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Basic Accounting Equation Formula, Calculation & Examples Video & Lesson Transcript


It is shown as the part of http://www.ubicomp2010.org/?page_id=2 equity in the liability side of the balance sheet of the company. Furthermore, the number of transactions entered as the debits must be equivalent to that of the credits.


This includes expense reports, cash flow and salary and company investments. So, now you know how to use the accounting formula and what it does for your books. The accounting equation is important because it can give you a clear picture of your business’s financial situation. It is the standard for financial reporting, and it is the basis for double-entry accounting.

How do you calculate accounting equation?

This equation is used to ensure that companies’ financial statements are accurate. The double-entry accounting system is designed to make sure that assets will always be equal to liabilities + owner’s equity. The totals above show that John has total assets worth $7,500, while his liabilities and equity are $3,000 & $4,500, respectively. The balance sheet shows the assets, liabilities & owners’ equity.


Tulsa Enterprises has decided to build a $50 million theme park near a large metropolitan area. The company plans to sell shares of ownership to finance the development. Tulsa plans to use ___________ financing for this project. During a period of rising prices, FIFO inventory valuation method will result in ________ net income figures than would LIFO . Balance SheetAssets SectionThe resources with economic value which can be sold for money post-liquidation or are anticipated to bring positive monetary benefits in the future. The global adherence to the double-entry accounting system makes the account keeping and tallying processes more standardized and more fool-proof. Debt is a liability, whether it is a long-term loan or a bill that is due to be paid.

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In order to make sure that the http://www.proplay.ru/forums/main/23219/ of a company are balanced, the total assets must equal the sum of the total of all liabilities and owner’s equity. To see if everything is balanced, the totals are simply plugged in to the accounting equation. Once the math is done, if one side is equal to the other, then the accounts are balanced.

It is based on the idea that each transaction has an equal effect. It is used to transfer totals from books of prime entry into the nominal ledger.

Double Entry & T Accounts

Metro Corporation paid a total of $1,200 for utility bill. Metro Corporation paid a total of $900 for office salaries. Metro performed work and will receive the money in the future. The corporation received $50,000 in cash for services provided to clients.

  • A mark in the debit column will increase a company’s asset and expense accounts, but decrease its liability, income and capital account.
  • The purpose of a Ledger is to bring together all of the transactions for similar activity.
  • Equity is also referred to as net worth or capital and shareholders equity.
  • If the expanded accounting equation is not equal on both sides, your financial reports are inaccurate.
  • The goal of the accounting equation is to ensure that a company’s financial statements are accurate.
  • Creating a separate list of the sum of all liabilities on the balance sheet.

The owner has positive http://www.humannova.org/author/humannova/ only to the extent that assets exceed liabilities. If a business has $1,000 of assets and $500 of liabilities the $500 of liabilities are, in effect, a claim on the assets. Equity is the difference between the assets and liabilities, or $500. Now that you understand the parts of the accounting equation, let’s talk about how it works. Purchasing the office machine with cash of $1,500 means an additional $1,500 on assets for the purchased machine and a deduction of $1,500 for the assets in terms of cash going out. This will cancel the values, and no change has happened on the right side of the equation. On January 1st, 2020, Sherry took out the money from her savings for $100,000 to start her skincare business.

What is the Basic Accounting Equation?

A mark in the credit column will increase a company’s liability, income and capital accounts, but decrease its asset and expense accounts. A mark in the debit column will increase a company’s asset and expense accounts, but decrease its liability, income and capital account.

  • Once you do understand the above, explained in very simple terms, you’re ready to “close the books” or to balance the accounts.
  • Notice that the left hand side of the equation shows the resources owned by the business and the right hand side shows the sources of funds used to acquire these resources.
  • The contributed capital and dividends, on the other hand, show the effect of transactions with the stockholders.
  • Shareholders thus, in fact, are the owners of the company and their equity is in the form of investments in shares.
  • It borrows $400 from the bank and spends another $600 in order to purchase the machine.
  • As you can see, shareholder’s equity is the remainder after liabilities have been subtracted from assets.
  • An accounting equation is a principal component of the double-entry accounting system and forms part of a balance sheet.

They prove that the financial statements balance and the double-entry accounting system works. The company’s assets are equal to the sum of its liabilities and equity. It gives meaning to the balance sheet structure and is the foundation of double-entry accounting. Double-entry accounting is the practice where one transaction affects both sides of the accounting equation. This is used extensively in journal entries, where an increase or decrease on one side of the equation may be explained by an increase or decrease on the other side. In a corporation, capital represents the stockholders’ equity. Thus, the accounting formula essentially shows that what the firm owns has been purchased with equity and/or liabilities.

Basic Accounting Equation

For example, if the company uses cash to purchase inventory, cash is decreased and inventory is increased ; thus, assets as a whole remain unchanged and the equation remains in balance. Likewise, as the company receives payment from its customers, accounts receivable is credited and cash is debited. The accounting equation is always in balance, which means that the total value of a company’s assets must always equal the sum of its liabilities and equity. This is because every transaction that a company makes has an equal and opposite effect on at least one other element of the equation. For example, if a company borrows money from a lender, the loan will increase the company’s liabilities and also increase its assets , thus maintaining the balance of the equation. An extension of that basic rule involves the balance sheet.

What represents the fundamental accounting equation?

The basic accounting equation formula is Assets = Liabilities + Equity. This equation states that the total value of an entity's assets must equal the total value of its liabilities plus its equity. It is this simple equation that forms the foundation for all financial statements.

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