What is Accounting Equation?
The accounting equation is considered to be the base for the double-entry system of bookkeeping.
A company’s balance sheet shows that a company’s total assets are equal to the sum of the company’s liabilities and shareholders’ equity.
The financial position of a company is measured by the following items:
- Assets (what it owns)
- Liabilities (what it owes to others)
- Shareholder’s Equity (Equity is equal to a firm’s total assets minus its total liabilities.)
The accounting equation is a basic principle of accounting and a fundamental element of the balance sheet.
The equation is as follows:
Assets = Liabilities + Shareholder’s Equity
Assets
Assets are company’s own resources. Examples of assets include cash, accounts receivable, inventory, prepaid insurance, investments, land, buildings, equipment, and goodwill.
Liabilities
Liabilities are a company’s obligations—the amount the company owes. Examples of liabilities include notes or loans payable, accounts payable, salaries and wages payable, interest payable.
Shareholder’s Equity
Share Capital
Share capital means the amount invested into the company by the owners plus the cumulative net income of the company that has not been withdrawn or distributed to the owners (I.e., Retained Earnings)
Retained Earnings
Retained Earning means a portion of the business’s profit that is not distributed to shareholders as dividends are kept as a reserve which is reinvested back into the business.
