The Basic Accounting Equation
or 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


Accounting = Balance

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

asset example - construction Vehicle

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. 

Click here for the full lesson on assets.


Liabilities

liability example - bank loan debt

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. 

Click here for the full lesson on liabilities.


Owners Equity (or Equity)

owners equity businessman

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. 

Click here for the full lesson on owners equity.



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:

1. Assets 
2. Liabilities 
3. Owners Equity 

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.



Return from The Basic Accounting Equation to Basic Concepts 

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



Questions Relating to This Lesson

Click below to see questions and exercises on this same topic from other visitors to this page... (if there is no published solution to the question/exercise, then try and solve it yourself)

Accounting Equation Exercises 
Q: Tom Jones is the owner and operator of Jones Enterprise, a motivational consulting business. At the end of its accounting period, December 31, 2009, …

MAIN PURPOSE OF
ACCOUNTING EQUATION
 
Q: WHAT IS THE MAIN PURPOSE OF THIS ACCOUNTING EQUATION? A: The main purpose of the basic accounting equation is to show the real-life financial …


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