The Basic Accounting Equation, also known as the Balance Sheet Equation or Fundamental Accounting Equation, is a fundamental principle in accounting that reflects the relationship between a company's assets, liabilities, and owner's equity. It serves as the foundation for double-entry bookkeeping, ensuring that the financial transactions of a business are properly recorded.
The equation can be expressed as follows: Assets = Liabilities + Owner's Equity. This equation emphasizes the two major sources of funding for a business, namely debts from external parties (liabilities) and investments made by owners (owner's equity). The relationship implies that a company's assets are always financed by either liabilities or owner's equity.
Assets refer to all the economic resources or properties that a company owns or controls, such as cash, inventory, equipment, or accounts receivable. Liabilities, on the other hand, represent the company's debts or obligations to external parties, including loans, accounts payable, or accrued expenses. Owner's Equity represents the residual interest in the assets after deducting liabilities, and it reflects the owner's investment in the business as well as the accumulated profits and losses.
The Basic Accounting Equation must always remain balanced, meaning that the sum of assets must always equal the sum of liabilities plus owner's equity. This equation serves as a basis for preparing financial statements, analyzing a company's financial position, and understanding the impact of transactions on a company's overall financial health.
