Accounting equation

Definition

The accounting equation, also known as the balance sheet equation, is a concept in accounting that forms the basis for recording financial transactions. It illustrates the relationship between a company’s assets, liabilities, and owner’s equity at any given point.

What is accounting equation?

To calculate accounting equation, use the following formula:

Assets = liabilities + owner’s equity

The equation must always balance, meaning that the total value of the company’s assets must equal the total of its liabilities plus owner’s equity. This principle reflects the accounting principle of double-entry bookkeeping.

The accounting equation is the foundation of financial accounting and is used to prepare the balance sheet, which is one of the three main financial statements that provide a snapshot of a company’s financial health at a given time.

Example of accounting equation

Let’s say a business, ABC Corporation, starts its operations. At the beginning, the company’s financial position can be represented by the following transactions:

ABC Corporation takes out a loan of £30,000 from a bank.

$\text{Assets}=\; \pounds 50,000(Cash)+\; \pounds 20,000(Equipment)$

$\text{Liabilities}=\; \pounds 30,000(Loan)$

Equity = £40,000 (Owner′sInvestment)

The accounting equation is in balance: £70,000 = £30,000 + £40,000