The entire concept of double-entry accounting depends on the basic accounting equation, making it fundamental to all accounting (Also see Definition of Accounting Cycle) systems. This basis equation shows two facts about a business: what it owns and what it owes. The accounting (Also see Accounting Concepts Used Most in the Financial World) equation equals the assets of a company to its liabilities and equity, revealing all the assets of the company acquired from creditors (liabilities) or investors (equity). For instance, the company’s assets are initially purchased with cash from creditors or investors when the company is formed.
What is the Basic Accounting Equation Formula?
Assets = Liabilities + Equity
The sum of liabilities and owner’s equity is equal to assets. Normally, creditors need to be paid before bankrupt investors, so the equation is usually written with liabilities occurring before the owner’s equity. In this case, liabilities are more mobile than equity. This is the same with financial reporting, where current assets and liabilities are usually entered before non-current assets and liabilities. This equation applies to all company activities and transactions, with assets always equating to liabilities and owner’s equity. As long as assets increase, liabilities or owner’s equity will also increase to balance the equation. If you’re unsure about the Accounting Equation, consider reaching out to an accounting service in Johor Bahru for assistance.
What are the Accounting Equation Components?
Assets
An asset is a source that is owned by the company and is utilized for future advantages. Some assets are intangible, like goodwill, while some are tangible, like cash. Below are some illustrations of assets:
• Current Assets: Cash, Accounts Receivable, Prepaid Expenses
• Fixed Assets: Motor Vehicle, Machinery, Buildings
• Intangible Assets: Goodwill, Copyrights, Licenses
Liabilities
A liability is an amount of money owed to another person or organization. In other words, liabilities are claims of creditors on the assets of the company, since that is the amount of assets the creditors will own when the company is liquidated. Below are some illustrations of liabilities:
• Bank debt
• Personal Loans
• Unearned income
Equity
Equity is the part of the assets of the company that stockholders or partners own. Said a different way, once all the debts are paid off, the stockholders or partners own the remaining assets. Business owners could maximize their ownership share by contributing money to the company, while business owners (Also see How a Good Accountant will Help Your Business to Grow and Save You Money?) could also withdraw the company funds to minimize their equity. Similarly, revenues would increase equity while expenses decrease equity. Below are some illustrations of equity accounts:
• Owner’s Capital
• Owner’s Withdrawals
• Officer Loans
• Unearned income
• Dividends