Financial Accounting
The Accounting Equation
5 question(s)
What is the basic accounting equation?
Beginner
Assets = Liabilities + Equity. It shows that everything a business owns is financed either by what it owes (liabilities) or by the owners (equity), so the two sides always balance.
Assets 100,000 = Liabilities 40,000 + Equity 60,000
Real-world example
A startup buys $60k of assets with $20k owner cash and a $40k loan — the equation holds.
How does a transaction keep the equation balanced?
Beginner
Every transaction has a dual effect: at least two accounts change so the equation stays equal.
Buy equipment $500 cash:
+500 Equipment (asset), -500 Cash (asset) -> net assets unchanged
Real-world example
Paying a supplier reduces cash and reduces a payable equally.
What is the expanded accounting equation?
Intermediate
Assets = Liabilities + Capital + Income - Expenses - Drawings. It breaks equity into its drivers to show how profit and owner activity affect it.
Equity = Opening capital + Profit (Income - Expenses) - Drawings
Real-world example
Explaining to an owner why equity rose: profit added, drawings subtracted.
A business takes a $10,000 bank loan. How does the equation change?
Intermediate
Assets increase (cash +10,000) and liabilities increase (loan +10,000); equity is unchanged.
Assets +10,000 (Cash) = Liabilities +10,000 (Loan) + Equity 0
Real-world example
Raising debt funds growth without diluting the owner's equity.
How does the accounting equation relate to the balance sheet?
Advanced
The balance sheet is the accounting equation presented at a point in time: total assets equal total liabilities plus equity.
Balance Sheet: Assets 250,000 | Liabilities 90,000 + Equity 160,000
Real-world example
A lender reads the balance sheet to see how much of the assets are debt-funded.