Basic Accounting Equation

The basic accounting equation is:

Assets = Liabilities + Capital
When a business is put up, its resources (assets) come from two sources: contributions by owners
(capital) and those acquired from creditors or lenders (liabilities). In other words, all assets initially
come from liabilities and owners' contributions.
As business transactions take place, the values of the accounting elements change. The accounting
equation nonetheless always stays in balance.
Every transaction has a two-fold effect. Meaning, at least two accounts are affected. Let's illustrate all
of that through these examples.
Assume the following transactions:
1.

Mr. Alex invested $20,000 to start a printing business,

2.

The company obtained a loan from a bank, $30,000,

3.

The company purchased printers and paid a total of $1,000.

How will the transactions affect the accounting equation?
Let us take a look at transaction #1:
Transaction
1. Owner's investment

Assets
20,000.00

Liabilities

Capital
20,000.00

Again, every transaction has a two-fold effect. In the above transaction, Assets increased as a result of
the increase in Cash. At the same time, Capital increased due to the owner's contribution. Remember
that capital is increased by contribution of owners and income, and is decreased by withdrawals and
expenses. No liability is affected hence, stays at zero.
Let's continue with transaction #2:
Transaction

Assets

Liabilities

1. Owner's investment

20,000.00

2. Loan from bank

30,000.00

30,000.00

Capital
20,000.00
-

In transaction #2, the company received cash. Thus, the value of total assets is increased. At the same
time, it incurred in an obligation to pay the bank. Therefore, liabilities are increased. The liability in this
case is recorded as Loans Payable.
Notice that the accounting equation is still equal (balanced).
Let's add transaction #3:
Transaction

Assets

Liabilities

1. Owner's investment

20,000.00

2. Loan from bank

30,000.00

3. Purchased printers

1,000.00
(1,000.00)

30,000.00
-

Capital
20,000.00

The company acquired printers, hence, an increase in assets. However, the company used cash to pay
for the printers. Thus, it also results in a decrease in assets. Transaction #3 results in an increase in
one asset (Service Equipment) and a decrease in another asset (Cash).

For those who are new to accounting format: The parentheses "()" around the 1,000 amount above
means "minus" or "less".
Liabilities and capital are not affected. Still, the equation in the third transaction is equal.In this case, it
has zero effect on both sides.
At this point, the balance of total assets is $50,000. The combined balance of liabilities and capital is
also at $50,000.
The accounting equation is (and should always be) in balance.
4.

Rendered services and received the full amount in cash, $500

5.

Rendered services on account (receivable from customer), $750

6.

Purchased office supplies on account (payable to supplier), $200

7.

Had some equipment repaired for $400, to be paid after 15 days

8.

Mr. Alex, the owner, withdrew $5,000 cash for personal use

9.

Paid one-third of the loan obtained in transaction #2

10.

Received customer payment from services in transaction #5

The transactions will result to the following effects:
Transaction

Assets

Liabilities

Capital

20,000.00

1. Owner's investment

20,000.00

2. Loan from bank

30,000.00

3. Purchased printers

1,000.00
(1,000.00)

4. Service revenue for cash

500.00

500.00

5. Service revenue on account

750.00

750.00

6. Supplies on account

200.00

200.00

400.00

(400.00)

(5,000.00)

7. Repair of equipment
8. Owner's withdrawal
9. Payment of loan
10. Collection of accounts
Balance

(5,000.00)

(10,000.00)

750.00
(750.00)

36,450.00

30,000.00

(10,000.00)

+
+

20,600.00

15,850.00

Examples Explained
4.

The company received cash for services rendered. Cash increased thereby increasing assets. At
the same time, capital is increased as a result of the income(Service Revenue). As we've mentioned in
the Accounting Elements lesson, income increases capital.

5.

The company rendered services on account. The services have been rendered, hence, already
earned. Thus, the $750 worth of services rendered is considered income even if the amount has not
yet been collected. Since the amount is still to be collected, it is recorded as Accounts Receivable, an
asset account.

6.

Office supplies worth $200 were acquired. This increases the company's Office Supplies, part of
the company's assets. The purchase results in an obligation to pay the supplier; thus a $200 increase
in liability (Accounts Payable).

7.

The company incurred in $400 Repairs Expense. Expenses decrease capital. The amount has not
yet been paid. Thus, it results in an increase in total liabilities.

8.

The owner withdrew $5,000 cash. Cash is decreased thereby decreasing total
assets. Withdrawals or drawings decrease capital.

9.

One-third of the $30,000 loan was paid. Therefore, Cash is decreased by $10,000 as a result of
the payment. And, liabilities are decreased because part of the obligation has been settled.

10.

The $750 account in a previous transaction has been collected. Therefore, the Accounts
Receivable account is decreased and Cash is increased.
Notice that every transaction results in an equal effect to assets and liabilities plus capital. The
beginning balances are equal. The changes arising from the transactions are equal. Therefore, the
ending balances would still be equal.
The balance of the total assets after considering all of the above transactions amounts to $36,450. It is
equal to the combined balance of total liabilities of $20,600 and capital of $15,850 (a total of $36,450).
Assets = Liabilities + Capital is a mathematical equation. Using algebra, the formula can be rewritten to
get other versions of the equation.

Liabilities = Assets - Capital

Capital = Assets - Liabilities