What Is the Accounting Equation?
Also known as the balance sheet equation, the account equation is Assets = Liabilities + Equity.
This equation should be supported by the information on a company’s balance sheet. The Accounting Equation is the foundation of double-entry accounting because it displays that all assets are financed by borrowing money or paying with the money of the business’s shareholders.
The balance sheet is a more detailed and complex display of the accounting equation. It shows that the total assets of a business are equal to the total liabilities and shareholder equity. In other words, all uses of capital (assets) are equal to all sources of capital (debt: liabilities and equity).
Another way to look at it is:
Shareholder equity = Assets – Liabilities
The Accounting Equation is often called the Basic Accounting Equation.
This article will also discuss:
What Are the Three Elements in the Accounting Equation?
The Accounting equations is:
Assets = Liabilities + Equity
So, let’s take at every element of that equation.
Assets are things of value owned by a business.
There are different categories of assets including long-term assets, capital assets, investments and tangible assets. They were acquired by boring money from lenders, receiving cash from owners and shareholders or offering goods or services.
Current assets include cash and accounts receivable, while long-term assets include notes receivable. Items such as plant, property and equipment are considered capital assets. Securities owned by a company like stocks and bonds are called investments. Intangible assets found on the balance sheet include trademarks, goodwill, patents and copyrights.
The accounting equation states that the amount of assets must be equal to liabilities plus shareholder or owner equity.
Obligations owed to other companies and people are considered liabilities and can be categorized at current and long-term liabilities.
Due within the year, current liabilities on a balance sheet include accounts payable, wages payable and taxes payable. Long-term liabilities are usually owed to lending institutions and include notes payable and possibly unearned revenue.
Unearned revenue from the money you have yet to receive for services or products that you have not yet delivered is considered a liability.
The revenue a shareholder can claim after debts have been paid is Shareholder Equity.
Shareholder Equity is equal a business’s total assets minus its total liabilities. It can be found on a balance sheet and is one of the most important metrics for analysts to assess the financial health of a company.
Shareholder Equity represents the net or book value of a business.