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9th October 2017

What is the Accounting Equation?

If you were to start learning bookkeeping, this would likely be part of the first lesson. The Accounting Equation is very easy to understand. See what you think:

ASSETS          –          LIABILITIES          =          CAPITAL

We use these terms in everyday speech – we could say: ‘This employee is a real asset to the company’. we would be implying that this employee was valuable to the company. we could likewise say: ‘This employee is a real liability’. We would be saying the opposite – that this employee would detract from the overall value of the company. This is exactly what an asset and a liability are.

Assets are items of value within the company, for example, a healthy bank account, stock to sell, your customers, office equipment, vehicles, land, property, plant & machinery, etc. They are the plus points in your company.

Liabilities are the opposite of assets – they are all the debt that your business owes, for example, credit card, overdraft, tax, vat, loans and mortgages.

The accounting equation, therefore, says that if you added up all the items of value within your business and then you took away all the debt that the business owes, whatever is left would belong to the owner of the business (capital). The owner is the individual (or group) that originally invested the money to set up the business, so everything that happens from thereon is the owner’s responsibility. So if a profit is made, it belongs to the owner(s) and if a loss is made, that also belongs to the owner and reduces the value of the original investment.

 

By: Jackie Hooper

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