Accounting Equation: Calculation and Explanation

The accounting equation is also known as the balance sheet equation. It represents the relationship between the assets, liabilities, and owner’s equity of a person or business. It is also termed the foundation for the double-entry bookkeeping system. For each transaction, the total debits equal the total credits.

Formula for Accounting Equation

Most calculations in financial accounting begins with formular.

The formular for Accounting Equation is written As:

$Assets = (Liabilities + Owner’s Equity)$

This can be broken down as:

Accounting Equation formula

In a corporation, capital represents the stockholders’ equity. Since every business transaction affects at least two of a company’s accounts, the accounting equation will always be “in balance,” meaning the left side should always equal the right side. Thus, the accounting formula essentially shows that what the firm owns (its assets) is purchased by either what it owes (its liabilities) or by what its owners invest (its shareholders equity or capital).

The formula can also be rewritten in this manner:

Assets – Liabilities = (shareholders’ or Owners’ Equity)

Now it shows owners’ equity is equal to property (assets) minus debts (liabilities). Since in a corporation owners are shareholders, owner’s equity is called shareholders’ equity. Every accounting transaction affects at least one element of the equation, but always balances. Simple transactions also include:

Balance sheet

Steps Involves In Calculating Accounting Equation

The balance sheet holds the basis of the accounting equation:

Locate the company’s total assets on the balance sheet for the period.
Total all liabilities, which should be a separate listing on the balance sheet.
Locate total shareholder’s equity and add the number to total liabilities.
Total assets will equal the sum of liabilities and total equity.

Example 2:

Lets take for example, the fiscal year of a leading retailer XYZ Corporation which reported the following on its balance sheet:

Total assets: $170 billion
Total liabilities: $120 billion
Total shareholders’ equity: $50 billion

If we calculate the right-hand side of the accounting equation (equity + liabilities), we arrive at ($50 billion + $120 billion) = $170 billion, which matches the value of the assets reported by the company.