The Accounting Equation Reading Activity

liabilities include

Used to ensure assets equal liabilities and equity, the accounting equation helps keep your books balanced. An asset is what gives your business added value on top of cash flow. Subsequently, a business’s assets can include cash, liquid assets (i.e., certificates of deposit and Treasury bills), prepaid expenses, equipment, inventory, and property. In fact, just about anything the company owns is classified as an asset. Money that customers owe for their purchases is called accounts receivable.

In all financial statements, the balance sheet should always remain in balance. A company’s “uses” of capital (i.e. the purchase of its assets) should be equivalent to its “sources” of capital (i.e. debt, equity). Prepaid ExpensePrepaid expenses refer to advance payments made by a firm whose benefits are acquired in the future.

Understanding Balance Sheet Equation

A sheet should always have a corresponding entry on the credit side for every entry made on the debit side. With an understanding of each of these terms, let’s take another look at the accounting equation.

total equity

Liabilities are basically the money which business owes to others. For example, payables, debt, etc. are a type of liabilities. Banks Balance Sheet – ExplainThe bank’s balance sheet is different from the company’s balance sheet. It is prepared on the mandate by the Bank’s Regulatory Authorities to reflect the tradeoff between the bank’s profit and its risk and its financial health. However, equity can also be thought of as investments into the company either by founders, owners, public shareholders, or by customers buying products leading to higher revenue. You don’t need to use the company’s Cash Flow Statement to compute the accounting equation.

Introduction to Accounting Equation

The remainder of the liquidated assets will be used to pay off parts of shareholder’s equity until no funds are remaining. The fundamental accounting equation is debatably the foundation of all accounting, specifically the double-entry accounting system and the balance sheet. Double-entry accounting is the concept that every transaction will affect both sides of the accounting equation equally, and the equation will stay balanced at all times. Double-entry accounting is used for journal entries of any kind. Although the balance sheet always balances out, the accounting equation can’t tell investors how well a company is performing. Single-entry accounting is similar to checkbook accounting, where you simply record transactions as they occur. Double-entry accounting requires that every transaction recorded as a debit has a separate but equal transaction recorded as a credit.


They can always make more in the future to pay them off. However, investors may still want to see that a company has enough cash flow potential to pay for long-term liabilities eventually. Sally’s deposit increased her cash account and also increased her equity account, keeping the accounting equation in balance. Today’s accounting software applications have the accounting equation built into the application, rejecting any entries that do not balance. This can be useful for those new to accounting, since any entry into your general ledger will directly affect your accounting equation.