# Accounting equation

Accounting equation
Accountancy
Key concepts
Accountant · Accounting period · Bookkeeping · Cash and accrual basis · Cash flow management · Chart of accounts · Journal  · Special journals · Constant Item Purchasing Power Accounting · Cost of goods sold · Credit terms · Debits and credits · Double-entry system · Mark-to-market accounting · FIFO & LIFO · GAAP / IFRS · General ledger · Goodwill · Historical cost · Matching principle · Revenue recognition · Trial balance
Fields of accounting
Cost · Financial · Forensic · Fund · Management · Tax
Financial statements
Statement of financial position · Statement of cash flows · Statement of changes in equity · Statement of comprehensive income · Notes · MD&A · XBRL
Auditing
Auditor's report · Financial audit · GAAS / ISA · Internal audit · Sarbanes–Oxley Act
Accounting qualifications
CA · CPA · CCA · CGA · CMA · CAT · CFA  · CIIA  · ACCA  · CIA  · CTP · ICAEW · CIMA  · IPA  · ICAN
This box:

The 'basic accounting equation' is the foundation for the double-entry bookkeeping system. For each transaction, the total debits equal the total credits.

Assets = Liabilities + Capital[1]

In a corporation, capital represents the stockholders' equity.

## In practice

For example: A student buys a computer for $945. This student borrowed$500 from his best friend and spent another $445 earned from his part-time job. Now his assets are worth$945, liabilities are $500, and equity$445.

The formula can be rewritten:

AssetsLiabilities = (Shareholders' or Owners' Equity or Capital)[1]

Now it shows owners' interest is equal to property (assets) minus debts (liabilities). Since in a company owners are shareholders, owner's interest is called shareholders' equity. Every accounting transaction affects at least one element of the equation, but always balances. Simplest transactions also include:[2]

Transaction
Number
Assets Liabilities Shareholder's
Equity
Explanation
1 + 6,000 + 6,000 Issuing stocks for cash or other assets
2 + 10,000 + 10,000 Buying assets by borrowing money (taking a loan from a bank or simply buying on credit)
3 900 900 Selling assets for cash to pay off liabilities: both assets and liabilities are reduced
4 + 1,000 + 400 + 600 Buying assets by paying cash by shareholder's money (600) and by borrowing money (400)
5 + 700 + 700 Earning revenues
6 200 200 Paying expenses (e.g. rent or professional fees) or dividends
7 + 100 100 Recording expenses, but not paying them at the moment
8 500 500 Paying a debt that you owe
9 0 0 0 Receiving cash for sale of an asset: one asset is exchanged for another; no change in assets or liabilities

These are some simple examples, but even the most complicated transactions can be recorded in a similar way. This equation is behind debits, credits, and journal entries.

This equation is part of the transaction analysis model,[3] for which we also write

Owners equity = Contributed Capital + Retained Earnings
Retained Earnings = Net Income − Dividends

and

Net Income = Income − Expenses

The equation resulting from making these substitutions in the accounting equation may be referred to as the expanded accounting equation, because it yields the breakdown of the equity component of the equation.[4]

## Expanded Accounting Equation

\begin{align} Assets & = Liabilities + Stockholders' Equity & = Liabilities + Common Stock + Retained Earnings - Dividends + Revenues - Expenses \\ \end{align}

## Balance sheet

An elaborate form of this equation is presented in a balance sheet which lists all assets, liabilities, and equity, as well as totals to ensure that it balances.

## References

1. ^ a b Meigs and Meigs. Financial Accounting, Fourth Edition. McGraw-Hill, 1983. pp.19-20.
2. ^ Accounting equation explanation with examples, accountingcoach.com.
3. ^ Libby, Libby, and Short. Financial Accounting, Third Edition. McGraw-Hill, 2001. p.120
4. ^ Wild.Financial Accounting, Third Edition.McGraw-Hill, 2005. p.13

Wikimedia Foundation. 2010.

### Look at other dictionaries:

• accounting equation — ➔ equation …   Financial and business terms

• Accounting Equation — The equation that is the foundation of double entry accounting. The accounting equation displays that all assets are either financed by borrowing money or paying with the money of the company’s shareholders. Thus, the accounting equation is …   Investment dictionary

• accounting equation — balance sheet equation The formula underlying a balance sheet; it can be expressed as: assets = liabilities + capital. An increase or decrease in the total assets of a concern must be accompanied by an equal increase or decrease in the… …   Accounting dictionary

• accounting equation — noun 1. : the equality of debits and credits as used in the double entry system 2. : a statement of net worth as equal to assets minus liabilities …   Useful english dictionary

• accounting equation, the — *Assets = liabilities + *capital. Under the conventions of *double entry bookkeeping, each accounting transaction has at least one *debit entry and at least one *credit entry of equal value. At any moment, the mathematical integrity of… …   Auditor's dictionary

• the accounting equation — UK US noun [S] (also the balance sheet equation) ACCOUNTING ► a mathematical statement showing that to calculate a company owners equity you subtract its liabilities from its assets …   Financial and business terms

• equation — e‧qua‧tion [ɪˈkweɪʒn] noun [countable] a statement in mathematics, showing that two quantities are equal acˈcounting eˌquation one of the relationships between assets and liabilities used in accounting: • The accounting equation here is: assets… …   Financial and business terms

• Accounting identity — In finance and economics, an accounting identity is an equality that must be true regardless of the value of its variables, or a statement that by definition (or construction) must be true. [ Principles of Macroeconomics , Mankiw et al., pp. 211… …   Wikipedia

• accounting — /euh kown ting/, n. 1. the theory and system of setting up, maintaining, and auditing the books of a firm; art of analyzing the financial position and operating results of a business house from a study of its sales, purchases, overhead, etc.… …   Universalium

• equation — /ɪ kweɪʒ(ə)n/ noun a set of mathematical rules applied to solve a problem ● The basic accounting equation is that assets equal liabilities plus equity …   Dictionary of banking and finance