The Basic Accounting Equation
or Formula

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

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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 important.

Why is it so important?

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

Let me say that again: 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 very hard.

No pressure, right?

Okay, so pay attention...

The whole of accounting is based on one single equation: 

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. 

Click here for the full lesson on assets.

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. 

Click here for the full lesson on liabilities.

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. 

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.

Test Yourself!

Before you start, I would recommend to time yourself to make sure that you not only get the questions right but are completing them at the right speed.

Difficulty Rating:
Beginner

Quiz length: 
3 questions

Time limit:
5 minutes

Important: The solution sheet on the following page only shows the solutions and not whether you got each of the questions right or wrong. So before you start, get yourself a piece of paper and a pen to write down your answers. Once you're done with the quiz and writing down your answers, click the Check Your Answers button at the bottom and you'll be taken to our page of solutions.

Good luck!

This Form cannot be submitted until the missing fields (labelled below in red) have been filled in
Basic Accounting Equation Mini Quiz:
Please note that all fields followed by an asterisk must be filled in.
1. Which of the following statements are true?*
a) About half of accounting entries are based on the accounting equation. b) Only a few accounting entries are based on the accounting equation. c) Only accounting entries relating to assets are based on the accounting equation. d) All accounting entries are based on the accounting equation. e) None of the above.
2. Assets are basically __________ of the business.*
a) Liabilities. b) Owner's Equity. c) Possessions. d) Debts. e) None of the above.
3. Liabilities are basically _____________.*
a) A form of owner's equity. b) Debts. c) Assets. d) Insurance. e) None of the above.
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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.

Return from The Basic Accounting Equation to Basic Concepts 

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

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