Loading the player...

What is the '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.

BREAKING DOWN 'Accounting Equation'

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 could also be written as Liabilities = Assets – Shareholder Equity and Shareholder Equity = Assets – Liabilities.

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.

Total Liabilities

The total liabilities indicate the amount of money a company owes to its short-term and long-term creditors. The total liabilities are divided into short-term liabilities, also known as current liabilities, and long-term liabilities. Short-term liabilities are expected to be paid off within one year, while long-term liabilities include debts that are expected to be paid off over one year from the balance sheet recording date. For example, assume a hypothetical company has total current liabilities of $5 million and total long-term liabilities of $20 million. Therefore, the company has total liabilities of $25 million, or $5 million + $20 million.

Shareholders' Equity

The shareholders' equity portion of the accounting equation could be calculated by summing the amount of share capital and retained earnings and subtracting the amount in treasury shares from the sum. The equation could be written as: Share Capital + Retained Earnings - Amount in Treasury Shares. For example, assume hypothetical company Rocket has share capital of $10 million, retained earnings of $25 million and treasury shares worth $5 million. Therefore, Rocket has total shareholders' equity of $30 million, or $10 million + $25 million - $5 million.

Real World Example

For example, Apple Inc. reported its annual balance sheet in September 2015. Apple had total current liabilities of $80.61 billion and total long-term liabilities of $90.51 billion. Therefore, it had total liabilities of $171.12 billion, or $80.61 billion + $90.51 billion. Apple had total common stock worth $27.42 billion, retained earnings of $92.28 billion and other stock holder equity of -$345 million. Therefore, it had total shareholders' equity of $119.36 billion, or $27.42 billion + $92.28 billion - $345 million. Consequently, it had total assets of $290.48 billion, or $171.12 billion + $119.36 billion.

RELATED TERMS
  1. Shareholders' Equity

    A firm's total assets minus its total liabilities. Equivalently, ...
  2. Total Liabilities

    The aggregate of all debts an individual or company is liable ...
  3. Balance Sheet

    A financial statement that summarizes a company's assets, liabilities ...
  4. Long-Term Liabilities

    In accounting, a section of the balance sheet that lists obligations ...
  5. Current Liabilities

    A company's debts or obligations that are due within one year. ...
  6. Liability

    A company's legal debts or obligations that arise during the ...
Related Articles
  1. Investing

    Understanding Total Liabilities

    Total liabilities are the combined debts an individual or company owes.
  2. Small Business

    What's a Liability?

    A liability is a debt. It is an obligation that arises during the course of business and represents a third-party claim on the company's assets. A liability can arise in a number of different ...
  3. Investing

    5 Tips For Reading A Balance Sheet

    If you know how to read it, the balance sheet provides valuable information on a potential investment.
  4. Investing

    Explaining Long-Term Liability

    A long-term liability is an obligation a company owes a year or more into the future.
  5. Investing

    Current Liabilities

    Current Liabilities are company debts due within one year or one operating cycle, whichever is greater. An operating cycle is the time it takes a company to purchase inventory and convert it ...
  6. Investing

    Reading The Balance Sheet

    Learn about the components of the statement of financial position and how they relate to each other.
  7. Investing

    How To Analyze A Company's Financial Position

    Find out how to calculate important ratios and compare them to market value.
  8. Investing

    Breaking Down The Balance Sheet

    Knowing what the company's financial statements mean will help you to analyze your investments.
  9. Investing

    What Does Negative Shareholder Equity On A Balance Sheet Mean?

    Negative shareholder equity on a company’s balance sheet is a red flag that should prompt potential investors to take a closer look before committing their money.
  10. Investing

    What is the Shareholder Equity Ratio?

    The shareholder equity ratio shows how much money shareholders will receive if a company has to liquidate its assets.
RELATED FAQS
  1. How do you calculate company equity?

    Find out more about company equity, or shareholders' equity, what company equity measures and how to calculate a company's ... Read Answer >>
  2. What is the difference between an expense and a liability?

    Learn what liabilities and expenses are, which financial statements they are listed on, and the differences between liabilities ... Read Answer >>
  3. How do you calculate shareholder equity?

    Find out more about shareholders' equity, what shareholders' equity measures and how to calculate a company's shareholders' ... Read Answer >>
  4. What items on the balance sheet are most important in fundamental analysis?

    Read about which balance sheet items are considered most important for fundamental analysis, including cash, current liabilities ... Read Answer >>
  5. On which financial statements does a company report its long-term debt?

    Discover which financial statements are used to report a company’s long-term debt, as well as how a company uses debt to ... Read Answer >>
  6. How might a company's contingent liabilities affect its share price?

    Discover what contingent liabilities are, and how and to what extent such liabilities may have an impact on a company's share ... Read Answer >>
Hot Definitions
  1. Graduate Record Examination - GRE

    A standardized exam used to measure one's aptitude for abstract thinking in the areas of analytical writing, mathematics ...
  2. Graduate Management Admission Test - GMAT

    A standardized test intended to measure a test taker's aptitude in mathematics and the English language. The GMAT is most ...
  3. Magna Cum Laude

    An academic level of distinction used by educational institutions to signify an academic degree which was received "with ...
  4. Cover Letter

    A written document submitted with a job application explaining the applicant's credentials and interest in the open position. ...
  5. 403(b) Plan

    A retirement plan for certain employees of public schools, tax-exempt organizations and certain ministers. Generally, retirement ...
  6. Master Of Business Administration - MBA

    A graduate degree achieved at a university or college that provides theoretical and practical training to help graduates ...
Trading Center