what is meant by accounting equation
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Answer:
The accounting equation states that a company's total assets are equal to the sum of its liabilities and its shareholders' equity. This straightforward number on a company balance sheet is considered to be the foundation of the double-entry accounting system
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Accounting Equation
By JASON FERNANDO Updated October 20, 2021
Reviewed by AMY DRURY
Fact checked by SUZANNE KVILHAUG
PART OF
Guide to Accounting
TABLE OF CONTENTS
EXPAND
What Is the Accounting Equation?
How It Works
Formula and Calculation
About the Double-Entry System
Limits of the Accounting Equation
Real-World Example
Accounting Equation FAQs
What Is the Accounting Equation?
The accounting equation states that a company's total assets are equal to the sum of its liabilities and its shareholders' equity.
This straightforward number on a company balance sheet is considered to be the foundation of the double-entry accounting system. The accounting equation ensures that the balance sheet remains balanced. That is, each entry made on the debit side has a corresponding entry (or coverage) on the credit side.
The accounting equation is also called the basic accounting equation or the balance sheet equation.
KEY TAKEAWAYS
The accounting equation is considered to be the foundation of the double-entry accounting system.
The accounting equation shows on a company's balance that a company's total assets are equal to the sum of the company's liabilities and shareholders' equity.
Assets represent the valuable resources controlled by the company. The liabilities represent their obligations.
Both liabilities and shareholders' equity represent how the assets of a company are financed.
Financing through debt shows as a liability, while financing through issuing equity shares appears in shareholders' equity.
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Accounting Equation
Understanding the Accounting Equation
The financial position of any business, large or small, is based on two key components of the balance sheet: assets and liabilities. Owners’ equity, or shareholders' equity, is the third section of the balance sheet.
The accounting equation is a representation of how these three important components are associated with each other.
Assets represent the valuable resources controlled by the company, while liabilities represent its obligations. Both liabilities and shareholders' equity represent how the assets of a company are financed. If it's financed through debt, it'll show as a liability, but if it's financed through issuing equity shares to investors, it'll show in 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.