Accounting equation

Definition

The accounting equation is the foundation of double-entry bookkeeping, stating that Assets = Liabilities + Equity. It ensures that the balance sheet remains balanced, reflecting a company's financial position accurately.

5 Must Know Facts For Your Next Test

1. The accounting equation must always be in balance for accurate financial reporting.
2. Assets represent what a company owns, while liabilities and equity represent how those assets are financed.
3. Equity can include common stock and retained earnings.
4. Transactions in a business will affect at least two accounts to keep the equation balanced.
5. Understanding the accounting equation is essential for analyzing and recording transactions.

Review Questions

• What components make up the accounting equation?
• How does an increase in liabilities affect the accounting equation?
• Why is it important for the accounting equation to remain balanced?

Related terms

Assets:

Resources owned by a company that have economic value.

Liabilities:

Obligations or debts that a company needs to pay off.

Equity:

The residual interest in the assets of a company after deducting liabilities.