Resources | Subject Notes | Accounting | Lesson Plan
The accounting equation is the fundamental principle of double-entry bookkeeping. It shows the relationship between a business's assets, liabilities, and owner's equity. This equation must always remain in balance.
Assets are resources controlled by the business as a result of past events and from which future economic benefits are expected. They represent what the business owns.
Examples of Assets:
Liabilities are obligations of the business to external parties. They represent what the business owes to others.
Examples of Liabilities:
Owner's Equity represents the owner's stake in the business. It is the residual interest in the assets of the business after deducting liabilities.
For a limited company, this is often referred to as Equity. For a sole trader or partnership, it's called Capital.
Examples of Owner's Equity:
The accounting equation is expressed as:
$$Assets = Liabilities + Owner's Equity$$This equation always holds true. Any change in the equation must be balanced by a corresponding change in another part of the equation.
Component | Definition | Example |
---|---|---|
Assets | What the business owns. | Cash, Inventory, Equipment |
Liabilities | What the business owes to others. | Loans, Creditors, Salaries Payable |
Owner's Equity | The owner's stake in the business. | Capital, Retained Earnings, Share Capital |
Illustration: Consider a small business with:
Applying the accounting equation:
$10,000 + $20,000 = $5,000 + $15,000$
$30,000 = $20,000$
The equation balances.