Accounting basic equations

The Accounting Equation

All accounting entries in the books of account for an organisation have a relationship based on the ‘accounting equation’:

Assets = Liabilities + Owners equity

Assets

Assets are tangible and intangible items of value which the business owns. Examples of assets are:

· Cash

· Cars

· Buildings

· Machinery

· Furniture

· Debtors (money owed from customers)

· Stock / Inventory

Liabilities

Liabilities are those items which are owed by the business to bodies outside of the business. Examples of liabilities are:

· Loans to banks

· Creditors (money owed to suppliers)

· Bank overdrafts

Owner’s Equity

The simplest way to understand the accounting equation is to understand what makes up ‘owner’s equity’

By rearranging the accounting equation you can see that Owner’s Equity is made up of Assets and Liabilities.

Owner’s Equity = Total Assets less Total Liabilities

Owner’s Equity can also be expressed as:

Owner’s Equity = Capital invested by owner + Profits (Losses) to date                                           (also known as ‘Retained Earnings ’)

Rearranging the equation again, therefore: Total Assets - Total Liabilities = Capital + Retained Earnings

Total Assets - Total Liabilities = Capital + Retained Earnings