Accounting equation

The fundamental accounting equation, also called the balance sheet equation, is the foundation for the double-entry bookkeeping system and the cornerstone of the entire accounting science. Like any equation, each side will always be equal. In the accounting equation, every transaction will have a debit and credit entry, and the total debits (left side) will equal the total credits (right side). In other words, the accounting equation will always be "in balance".

The equation can take various forms, including:

$A=L+E$ (i.e. ${\text{Assets}}={\text{Liabilities}}+{\text{Equity}}$ ) ^[1]^[2]
$A=OE+L$ (i.e. ${\text{Assets}}={\text{Liabilities}}+{\text{Owner’s Equity}}$ )
$A=SE+L$ (i.e. ${\text{Assets}}={\text{Shareholders’ Equity}}+{\text{Liabilities}}$ ) ^[1]^[3]

The formula can also be rearranged, e.g.:

$A-L=OE$ (i.e. ${\text{Assets}}-{\text{Liabilities}}={\text{Owner’s Equity}}$ )
$A-L=SE$ (i.e. ${\text{Assets}}-{\text{Liabilities}}={\text{Shareholders’ Equity}}$ ) ^[1]

Every accounting transaction affects at least one element of the equation, but always balances. Simple transactions also include:^[4]

Transaction Number	Assets		Liabilities		Equity		Explanation
1	+	6,000			+	6,000	Issuing capital stock 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 debits, credits, and journal entries.

This equation is part of the transaction analysis model,^[5] for which we also write

Owner's equity = Contributed Capital + Retained Earnings

Retained Earnings = Net Income - Dividends

and

Net Income = Revenue - 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 component of the equation.^[6]

Assets = Liabilities + Contributed Capital + Revenue - Expenses - Dividends

^ ^a ^b ^c Meigs and Meigs. Financial Accounting, Fourth Edition. McGraw-Hill, 1983. pp.19-20.
^ Financial Accounting 5th Ed,p 47, HornGren, Harrison, Bamber, Best, Fraser, Willet, Pearson/Prentice Hall, 2006
^ Financial Accounting 5th Ed,p 47, HornGren, Harrison, Bamber, Best, Fraser, Willet, Pearson/Prentice Hall, 2006
^ Accounting equation explanation with examples, accountingcoach.com.
^ Libby, Libby, and Short. Financial Accounting, Third Edition. McGraw-Hill, 2001. p.120
^ Wild.Financial Accounting, Third Edition.McGraw-Hill, 2005. p.13, ISBN 978-0078025389

[meigs-1] Meigs and Meigs. Financial Accounting, Fourth Edition. McGraw-Hill, 1983. pp.19-20.

[2] Financial Accounting 5th Ed,p 47, HornGren, Harrison, Bamber, Best, Fraser, Willet, Pearson/Prentice Hall, 2006

[3] Financial Accounting 5th Ed,p 47, HornGren, Harrison, Bamber, Best, Fraser, Willet, Pearson/Prentice Hall, 2006

[4] Accounting equation explanation with examples, accountingcoach.com.

[5] Libby, Libby, and Short. Financial Accounting, Third Edition. McGraw-Hill, 2001. p.120

[6] Wild.Financial Accounting, Third Edition.McGraw-Hill, 2005. p.13, ISBN 978-0078025389

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