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the fundamental accounting equation is

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To prepare the balance sheet and other financial statements, you have to first choose an accounting system. The three main systems used in business are manual, cloud-based accounting software, and ERP software. Now, these changes in the accounting equation get recorded into the business’ financial books through double-entry bookkeeping. As we previously mentioned, the accounting equation is the same for all businesses. It’s extremely important for businesses in that it provides the basis for calculating various financial ratios, as well as for creating financial statements. The accounting equation sets the foundation of “double-entry” accounting, since it shows a company’s asset purchases and how they were financed (i.e. the off-setting entries).

What Is the Accounting Equation, and How Do You Calculate It?

In terms of results, in double-entry accounting both sides of the accounting equation are required to balance out at all times. For example, if your business assets total $200,000, the sum of your liabilities plus the owners’ or stockholders’ equity also equals $200,000. If it doesn’t balance, go back and check for an accounting or data entry error. For example, an increase in an asset account can be matched by an equal increase to a related liability or shareholder’s equity account such that the accounting equation stays in balance.

Let’s check out what causes increases and decreases in the owner’s equity. Each entry on the debit side must have a corresponding entry on the credit side (and vice versa), which ensures the accounting equation remains true. Under the double-entry accounting system, each recorded financial transaction results in adjustments to a minimum of two different accounts. The accounting equation is fundamental to the double-entry bookkeeping practice.

The Formula for the Accounting Equation

Other names for owner’s equity you may face are also net assets, or stockholder’s equity (for public corporations). The owner’s equity is the value of assets that belong to the owner(s). More specifically, it’s the amount left once assets are liquidated and liabilities get paid off. Before getting into how the accounting equation helps balance double-entry bookkeeping, let’s explain each element of the equation in detail. The owner’s equity is the share the owner has on these assets, such as personal investments or drawings.

The monthly trial balance is a list of account names from the chart of accounts, along with their total account balances or amounts. The value of assets owned solely by owner equity can be calculated using this equation. Your liabilities, which come in accounting equation the shape of debts to suppliers, banks, and other third parties, represent the difference between your assets and the owner’s investment in the business. An asset is a resource that is owned or controlled by the company to be used for future benefits.


This transaction affects both sides of the accounting equation; both the left and right sides of the equation increase by +$250. Metro Courier, Inc., was organized as a corporation on  January 1, the company issued shares (10,000 shares at $3 each) of common stock for $30,000 cash to Ron Chaney, his wife, and their son. Equity represents the portion of company assets that shareholders or partners own. In other words, the shareholders or partners own the remainder of assets once all of the liabilities are paid off. So, let’s take a look at every element of  the accounting equation.

Speakers, Inc. purchases a $500,000 building by paying $100,000 in cash and taking out a $400,000 mortgage. This business transaction decreases assets by the $100,000 of cash disbursed, increases assets by the new $500,000 building, and increases liabilities by the new $400,000 mortgage. The revenue a company shareholder can claim after debts have been paid is Shareholder Equity. In our examples below, we show how a given transaction affects the accounting equation. We also show how the same transaction affects specific accounts by providing the journal entry that is used to record the transaction in the company’s general ledger. A trade receivable (asset) will be recorded to represent Anushka’s right to receive $400 of cash from the customer in the future.

Capital essentially represents how much the owners have invested into the business along with any accumulated retained profits or losses. The capital would ultimately belong to you as the business owner. Want to learn more about recording transactions and doing accounting for your small business? Now, there’s an extended version of the accounting equation that includes all of the elements (described in the section above) that comprise the Owner’s Equity. Creditors include people or entities the business owes money to, such as employees, government agencies, banks, and more. A company’s “uses” of capital (i.e. the purchase of its assets) should be equivalent to its “sources” of capital (i.e. debt, equity).

the fundamental accounting equation is

Shareholders’ equity is the total value of the company expressed in dollars. Put another way, it is the amount that would remain if the company liquidated all of its assets and paid off all of its debts. The remainder is the shareholders’ equity, which would be returned to them. The double-entry practice ensures that the accounting equation always remains balanced, meaning that the left side value of the equation will always match the right side value. Essentially, the representation equates all uses of capital (assets) to all sources of capital, where debt capital leads to liabilities and equity capital leads to shareholders’ equity.