The Accounting Equation
Assets, liabilities and equity.
Every business transaction is recorded against one identity: Assets = Liabilities + Equity. Assets are what the business owns or controls, such as cash, inventory and equipment. Liabilities are what it owes to outsiders, such as loans and unpaid bills. Equity is the owners' claim on what is left.
Because the equation must always balance, every transaction changes at least two accounts. This is the basis of double-entry bookkeeping: buying equipment with cash swaps one asset for another, while buying it on credit raises assets and liabilities together.
Key terms
- Accounting equation
- Every transaction keeps both sides equal.
Key ideas
- after every transaction.
- Revenue increases equity; expenses and owner withdrawals decrease it.
- Debits increase assets and expenses; credits increase liabilities, equity and revenue.
- Rearranged: (net worth).
Worked example
A business has assets of $80,000 and liabilities of $30,000. It takes out a $10,000 loan and buys equipment with the money. What is its equity afterwards?
- Starting equity: .
- Loan: cash +10,000, liabilities +10,000.
- Equipment purchase: equipment +10,000, cash −10,000.
- Assets 90,000, liabilities 40,000, equity still 50,000.
Answer: Equity stays $50,000
Common mistakes
- Treating a loan as revenue.
- Recording only one side of a transaction.
- Thinking debit always means decrease.
Practice questions
Try each one, then open the answer. Numerical answers on this page are verified by an automated calculation check.
1.Assets $120,000 and equity $75,000. Liabilities?
Show answer
$45,000
2.Equity rises by revenue $9,000 and falls by expenses $6,500. Net change?
Show answer
$2,500
3.Liabilities $20,000, equity $55,000. Total assets?
Show answer
$75,000