Basic Accounting Equation

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Basic Accounting Equation

The accounting equation is Assets = Liabilities + Stockholders’ Equity. The resources owned by a business are its assets. The rights or claims to the assets are divided into the rights of the creditors and the rights of the owners. The rights of the creditors are the debts of the business. They are called liabilities. The rights of the owners are called stockholders’ equity for a corporation and owners’ equity for a proprietorship, partnership or limited liability company.

Anything of value that a business owns is called an asset. Examples of assets are land, buildings, supplies, cash, and accounts receivable. Liabilities are debts. Examples of debts are accounts payable, wages payable, mortgage payable, and taxes payable. Stockholders’ Equity (called capital in sole proprietorships) is the amount of the business that belongs to the owners. For example, let’s say the business owns one asset, a building for which they paid $200,000. They did not have $200,000 in cash to buy the building so they paid $20,000 and borrowed $180,000 from the bank. If the building were sold for $200,000 they would have to repay the bank $180,000 which would leave $20,000 in cash for them. The $20,000 is their equity. Most people would say, “I bought a building for $200,000. I own that building.” In reality, that’s not true. You owe the bank $180,000. You have a debt of $180,000. In reality the bank owns $180,000 of the building. You only own $20,000. $20,000 is your equity. The accounting equation would look like this:

Asset = Liabilities + Stockholders’ Equity
Building = Bank Loan + Cash from owners
$200,000 = $180,000 + $20,000

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