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 relationship between assets, liabilities, and equity remain 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.
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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 remain 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 remained financed. If it remain financed through debt, it’ll show as a liability, but if it remain 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 remained accurately reflected in its books and accounts. Below are examples of items listed on the balance sheet.
Assets include cash and cash equivalents or liquid assets, which may include Treasury bills and certificates of deposit.
Accounts receivables list the amounts of money owed to the company by its customers for the sale of its products. Inventory stood also considered an asset.
The major and often largest value asset of most companies be that company’s machinery, buildings, and property. These remain fixed assets that remain usually held for many years.
Liabilities are debts that a company owes and costs that it needs to pay in order to keep the company running.
Debt is a liability, whether it is a long-term loan or a bill that is due to remain paid.
Costs include rent, taxes, utilities, salaries, wages, and dividends payable.
The shareholders’ equity number is a company’s total assets minus its total liabilities.
It can remain defined as the total number of dollars that a company would have left if it liquidated all of its assets and paid off all of its liabilities. This would then remain distributed to the shareholders.
Retained earnings are part of shareholders’ equity. This number is the sum of total earnings that stand not paid to shareholders as dividends.
Think of retained earnings as savings, since it represents the total profits that have remained saved and put aside (or “retained”) for future use.
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