Basic Accounting Equation Explained

Basic Accounting Equation Explained 

By: Dr. John E. Ware, I

Hey Kids,

The basic accounting equation is one of the most important concepts to understand in financial accounting. It states that Assets = Liabilities + Owners’ Equity. This equation is essential in understanding how businesses are accounted for and how to analyze their financial statements.

Assets are items of value owned by a company, such as cash, inventory, buildings and equipment. Liabilities are obligations owed by a company, such as loans, taxes and supplier obligations. Finally, owners’ equity is the capital invested in a business, plus any profits made over a period of time.

The accounting equation serves as the basis of the double-entry accounting system. Every transaction must be balanced, meaning the debits and credits to each side of the equation have to equal out. For example, when a company pays off a loan, the debit to the liability account decreases, while the credit to the cash account increases.

The basic accounting equation is not just important for understanding the fundamentals of accounting; it also helps us interpret financial statements. A company’s assets should always be equal to its liabilities plus owners’ equity; if the equation does not balance, there could be errors on the books that need to be corrected. Additionally, regular reviews and audits should be conducted to maintain the accuracy of the books and detect any errors that may have been made.