Accounting equation
Definition
The accounting equation is the fundamental principle that states Assets = Liabilities + Equity. This equation forms the basis of double-entry bookkeeping and ensures that a company's financial statements are balanced.
5 Must Know Facts For Your Next Test
- The accounting equation must always be in balance, meaning total assets should equal the sum of liabilities and equity.
- It is used to prepare the balance sheet, one of the key financial statements.
- Changes in either assets, liabilities, or equity will affect the overall balance but must still conform to the equation.
- Equity represents the owner's residual interest after deducting liabilities from assets.
- Understanding this equation is crucial for analyzing a company’s financial health.
Review Questions
- What components make up the accounting equation?
- How does purchasing equipment with cash affect the accounting equation?
- Why is it important for the accounting equation to remain balanced?
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Subjects (1)
Related terms
Assets: Resources owned by a company that have economic value.
Liabilities: Debts and obligations that a company owes to external parties.
Equity: The residual interest in the assets of an entity after deducting liabilities.
