Accounting Equation

AAA

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.

INVESTOPEDIA EXPLAINS '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.

RELATED TERMS
  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. Retained Earnings

    The percentage of net earnings not paid out as dividends, but ...
  5. Liability

    A company's legal debts or obligations that arise during the ...
  6. Asset

    1. A resource with economic value that an individual, corporation ...
Related Articles
  1. Active Trading

    An Introduction To Depreciation

    Companies make choices and assumptions in calculating depreciation, and you need to know how these affect the bottom line.
  2. Markets

    A Clear Look At EBITDA

    This measure has its benefits, but it can also present earnings through rose-colored glasses.
  3. Taxes

    How After-Tax Rollovers Affect Your IRA

    Consolidating retirement assets? Make sure you account for pre-tax and after-tax assets separately.
  4. Fundamental Analysis

    Accounting For Differences In Oil And Gas Accounting

    How a company accounts for its expenses affects how its net income and cash flow numbers are reported.
  5. Forex

    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 and equity every time. The assets on the balance sheet consist of ...
  6. Insurance

    International Reporting Standards Gain Global Recognition

    Comparing financial numbers from corporations in different countries is possible with the adoption of IFRS.
  7. Options & Futures

    Advanced Financial Statement Analysis

    Learn what it means to do your homework on a company's performance and reporting practices before investing.
  8. Fundamental Analysis

    What is the difference between profitability and profit?

    Calculating company profit and profitability are not one and the same, and investors should understand the difference between the two terms.
  9. Fundamental Analysis

    Should companies break out accounts receivables into subledgers?

    Find out why every company that sells on credit should break down its accounts receivable into individual customer subsidiary ledgers, or subledgers.
  10. Fundamental Analysis

    What metrics can be used to evaluate companies in the forest products sector?

    Understand some of the best financial and equity valuation measurements that can be utilized to evaluate companies in the forest products sector.

You May Also Like

Hot Definitions
  1. Weather Insurance

    A type of protection against a financial loss that may be incurred because of rain, snow, storms, wind, fog, undesirable ...
  2. Portfolio Turnover

    A measure of how frequently assets within a fund are bought and sold by the managers. Portfolio turnover is calculated by ...
  3. Commercial Paper

    An unsecured, short-term debt instrument issued by a corporation, typically for the financing of accounts receivable, inventories ...
  4. Federal Funds Rate

    The interest rate at which a depository institution lends funds maintained at the Federal Reserve to another depository institution ...
  5. Fixed Asset

    A long-term tangible piece of property that a firm owns and uses in the production of its income and is not expected to be ...
  6. Break-Even Analysis

    An analysis to determine the point at which revenue received equals the costs associated with receiving the revenue. Break-even ...
Trading Center