The accounting equation is Assets = Liabilities + Owner’s (Stockholders’) Equity. The accounting equation should remain in balance at all times because of the double-entry system of accounting or bookkeeping. (This system means every transaction will affect at least two accounts in the general ledger.)
Here are some examples of how the accounting equation remains in balance:
An owner’s investment into the company will increase the company’s assets and will also increase owner’s equity
When the company borrows money from its bank, the company’s assets increase and the company’s liabilities increase
When the company repays the loan, the company’s assets decrease and the company’s liabilities decrease
If the company pays cash for a new delivery van, one asset (cash) will decrease and another asset (vehicles) will increase
If a company provides a service to a client and immediately receives cash, the company’s assets increase and the company’s owner’s equity will increase because it has earned revenue
If the company provides a service and allows the client to pay in 30 days, the company has increased its assets (Accounts Receivable) and has also increased its owner’s equity because it has earned service revenue
If the company runs a radio advertisement and agrees to pay later, the company incurs an expense that reduces owner’s equity and increases its liabilities
From our examples, you can see that owner’s equity increased when the owner made an investment in the business and also when revenues were earned. Owner’s equity decreased when the owner withdrew assets from the business and when expenses were incurred. This leads us to the expanded accounting equation:
Assets = Liabilities + Owner’s Capital + Revenues – Expenses – Draws
Featured Review
"As a seasoned accounting/auditing professional in a dynamic corporate environment, I rely on AccountingCoach as an invaluable resource to refresh my understanding on important accounting matters and stay ahead in my field. Becoming a PRO user was a no-brainer; the comprehensive materials cater perfectly to my professional needs. The clear explanations, real-world examples, and interactive quizzes have significantly enhanced my understanding of complex accounting concepts. This platform has not only helped me excel in my current role but has also empowered me with the knowledge and confidence to take on new challenges. I have referred several others to the AccountingCoach platform over the years. Kudos to AccountingCoach for being my go-to resource!" - Gary
Join PRO or PRO Plus and Get Lifetime Access to Our Premium Materials
Read all 2,645 reviewsWe now offer 10 Certificates of Achievement for Introductory Accounting and Bookkeeping: