Accounting Essay

466 Words2 Pages
Accounting Equation Johnny Dixon, Instructor: Shanese Smith November 18, 2012 The basic accounting equation is that Assets = Liabilities + Equity (QuickMBA, 2010). These components are the two sides of the balance sheet, and therefore this accounting equation must always hold true. If it does not hold true, then the balance sheet will not be balanced. The assets are the items of value that a company has, examples being cash, property, accounts receivable and equipment. All of these assets need to be paid for in some way. There are multiple ways to pay for these things, but all will fall into the category of a liability or equity (Investopedia, 2012). Liabilities are debts that the company owes, such as accounts payable, lines of credit or long-term debt. Equity is the value of the assets of the company, less the value of the liabilities. Equity, therefore, is essentially what is left over for the shareholders. Any balance sheet transaction must have a movement on the asset side, and a corresponding movement on other liabilities or shareholders' equity. For example, if a store sell a can of Coke for \$1, and it paid \$0.50 for that Coke in the first place, the following happens. The first is that the inventory declines by \$0.50 and the second is that the cash increases by \$1. So the total value of assets is now \$0.50 higher than it was before. That must be offset, otherwise the balance sheet will be out of balance. The amount of that profit must be added to retained earnings on the equity side, so that the equity increases by the same amount as the firm's assets. Another example would be if the firm takes out a loan for \$1 million to buy some new equipment. Initially this loan is added to the liabilities. However, the firm received \$1 million in cash as well, so that must be added to the cash on the assets side. This happens simultaneously,