Accounting Equation


DEFINITION of 'Accounting Equation'

The equation that is the foundation of double entry accounting. The accounting equation displays that all assets are either financed by borrowing money or paying with the money of the company's shareholders. Thus, the accounting equation is: Assets = Liabilities + Shareholder Equity. The balance sheet is a complex display of this equation, showing that the total assets of a company are equal to the total of liabilities and shareholder equity. Any purchase or sale by an accounting equity has an equal effect on both sides of the equation, or offsetting effects on the same side of the equation. The accounting equation is also written as Liabilities = Assets – Shareholder Equity and Shareholder Equity = Assets – Liabilities.


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BREAKING DOWN 'Accounting Equation'

The basic equation shows that a company can fund the purchase of an asset with assets (a $50 purchase of equipment using $50 of cash) or fund it with liabilities or shareholder equity (a $50 purchase of equipment by borrowing $50 or using $50 of retained earnings). In the same vein, liabilities can be paid down with assets, like cash, or by taking on more liabilities, like debt.

  1. Balance Sheet

    A financial statement that summarizes a company's assets, liabilities ...
  2. Accounting

    The systematic and comprehensive recording of financial transactions ...
  3. Shareholders' Equity

    A firm's total assets minus its total liabilities. Equivalently, ...
  4. Liability

    A company's legal debts or obligations that arise during the ...
  5. Retained Earnings

    Retained earnings is the percentage of net earnings not paid ...
  6. Asset

    1. A resource with economic value that an individual, corporation ...
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  1. Why does accumulated depreciation have a credit balance on the balance sheet?

    Accumulated depreciation is increased with a credit entry, although it is shown on the asset side of the balance sheet. Following ... Read Full Answer >>
  2. Does the balance sheet always balance?

    Yes, a balance sheet should always balance. The name "balance sheet" is based on the fact that assets will equal liabilities ... Read Full Answer >>
  3. Does working capital include inventory?

    A company's working capital includes inventory, and increases in inventory make working capital increase. Working capital ... Read Full Answer >>
  4. Does working capital include salaries?

    A company accrues unpaid salaries on its balance sheet as part of accounts payable, which is a current liability account, ... Read Full Answer >>
  5. Are dividends considered an asset?

    Whether dividends paid on stock are considered an asset depends on which role you play in the investment: the issuing company ... Read Full Answer >>
  6. What is a profit and loss (P&L) statement and why do companies publish them?

    A profit and loss (P&L) statement, or balance sheet, is essentially a snapshot of a company's financial activity for ... Read Full Answer >>

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