Accounting equation
Encyclopedia
The basic accounting equation' is the foundation for the double-entry bookkeeping system
Double-entry bookkeeping system
A double-entry bookkeeping system is a set of rules for recording financial information in a financial accounting system in which every transaction or event changes at least two different nominal ledger accounts....

. For each transaction, the total debits equal the total credits.
Assets = Liabilities + Capital

In a corporation, capital represents the stockholders' equity.

## In practice

For example: A student buys a computer
Computer
A computer is a programmable machine designed to sequentially and automatically carry out a sequence of arithmetic or logical operations. The particular sequence of operations can be changed readily, allowing the computer to solve more than one kind of problem...

for \$945. This student borrowed \$500 from his best friend and spent another \$445 earned from his part-time job. Now his asset
Asset
In financial accounting, assets are economic resources. Anything tangible or intangible that is capable of being owned or controlled to produce value and that is held to have positive economic value is considered an asset...

s are worth \$945, liabilities are \$500, and equity \$445.

The formula can be rewritten:
Assets - Liabilities = (Shareholders' or Owners' Equity or Capital)

Now it shows owners' interest
Interest
Interest is a fee paid by a borrower of assets to the owner as a form of compensation for the use of the assets. It is most commonly the price paid for the use of borrowed money, or money earned by deposited funds....

is equal to property
Property
Property is any physical or intangible entity that is owned by a person or jointly by a group of people or a legal entity like a corporation...

(assets) minus debts (liabilities). Since in a company owners are shareholders, owner's interest is called shareholders' equity.
Every accounting transaction
Financial transaction
A financial transaction is an event or condition under the contract between a buyer and a seller to exchange an asset for payment. It involves a change in the status of the finances of two or more businesses or individuals.-History:...

affects at least one element of the equation, but always balances. Simplest transactions also include:
Transaction
Number
Assets Liabilities Shareholder's
Equity
Explanation
1 + 6,000 + 6,000 Issuing stock
Stock
The capital stock of a business entity represents the original capital paid into or invested in the business by its founders. It serves as a security for the creditors of a business since it cannot be withdrawn to the detriment of the creditors...

s for cash or other assets
2 + 10,000 + 10,000 Buying assets by borrowing money (taking a loan from a bank or simply buying on credit)
3 900 900 Selling assets for cash to pay off liabilities: both assets and liabilities are reduced
4 + 1,000 + 400 + 600 Buying assets by paying cash by shareholder's money (600) and by borrowing money (400)
5 + 700 + 700 Earning revenues
6 200 200 Paying expenses (e.g. rent or professional fees) or dividends
7 + 100 100 Recording expenses, but not paying them at the moment
8 500 500 Paying a debt that you owe
9 0 0 0 Receiving cash for sale of an asset: one asset is exchanged for another; no change in assets or liabilities

These are some simple examples, but even the most complicated transactions can be recorded in a similar way. This equation is behind debit
Debit
Debit and credit are the two aspects of every financial transaction. Their use and implication is the fundamental concept in the double-entry bookkeeping system, in which every debit transaction must have a corresponding credit transaction and vice versa.Debits and credits are a system of notation...

s, credits, and journal entries.

This equation is part of the transaction analysis model, for which we also write
Owners equity = Contributed Capital + Retained Earnings

Retained Earnings = Net Income − Dividends

and
Net Income = Income − Expenses

The equation resulting from making these substitutions in the accounting equation may be referred to as the expanded accounting equation, because it yields the breakdown of the equity
Ownership equity
In accounting and finance, equity is the residual claim or interest of the most junior class of investors in assets, after all liabilities are paid. If liability exceeds assets, negative equity exists...

component of the equation.

## Balance sheet

An elaborate form of this equation is presented in a balance sheet
Balance sheet
In financial accounting, a balance sheet or statement of financial position is a summary of the financial balances of a sole proprietorship, a business partnership or a company. Assets, liabilities and ownership equity are listed as of a specific date, such as the end of its financial year. A...

which lists all assets, liabilities, and equity, as well as totals to ensure that it balances.