What is the Accounting Equation?
The Accounting Equation is a fundamental principle stating that a company’s assets (i.e. resources) must always be equal to the sum of its liabilities and equity (i.e. funding sources).
Accounting Equation: Assets = Liabilities + Equity
The chart below summarizes the accounting equation:
Balance Sheet Equation: Fundamental Concepts
The balance sheet is one of the three main financial statements that depicts a company’s assets, liabilities, and equity sections at a specific point in time (i.e. a “snapshot”).
Typically reported on a quarterly or annual basis, the balance sheet consists of three components:
|Shareholders’ Equity Section||
Accounting Equation Formula
The fundamental accounting equation, as mentioned earlier, is as follows:
The rationale is that the assets belonging to a company must have been funded somehow, i.e. the money used to purchase the assets did not just appear out of thin air to state the obvious.
If a company’s assets were hypothetically liquidated (i.e. the difference between assets and liabilities), the remaining value is the shareholders’ equity account.
Therefore, the assets side must always be equal to the sum of the liabilities and equity — which are the company’s two funding sources:
- Liabilities — e.g. Accounts Payable, Accrued Expenses, Debt Financing
- Shareholders’ Equity — e.g. Common Stock and APIC, Retained Earnings