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Accounting equation: Examples, formula, and explanation

accounting equation

Fixed costs are recurring, predictable costs that you have to pay in order to conduct business. These costs include insurance premiums, rent, employee salaries, etc. Drawings are amounts taken out of the business by the business owner. It’s got to be something that is cost effective, both for the planet and for us, and that is achievable.

accounting equation

We call an asset a credit, which can be a reduction in assets, a loan, an increase in income, etc. The entry of a credit in the company's accounts means that an asset is used. You can download our free excel workout to test your understanding of the accounting equation. This category includes the value of any investments made in the organisation, whether through the owners or shareholders.


 Based on the accounting equation, the assets are on the left side of the equation which should equal to the sum of the liabilities and Capital which is the right side of the equation. Also known as the balance-sheet equation, The accounting equation is the underlying formula of a balance sheet. Additionally, adding liability will reduce the value, while decreasing liability, for example, squaring away obligation, will build value. These fundamental ideas are caught by the accounting equation and are vital for current accounting techniques. An income statement will also be produced and explains the changes in retained earnings during the period. Net income increases retained earnings balance; dividends decrease it.

accounting equation

For example, accounts payable are monies owed to suppliers as a result of that supplier delivering goods or services at some time in the past. It is important to understand the definitions of each component in the equation. An asset is a resource, controlled by the business, that is expected to provide benefits in the future. Common examples include inventory, account receivables and PP&E (property, plant and equipment). These three elements of the accounting equation are what constitute a balance sheet.

The expanded version of the accounting equation

Indeed, by convention, the assets are presented on the right and the liabilities on the left of a balance sheet. Taking into account the basic accounting principles, the informed entrepreneur will be at his best when the assets of his balance sheet are equal or "balanced" with the liabilities. However, an asset cannot be recorded because of the uncertainty of future benefits accruing from the salary expenditure. The balancing entry is a reduction in the equity of the shareholders. It is, in fact, an expense and all expenses reduce retained earnings which is part of the shareholder’s equity.

The basic accounting equation is a fundamental principle of double-entry bookkeeping. The equation states that the total assets of a company must be equal to the total liabilities plus owner’s equity. This equation ensures that all transactions are accounted for and provides a snapshot of a company’s financial position at any given moment. Individual transactions which result in income and expenses being recorded will ultimately result in a profit or loss for the period.


The business also operates from home which means it can offer a competitive and affordable pricing structure. The majority of our customers are situated in the Great Yarmouth area but we have established clients in other areas of the UK who use email and postal services to provide information. The director James Bool is a qualified accountant with over 25 years experience. He bookkeeping for startups also worked in teaching for 20 years and left his position as Lecturer in Accountancy at Lowestoft College in 2007 to concentrate on his work as an accountant. The main services provided are book-keeping, accounts preparation, VAT, payroll and self assessment. Other services offered include business start ups, management accounting, business incorporation and tax planning.

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