What is the basic accounting equation
The basic accounting equation is the foundation of double-entry bookkeeping and forms the basis for all accounting systems. The equation is:
Assets=Liabilities+Equity\text{Assets} = \text{Liabilities} + \text{Equity}Assets=Liabilities+Equity
Here's a breakdown of each component:
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Assets: Resources owned by a business that have economic value and can provide future benefits. Examples include cash, accounts receivable, inventory, property, equipment, and investments.
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Liabilities: Obligations or debts that a business owes to external parties. These are claims against the company’s assets and include items such as loans, accounts payable, mortgages, and accrued expenses.
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Equity: The residual interest in the assets of the business after deducting liabilities. It represents the owners' claim on the business and includes items like common stock, retained earnings, and additional paid-in capital.
The basic accounting equation ensures that the balance sheet remains balanced, reflecting the company's financial position accurately. It can also be expressed in different forms to highlight specific aspects of the financial statements:
- Equity=Assets−Liabilities\text{Equity} = \text{Assets} - \text{Liabilities}Equity=Assets−Liabilities
- Liabilities=Assets−Equity\text{Liabilities} = \text{Assets} - \text{Equity}Liabilities=Assets−Equity
This equation underpins the double-entry accounting system, where every financial transaction affects at least two accounts, ensuring that the accounting equation always stays in balance.
