The accounting equation is cornerstone for double-entry bookkeeping. It states that resources (also known as assets) equals to liabilities plus equity. The financial report, one of the three major financial statements used in accounting, is built on the core elements of this equation.
The accounting equation can be expressed as:
Resources = Liabilities + Equity
R = L + E
The accounting equation is important because it show that organizations’s total resources are always equal to the sum of its total liabilities and total equity. This is because every financial The double-entry bookkeeping technique, which is the most typical type of bookkeeping, is likewise based on the accounting equation. Every financial transaction is tracked using this method in at least two accounts. The accounting equation is always in balance thanks to the use of the double-entry bookkeeping method. This is because every transaction is recorded on both the asset and liability side of the equation. The accounting equation can be used to solve for any of the three variables.
For example, when a organization borrows money from a bank, the transaction would be recorded in resources account “Loan” and in the liability account “Borrowing” In this case the organization’s resources will increase by amount of loan, and organization liabilities will increase by same amount. And if organization’s total resources are $100,000 and its total liabilities are $50,000, organization’s equity must be $50,000 (E = R – L). Similarly, if a organization total assets are $100,000 and its equity is $40,000, the organization’s liabilities must be $60,000 (L = A – E). Finally, if a organization’s liabilities are $35,000 and its equity is $25,000, organization’s resources must be $60,000 (R = L + E).
The accounting equation is a simple but important concept in accounting. It is building block of the double-entry bookkeeping technique and is used to prepare financial balance sheet, one of the three primary financial statements. The equation is always in balance because every financial transaction is recorded on both the asset and liability side. The equation can be used to solve for any of the three variables, which makes it a useful tool for financial analysis.