Introduction to Accounting

5. Basic accounting equation

Before we can proceed with the basic accounting equation we need to understand
claims:

A company's assets belong to the resource providers who are said to have claims on
the assets.

In other words, each asset has its own source provided by an owner or creditor. So,
there can't be a claim without an appropriate asset and vice versa. Based on this
statement, we can define the basic accounting equation as:
Assets = Claims
Claims are divided into two categories:
Creditors' claims that are called liabilities
Owners' claims that are called equity
Taking this into account, the basic accounting equation can also be presented as
follows:
Assets
=
Claims
Assets
=
Liabilities + Equity
Liabilities are debts and obligations of a company.

Equity is what the company "owes" to owners. Equity is also called net assets or
residual equity.

The amount of total assets minus total liabilities equals equity. Because equity
equals the difference between assets and liabilities, it is also called net assets.
If a company goes bankrupt, liabilities are paid off first to creditors, while
equity is the last to be distributed. Therefore, owners' equity is also called
residual equity.
Let us look at an example of the basic accounting equation. Suppose a company has
assets of $800, liabilities of $300, and equity of $500. These amounts will be
shown in the basic accounting equation as follows: