What is the role of the accounting equation?

 Assets = Liabilities + Owner’s Equity

The basic accounting equation is Assets = Liabilities + Owner’s Equity (Weygandt, Kimmel, & Kieso, 2008). Assets are resources owned by a business. Liabilities are claims against assets. Put more simply, liabilities are existing debts and obligations. Owner’s equity is the ownership claim on total assets. The role of the accounting equation is to maintain the double-entry bookkeeping system by managing the relationship between the assets, liabilities, and owners’ equity. For this reason, each business transaction must have a dual effect on the accounting equation. For example, an increase in assets will increase the owners’ equity. The reason for this change in the accounting equation is due to the increasing of assets means that the owner will have a higher value of ownership. There are a variety of ways in which the accounting question is impacted in this way. Any of the following circumstances can alter the accounting equation:

a. Investment of owner in Assets
b. Sale of Goods or services on account.
c. Assets were acquired on long term debt.
d. Payment of expenses by cash
e. Payment of long term debt.
f. Exchange of one asset for another.
g. Exchange of one liability for another
h. Declaration of stock dividend.
i. Declaration of cash dividends.
j. Expenses incurred on account etc…

Any time one of the components of the accounting equation is altered, another area of the equation will be changed. This can be seen in the following balance sheet items.

Accounts payable
Accounts receivable
Cash Notes payable
Cleaning equipment
Salaries payable
Cleaning supplies
Common stock

Classifying each item as an asset, liability, or stockholders’ equity reflects as.

Accounts Payable - Liability
Accounts receivable - Asset
Cash - Asset
Notes Payable - Liability
Cleaning equipment - Asset
Salaries Payable - Liability
Cleaning Supplies - Asset
Common Stock - Stockholder's Equity

References

Weygandt, J. J., Kimmel, P. D., & Kieso, D. E. (2008). Financial accounting (6th ed.). Hoboken, NJ: Wiley.

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