The Basic Accounting Equation Financial Accounting

accounting equation

Every transaction demonstrates the relationship of the elements and shows how balance is maintained. To understand the purpose of the Accounting Information For Retail Businesses: A Comprehensive Guide, it’s first helpful to take a closer look at double-entry accounting. At the heart of this is the balance sheet, which shows a balance of total assets, total liabilities, and shareholder equity. Thus, you have resources with offsetting claims against those resources, either from creditors or investors.

Thus, the accounting formula essentially shows that what the firm owns (its assets) has been purchased with equity and/or liabilities. Examples of assets include cash, accounts receivable, inventory, prepaid insurance, investments, land, buildings, equipment, and goodwill. From the accounting equation, we see that the amount of assets must equal the combined amount of liabilities plus owner’s (or stockholders’) equity. The accounting equation can help you see the relationship between your assets, liabilities, and owners’ equity.


Account classes such as Assets & Expenses tend to have a debit balance, while account classes such as liabilities & income have a credit balance. The main idea behind the double-entry basis of accounting is that Assets will always equal liabilities plus equity. Here are a few of these equations along with a brief explanation of how they work.

If it’s financed through debt, it’ll show as a liability, but if it’s financed through issuing equity shares to investors, it’ll show in shareholders’ equity. The monthly trial balance is a listing of account names from the chart of accounts with total account balances or amounts. Total debits and credits must be equal before posting transactions to the general ledger for the accounting cycle.

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Owner’s equity will equal anything left from the assets after all liabilities have been paid. An accounting transaction is a business activity or event that causes a measurable change in the accounting equation. Merely placing an order for goods is not a recordable transaction because no exchange has taken place.

Liabilities include amounts which a company owes to another party. Like assets, liabilities can also be divided into non-current & current. Non-Current liabilities are mainly used to finance non-current assets and include long term debt, mortgage, bonds, etc. Owner’s equity represents the amount owed to the owner or owners by the company.

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