The Accounting Equation (Assets, Liabilities & Equity)
From the multi-national, huge enterprise down to the corner barbershop, a company financial position is affected by every single business transaction. The assets, liabilities and equity determine the economic status of a business (Also see How to Create Your Chart of Accounts).
The accounting equation, known as the basic accounting equation, explains the relationship between these three elements.
For sole proprietorship, the accounting equation will be:
Assets = Liabilities + Owner’s equity
For a company, the accounting formula will be:
Assets = Liabilities + Shareholder’s equity
Assets are the things owned by the business, which are the business’s resources. Some examples of assets are accounts receivable, prepaid insurance, goodwill, land, building, investments, equipment and cash. According to the accounting equation, we know that the combined quantity of liabilities and equity need to equate to the number of assets.
Liabilities are a business’s debts, which are the amounts the business owes. For example, wages and salaries payable, loans or notes payable, interest payable, income taxes payable and accounts payable.
Liabilities could be categorised into two types:
- Viewed as a claim by creditors against the business’s assets
2. Viewed as a source together with the owner or shareholder equity and the business’s assets.
Shareholders’ equity or owner’s equity is remaining when the liabilities are subtracted from the assets:
Assets – Liabilities = Owner’s or Shareholders’ Equity
Equity reports the quantities invested into the business by the owners and the cumulative net earnings of the business that is not withdrawn or dispersed to the owners.
The accounting equation will always be “in balance” if a business keeps precise records. The balanced accounting equation indicates that the right side needs to equate to the left side. As every business transaction would have an impact on at least two of a business’s accounts, the balance is kept for both sides.
For instance, the business’s assets will increase and its liabilities will increase too by the same quantity when a company borrows money from a bank. When a business purchases stock for money, one’s asset will increase and one’s asset will reduce. The accounting system is known as double-entry accounting since there are two or more accounts are impacted by every deal.
If you find it cumbersome to understand all these, an alternative will be to engage an accounting services in Singapore and let the professionals get things sorted out for you.