The 'basic accounting equation' is the foundation for the double-entry bookkeeping system. It shows how assets were financed: either by borrowing money from someone (liability) or by paying your own money (ownership equity).

Assets = Liabilities + (Shareholders or Owners equity)^[1]

Contents 1 How it works 2 Balance sheet 3 History 4 References

[edit] How it works

For example: A student buys a computer for $945. This student borrowed $500 from his best friend and saved another $445 from his part-time job. Now his assets are worth $945, liabilities are $500, and equity $445.

The formula can be rewritten:

Assets - Liabilities = (Shareholders or Owners equity)^[1]

Now it shows owner's interest is equal to property (assets) minus debts (liabilities). Since in a company owners are shareholders, owner's interest is called shareholder's equity. Every accounting transaction affects at least one element of the equation, but always balances. Simplest transactions also include:^[2]

Transaction Number	Assets		Liabilities		Shareholder's Equity		Explanation
1	+	6,000			+	6,000	Issuing stocks 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.

Also, the equation can be rewritten as:

Assets = Liabilities + Owners equity + (Revenue − Expenses)

OR

Assets + Expenses = Liabilities + Owners equity + Revenue

This is often referred to as the expanded accounting equation, because it yields the breakdown of the equity component of the equation.^[3]

[edit] Balance sheet

An elaborate form of this equation is presented in a balance sheet which lists all assets, liabilities, and equity, as well as totals to ensure that it balances.

[edit] History

Luca Pacioli is notable for including the first published description of the method of keeping accounts that Venetian merchants used during the Italian Renaissance, known as the double-entry accounting system.

[edit] References