What Is the Accounting Equation?

The accounting equation is considered to be the foundation of the double-entry

accounting system. The accounting equation shows on a company's balance sheet where by the
total of all the company's assets equals the sum of the company's liabilities and shareholders'
equity.

Based on this double-entry system, the accounting equation ensures that the balance sheet
remains “balanced,” and each entry made on the debit side should have a corresponding entry
(or coverage) on the credit side.

Accounting Equation Formula

Asset = Liabilities + Owners Equity

ASSETS

An asset is a resource with economic value that an individual, corporation or country owns or
controls with the expectation that it will provide a future benefit. Assets are reported on a
company's balance sheet and are bought or created to increase a firm's value or benefit the
firm's operations.

An asset can be thought of as something that, in the future, can generate cash flow, reduce
expenses, or improve sales, regardless of whether it's manufacturing equipment or a patent

Examples of Assets:

Current Assets

Current assets are short-term economic resources that are expected to be converted into cash
within one year. Current assets include cash and cash equivalents, accounts receivable,
inventory, and various prepaid expenses.

While cash is easy to value, accountants periodically reassess the recoverability of inventory
and accounts receivable. If there is evidence that accounts receivable might be uncollectible,
it'll become impaired. Or if inventory becomes obsolete, companies may write off these assets.

Fixed Assets
Fixed assets are long-term resources, such as plants, equipment, and buildings. An adjustment
for the aging of fixed assets is made based on periodic charges called depreciation, which may
or may not reflect the loss of earning powers for a fixed asset.
Generally accepted accounting principles (GAAP) allow depreciation under two broad methods.
The straight-line method assumes that a fixed asset loses its value in proportion to its useful
life, while the accelerated method assumes that the asset loses its value faster in its first years
of use.

Financial Assets
Financial assets represent investments in the assets and securities of other institutions.
Financial assets include stocks, sovereign and corporate bonds, preferred equity, and other
hybrid securities. Financial assets are valued depending on how the investment is categorized
and the motive behind it.

Intangible Assets
Intangible assets are economic resources that have no physical presence. They include patents,
trademarks, copyrights, and goodwill. Accounting for intangible assets differs depending on the
type of asset, and they can be either amortized or tested for impairment each year.

LIABILITIES

A liability, in general, is an obligation to, or something that you owe somebody else. Liabilities
are defined as a company's legal financial debts or obligations that arise during the course of
business operations. Liabilities are settled over time through the transfer of economic benefits
including money, goods, or services. Recorded on the right side of the balance sheet, liabilities
include loans, accounts payable, mortgages, deferred revenues, and accrued expenses.

In general, a liability is an obligation between one party and another not yet completed or paid
for. In the world of accounting, a financial liability is also an obligation but is more defined by
previous business transactions, events, sales, exchange of assets or services, or anything that
would provide economic benefit at a later date. Liabilities are usually considered short
term (expected to be concluded in 12 months or less) or long term (12 months or greater).

Liabilities are also known as current or non-current depending on the context. They can include
a future service owed to others; short- or long-term borrowing from banks, individuals, or other
entities; or a previous transaction that has created an unsettled obligation. The most common
liabilities are usually the largest like accounts payable and bonds payable. Most companies will
have these two line items on their balance sheet, as they are part of ongoing current and long-
term operations.

Examples of Liabilities:

Long Term Liabilities

Short Term Liabilities

 OWNERS EQUITY

Owner's equity is one of the three main sections of a sole proprietorship's balance sheet and
one of the components of the accounting equation: Assets = Liabilities + Owner's Equity.
Owner's equity represents the owner's investment in the business minus the owner's draws or
withdrawals from the business plus the net income (or minus the net loss) since the business
began.
Owner's equity is viewed as a residual claim on the business assets because liabilities have a
higher claim. Owner's equity can also be viewed (along with liabilities) as a source of the
business assets.

Examples of Owners Equity:

Business Capital

FORMS OF BUSINESS

1. Sole Proprietorship

A sole proprietorship is a business owned by only one person. It is easy to set-up and is
the least costly among all forms of ownership.
The owner faces unlimited liability; meaning, the creditors of the business may go after the
personal assets of the owner if the business cannot pay them.
The sole proprietorship form is usually adopted by small business entities.

2. Partnership

A partnership is a business owned by two or more persons who contribute resources

into the entity. The partners divide the profits of the business among themselves.
In general partnerships, all partners have unlimited liability. In limited partnerships, creditors
cannot go after the personal assets of the limited partners.

3. Corporation

A corporation is a business organization that has a separate legal personality from its
owners. Ownership in a stock corporation is represented by shares of stock.
The owners (stockholders) enjoy limited liability but have limited involvement in the company's
operations. The board of directors, an elected group from the stockholders, controls the
activities of the corporation.
In addition to those basic forms of business ownership, these are some other types of
organizations that are common today:
Limited Liability Company
Limited liability companies (LLCs) in the USA, are hybrid forms of business that have
characteristics of both a corporation and a partnership. An LLC is not incorporated; hence, it is
not considered a corporation.
Nonetheless, the owners enjoy limited liability like in a corporation. An LLC may elect to be
taxed as a sole proprietorship, a partnership, or a corporation.

4.Cooperative

A cooperative is a business organization owned by a group of individuals and is operated for

their mutual benefit. The persons making up the group are called members. Cooperatives may
be incorporated or unincorporated.
Some examples of cooperatives are: water and electricity (utility) cooperatives, cooperative
banking, credit unions, and housing cooperatives.