Accounting equation
Encyclopedia of Business Terms and Methods, ISBN 978-1-929500-10-9. Copyright © 2012 by Marty J.Schmidt. Revised 89 January 2012.
The Meaning of Accounting Equation
The Accounting equation is a commonly used name for the properties of the balance sheet:
Assets = Liabilities + Owners Equities
The three elements of this equation assets, liabilities, and owner’s equities are the three major sections of the balance sheet. Through the use of double entry bookkeeping, bookkeepers and accountants ensure that the "balance" always holds (both sides of the equation are always equal).
The term accounting equation is sometimes extended to include another fundamental rule that applies to every accounting transaction, where double entry bookkeeping is used:
Debits = Credits
The equation means that every financial transaction brings changes (entries) in two different accounts: every transaction brings a credit entry in one account and an equal, offsetting debit entry in another account. For example, a cash flow transaction to purchase an asset brings a credit to one asset account, "cash on hand" (a credit decreases an asset account) and an equal, offsetting debit to another asset account, perhaps "production machinery" (a debit increases an asset account).
For more examples of both equations in use, and their relationship to each other, see balance sheet in this encyclopedia. See also double entry system, credit, and debit.
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