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Accounting Equation: Definition, Formula & Examples


The left side of the T shows a debit balance while the right side of the T account shows a credit balance. Account classes such as Assets & Expenses tend to have a debit balance, while account classes such as liabilities & income have a credit balance. The main idea behind the double-entry basis of accounting is that Assets will always equal liabilities plus equity. This reduces the cash account and reduces the accounts payable account.

  • The financial interest of the owner of a business.
  • Shanti purchases the laptop with a credit card, and the clerk finalizes the sale.
  • Cash flow isn’t considered in the accounting equation.
  • Assets including long-term assets, capital assets, investments and tangible assets.
  • The income statement shows revenue, ___________________, and net income or net loss for a period of time.

For example, you can talk about how you checked that the books were balanced for a friend or family member’s small business.

How to Journalize Notes Payable to Accounts Payable

They are categorized as current assets on the balance sheet as the payments expected within a year. 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. When John sets up his business, assets will increase by $5,000, while the owner’s equity will increase by $5,000. You may have made a journal entry where the debits do not match the credits.

Liability is also classified as current or long-term. This equation sets the foundation of double-entry accounting, also known as double-entry bookkeeping, and highlights the structure of the balance sheet. Double-entry accounting is a system where every transaction affects at least two accounts. Locate the company’s total assets on the balance sheet for the period. TRUE or FALSE The net income or net loss for the period is shown on both the income statement and the balance sheet. TRUE or FALSE The statement of owner’s equity is prepared before the balance sheet so that the ending capital balance is available.

Resources for Your Growing Business

We want to increase the asset Cash and decrease the asset Accounts Receivable. Metro Corporation collected a total of $5,000 on account from clients who owned money for services previously billed. The corporation prepaid the rent for next two months making an advanced payment of $1,800 cash. The corporation paid $300 in cash and reduced what they owe to Office Lux.


Note that in case of a, instead of owner’s equity we have shareholder’s equity as many shareholders invest money and have equity stake in the corporation. Is a debt that a company has incurred with another party, as when it borrows money from a bank or purchases materials from other suppliers. The business is required to make a future payment to satisfy that debt. For accounting purposes, we want to be able to see what the business owns compared with what it owes . For example, if Shanti does not have sufficient cash to pay for the laptop, she may have the electronics store charge her credit card for the purchase. In that case, the credit card company pays the store, and Shanti’s business now owes the credit card company for the amount of purchase . Accounts ReceivableAccounts receivables is the money owed to a business by clients for which the business has given services or delivered a product but has not yet collected payment.

Examples of Accounting Equation Transactions

If a’s assets were hypothetically liquidated (i.e. the difference between assets and liabilities), the remaining value is the shareholders’ equity account. Equity refers to the owner’s value in an asset or group of assets. Equity is also referred to as net worth or capital and shareholders equity. The accounting equation helps to assess whether the business transactions carried out by the company are being accurately reflected in its books and accounts. Below are examples of items listed on the balance sheet.

A company’s financial risk increases when liabilities fund assets. This is sometimes referred to as the company’s leverage. A company’s liabilities include every debt it has incurred. These may include loans, accounts payable, mortgages, deferred revenues, bond issues, warranties, and accrued expenses.

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