View In English

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

common stock

The accounting equation is only designed to provide the underlying structure for how the balance sheet is formulated. As long as an organization follows the accounting equation, it can report any type of transaction, even if it is fraudulent. The accounting equation states that the amount of assets must be equal to liabilities plus shareholder or owner equity.

financial statements

Note, by the way, that the two offsetting that follow a single transaction do not need to occur on opposite sides of the Balance sheet. The purpose of the accounting equation is that the organization’s financial resources be in balance. A company’s assets could include everything from cash to inventory.

Who Uses the Accounting Equation?

Under the umbrella of, liabilities refer to a company’s debts or financially-measurable obligations. Shareholders’ equity is the total value of the company expressed in dollars.

For example, inventory is very liquid — the company can quickly sell it for money. Real estate, though, is less liquid — selling for cash is time-consuming and sometimes difficult, depending on the market. You don’t need to use the company’s Cash Flow Statement to compute the accounting equation. This transaction affects both sides of the accounting equation; both the left and right sides of the equation increase by +$250. If a company wants to manufacture a car part, they will need to purchase machine X that costs $1000. It borrows $400 from the bank and spends another $600 in order to purchase the machine.

Resources created by teachers for teachers

As you can see, equal the sum of liabilities and owner’s equity. This makes sense when you think about it because liabilities and equity are essentially just sources of funding for companies to purchase assets.

  • This becomes an important financial record for future reference.
  • Real estate, though, is less liquid — selling for cash is time-consuming and sometimes difficult, depending on the market.
  • There are accounting standards that dictate what items appear in which category, but there is also much latitude in reporting that still remains within the realm of accounting standards.
  • In bookkeeping and management of ledgers, the basic accounting formula is extensive.
  • The accounting equation appears to be quite straightforward, but often that is not the case.

Leave a comment


    Tech Support Request

    *Please use this form to report ONLY technical issues.
    You can use the contact form on the website if you have any general questions. - Thank you!