What are Accounting Principles
- Accounting Cycle
- Accrual Accounting Basis
- Cash Basis Accounting
- Matching Principle of Accounting
- Conservatism Principle of Accounting
- Cash Accounting
- What are Accounting Policies?
- Accounting Estimates
- Mark to Market Accounting
- Cash Accounting vs Accrual Accounting
- Operating Cycle
- Fiscal Year
- Fiscal Year vs Calendar Year | Top Differences | Examples |
- Financial Reporting
- Consolidated Financial Statement
- Audited Financial Statements
- Accounting Scandals
- IFRS vs US GAAP
- IFRS vs Indian GAAP
- Debit vs Credit in Accounting
- Double Entry Accounting System
- Journal in Accounting
- Ledger in Accounting
- Journal vs Ledger
- What is Trial Balance ? | Examples | Steps | Prepare | Errors
- Reconciliation of Books | Types, Best Practices | Useful Tips
- Petty Cash | Meaning | Template | Accounting | Example
- Debit Note | Debit Notes Accounting & its Top Characteristics
- Credit Note
- Debit Note vs Credit Note | Top 7 Differences (Infographics)
- Balance Sheet
- Balance Sheet
- Accounting Equation
- Assets vs Liabilities | Top 9 Differences (with Infographics)
- Trial Balance vs Balance Sheet | Top 10 Differences You Must Know!
- Balance Sheet vs Consolidated Balance Sheet
- Bank vs Company Balance Sheet
- Commitments and Contingencies
- Management Discussion & Analysis
- Revenue Reserve vs Capital Reserve | Top 7 Differences
- Revenue Reserve
- Capital Reserve
- Capital Receipts vs Revenue Receipts | Top 8 Differences
- Capital Lease vs Operating Lease | Top Differences You Must Know!
- Debt vs Equity Financing | Advantages | Disadvantages | Example
- Internal vs External Financing | Top 7 Differences (Infographics)
- Available for Sale for securities
- Held to Maturity to securities
- Cash and Cash Equivalents | Examples, List & Top Differences
- Cash Equivalents
- Restricted Cash
- 3 Types of Inventory | Raw Material | WIP | Finished Goods
- Current Assets
- FIFO vs LIFO
- First In First Out (FIFO)
- Last in First Out (LIFO)
- Non-Current Assets
- Accounts Receivables? | Definition, Accounting Examples
- Accounts Receivables Factoring
- Allowance for Doubtful Accounts
- Accrued Revenue
- Liquid Assets
- Marketable Securities on the Balance Sheet | Top Examples
- Prepaid Expenses
- Tangible vs Intangible Assets
- Net Tangible Assets | Calculate Net Tangible Assets Per Share
- Tangible Assets
- Salvage Value
- Residual Value
- Fixed Capital vs Working Capital | Top 8 Differences (Infographics)
- Impariment of Assets
- Negative Goodwill
- Accounts Payable | Days Payable Outstanding | Formula |
- Current Liabilities | List of Current Liabilities on Balance Sheet
- Accrued Liabilities
- Notes Payable
- Revolving Credit Facilities
- Bonds Payable Accounting
- Bad Debt Reserve Allowance
- Deferred Expenses
- Unearned Revenue (Sales)
- Deferred Revenue (Income)
- Current Portion of Long-Term Debt (CPLTD) | Balance Sheet
- Long-Term Debt in Balance Sheet
- Financial Liabilities | Definition, Types, Ratios, Examples
- Long-Term Liabilities
- Accounts Receivable vs Accounts Payable
- Minority Interest
- Accounting for Convertibles
- Accounting for Derivatives
- Financial Lease vs Operating Lease
- Off balance Sheet Financing
- Finance vs Lease
- Shareholders Equity
- Shareholders Equity Statement
- Negative Shareholders Equity
- Par Value of Stock
- Share Capital
- Outstanding Shares (Definition, Formula) | Stocks Outstanding
- Additional Paid-in Capital on Balance Sheet
- Retained Earnings (Formula, Examples) | How to Calculate?
- How to Calculate Net Worth of a Company | Formula | Top Examples
- Owners Equity
- Preferred Shares
- Weighted average Shares average outstanding
- Share Buyback
- Accelerated Share Repurchase
- Restricted Stocks Units (RSUs)
- Contingent Shares
- Stock Splits Share
- Treasury Stock Shares
- Dilutive Securities
- Anti Dilutive Securities
- Stock Dividend
- Cash Dividend
- Preferred Dividends
- Ex dividend date
- Date of Record of dividends
- Cost of preferred Stock
- Common Stock vs Preferred Stock | Top 8 Differences You Must Know
- Stocks Vs Shares
- Stock Options Vs RSU
- Shareholder Equity vs Net Worth | Top 5 Differences You Must Know!
- Stock vs Option
- Stock vs Mutual Funds
- Income Statement
- Income Statement | Top Examples | Template | Format | Analysis
- Cost of Goods Sold
- Direct Costs
- Indirect Costs
- Non Recurring Items
- EBIT vs EBITDA | Top Differences | Examples | Calculation
- Depreciation – Formula | Types | Most Comprehensive Guide
- EBITDA vs Operating Income
- Straight Line Depreciation Method
- Amortization of Intangible Assets
- Unrealized Gains (Losses)
- Non Cash Expense
- Share based compensation
- Restructuring Cost
- Extraordinary Items
- Double Taxation
- Net Operating Loss (NOL)
- Tax Shield
- Sundry Expenses
- Interest vs Dividend | Top 9 Differences (with Infographics)
- EBITDA vs Net Income
- EBIT vs Net Income
- EBIT vs Operating Income
- Accounting Profit vs Economic Profit
- Income Tax vs Payroll Tax
- Tax credits vs Tax deductions
- Gross Income vs Net Income
- Profit vs Revenue
- Revenue vs Earnings
- Revenue vs Income
- Profit vs Income
- Revenue vs Sales
- Capitalization vs Expensing
- Income Statement vs Balance Sheet | Top 5 Differences You Must Know!
- Statement of Comprehensive Income | Items | Colgate Example
- FOB Destination
- Explicit Cost
- Implicit Cost
- Direct cost vs Indirect Cost
- Nopat vs Net Income
- Marginal Costing vs Absorption Costing
- Cash Flow Statement
- Cash flow from Operations | Formula, Calculations & Examples
- Cash Flow from Investing Activities (Formula & Top Examples)
- Cash Flow From Financing Activities | Formula & Calculations
- Cash Flow Analysis
- Fund Flow Statement
- Direct vs Indirect Cash Flow Methods
- Cash flow vs Net Income | Key Differences & Top Examples
- Cash Flow vs Fund Flow | Top 8 Differences (with Infographics)
- Accounting Careers
- Accounting Interview Questions
- Financial Accounting Careers
- Top Accounting Firms
- Big Four Accounting Firms
- Forensic Accounting
- Cost Accounting
- Financial Accounting
- Accounting vs Engineering
- Finance vs Accounting
- Bookkeeping vs Accounting
- Accounting vs Auditing
- Bookkeepers vs Accountants
- Accounting vs Financial Management
- Cost Accounting vs Financial Accounting
- Cost Accounting vs Management Accounting
- Financial Accounting vs Management Accounting
- Accounting Firms in Australia
- Accounting Firms in Canada
- Top Accounting Firms in US
- Accounting Books
Accounting Equation Definition
Accounting Equation is based on the double-entry bookkeeping system, which means that all assets should be equal to all liabilities in the book of accounts. All the entries which are made to the debit side of a balance sheet should have a corresponding credit entry in the balance sheet. Thus the basic accounting equation which is also known as the balance sheet equation.
Accounting Equation Formula
Basic Accounting equation formula can be written as per below –
Breaking down the Basic Accounting Equation Formula
- Assets: This is the value of the items that a company owns, they may be tangible or intangible but belong to the company.
- A liability: This is a term for total value that a company is required to pay in the short term or the long term.
- Shareholders’ Equity: Shareholders Equity is the amount of money a company has raised through its issue of shares. Alternatively, it is also the amount of retained earnings of a company. As the shareholders invest their money in the company, they are required to be paid with some amount of returns, which is why this is a liability in the company’s account books.
Hence, the total assets should always be equal to the total liabilities in a balance sheet, which fundamental forms the basis of the whole accounting system of any company when it follows the double-entry bookkeeping system.
Basic Accounting Equation Example #1
On December 1, 2007 Kartik starts his business FastTrack Movers and Packers. The first transaction that Kartik will record for his company is his personal investment of $20,000 in exchange for 5,000 shares of FastTrack Movers & Packers common stock. There are no revenues because no delivery fees were earned by the company on 1st December, and there were no expenses. How will this transaction get recorded in the balance sheet?
Cash & Common Stocks
- Common Stock will be increased when the corporation issues shares of stock in exchange for cash (or some other asset)
- Retained Earnings will increase when the corporation earns a profit and there will be a decrease when the corporation has a net loss
- Core link between a company’s balance sheet and income statement
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Accounting Equation Example #2
The concept of double-entry bookkeeping system helps us understand the flow of any particular transaction from the source to the end. Let’s take another basic accounting equation example
When there is a purchase of an asset in a company, the amount to purchase should also be withdrawn from some account in the company (generally the Cash account). Hence, the account from where the amount is withdrawn gets credited and there needs to be an account debited for the asset purchased (the account which relates to the asset purchased gets debited).
Consider the below entries:
- On Dec 27, Joe started with a new company by investing $15,000 as equity in the same.
- On Jan 3, Joe purchased an office table for his company which cost him $5,000.
- He paid wages to his labor on Jan 5 totaling $15,000.
- On Jan 10, he received a contract from his clients, and they paid him $2,000.
- On Jan 13, Joe received another contract for which the client paid $4,000 in advance.
- On Jan 15, he completed the service contract that was received on Jan 13, and remaining amount of $8,000 was paid by the client.
The Journal entries for the above transactions are as below:
The corresponding entries in a balance sheet as of Jan 15 should be as below:
It is seen that the total credit amount equals the total debt amount. This is the fundamental of double-entry bookkeeping system of accounting, which helps us understand from the illustration above that total assets should be equal to total liabilities.
In this illustration, Assets are – Cash, Furniture A/C and Accounts Receivable; Liabilities are Wages Expense and Service Revenue.
If we refer to any balance sheet, we can realize that the assets and liabilities along with the shareholder’s equity are represented as of a particular date and time. Hence, as of Jan 15, only 3 accounts exist with a balance – Cash, Furniture A/C and Service Revenue (the rest get net off during the period of the whole transaction by Jan 15). Only those accounts which exist with a balance (positive or negative) as on a particular date get reflected on the balance sheet.
Alternatively, we can also understand that total liabilities can be derived if only asset value is mentioned, and owner’s equity can also be determined if total assets and total liabilities are available. The basic accounting equation formula can also be used as below:
Hence, this basic accounting equation formula forms the basis of a lot of analysis to market investors, financial analysts, research analysts and other financial institutions.
Accounting equation in an Income Statement
Not only does the balance sheet reflect the basic accounting equation as implemented, but also the income statement.
- An income statement is prepared to reflect the company’s total expenses and total income to calculate the net income to be used for the further purpose. This statement is also prepared in the same conjunction as the balance sheet, however, a little differently applied.
- Here, we do not have total assets and liabilities, but the statement is prepared in such a way that if an expense is credited, it will have an equal and opposite entry in debt in a related ledger account.
- The income statement includes the accounts which directly refer to a company’s income or expense like Cost of Goods Sold, Tax expenses and Interest Payable expenses.
Basic Accounting Equation – Final Thoughts
It is understood that the double-entry book-entry accounting system is followed globally and adheres to the rules of debit and credit entries. These entries should tally to each other at the end of a particular period, and if there is a gap in total balances then it needs to be investigated. This system makes accounting a lot easier, by making us create a relationship between the expense/liability and cause of expense/liability (or income/asset and source of income/asset). We need to understand the underlying concept and thumb rule of accounting which relates to debit and credit entries at the root level. Thus, although the accounting equation formula seems like a one-liner, it contains a lot of meaning to it and, can be explored deeper with complex expense entries as well.
Accounting Equation Video
This has been a guide to Accounting Equation and its definition. Here we discuss the accounting equation in detail, including its accounting equation formula, breaking down the accounting equation formula and also accounting equation examples. You may also have a look at the following basic accounting articles for gaining further knowledge –