# The Basic Accounting Equationor Formula

Previous lesson: Define Accounting
Next lesson: What Are Assets?

Have you heard of the basic accounting equation or accounting formula?

Do you know what it is?

It's the fundamental equation that underpins all of accounting.

In other words, it's really, really important.

Why is it so important?

Because all accounting entries - all of them - are derived from it.

All accounting entries. All of them.

So, if you really understand this equation, the rest of accounting becomes that much easier.

If you don't understand it, you'll probably find the subject pretty hard.

No pressure, right?

Okay, so listen up...

The whole of accounting is based on one single equation:

ASSETS = OWNERS EQUITY + LIABILITIES

The word equation comes from the word equal.

For any equation, one side always equals another.

Also, equations can actually be made out of anything.

For example:

• 1 Orange = \$0,50
• House = Walls + Doors + Windows + Roof
• 1 week = 7 days

So what does the basic accounting equation or basic accounting formula mean?

Well, in order to answer that question we need to look at what each of the terms in the equation mean.

## Assets Assets are basically possessions of the business. They are things that add value to the business and will bring it benefits in some form.

For example, furniture, machinery, vehicles, computers, stationery or cash.

## Liabilities Liabilities are basically debts.

The amount of liabilities represents the value of the business assets that are owed to others. It is the value of the assets that people outside the business can lay claim to.

## Owners Equity (or Equity) Owners equity, or simply, equity, is the value of the business assets that the owner can lay claim to.

It is the value of the assets that the owner really owns.

## What the Basic Accounting Equation Means In a nutshell, the accounting equation above shows us:

• How much of the assets are owed to others (liabilities), and
• How much are owned by the owner (equity).

It's as simple as that.

Does this equation and its meaning still seem a bit tricky right now? If so, don't worry, it will become easier as you continue along.

Read through the following lessons, where I will go into more details about each of the elements of the basic accounting equation, including examples for each one:

Once you are done with these lessons be sure to check out the final lesson on the accounting equation and financial position, which will give you more info and certainty about this key concept.

Did you know?

Not only does the accounting equation underpin all accounting entries, but it also forms the exact structure of one of accounting's most important reports - the balance sheet.

To see the report showing the accounting equation, check out the lesson on the balance sheet.

Previous lesson: Define Accounting
Next lesson: What Are Assets?

### Questions Relating to This Lesson

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