Cuttington University Graduate School

Congo Town, Monrovia, Liberia

Course: Assignment-1

Submitted
By:
Mardea T. Smith
ID#: GP93699

Submitted
To
MR. Gust A.D. Togbah II
Instructor

Submission date: March 11, 2022

Table of Contents
What Is Accounting Equation and its-------1
Importance?
Understanding the Accounting Equation-----2
Accounting Equation Formula and Circulation-3
About the double Equation------------------------4
Limits of the Accounting Equation-----------4
Why Is the Accounting Equation Important? --5
References/Sources---------------------- --------6
 What Is the Accounting Equation?
The accounting equation is the total assets of a company equal to the sum of its liabilities
and its shareholders' equity.

The accounting equation is also referred to as the basic principle of accounting and a
fundamental element of the balance sheet.

This straightforward relationship between assets, liabilities, and equity is considered to be

the foundation of the double-entry accounting system. The accounting equation ensures that the
balance sheet remains balanced. That is, each entry made on the debit side has a corresponding
entry (or coverage) on the credit side.

Assets = Liabilities + Shareholder’s Equity

This equation sets the foundation of double-entry accounting, also known as double-entry
bookkeeping, and highlights the structure of the balance sheet. Double-entry accounting is a
system where every transaction affects at least two accounts.

For example, an increase in an asset account can be matched by an equal increase to a

related liability or shareholder’s equity account such that the accounting equation stays in
balance. Alternatively, an increase in an asset account can be matched by an equal decrease in
another asset account. It is important to keep the accounting equation in mind when performing
journal entries.

Journal entries often use the language of debits (DR) and credits (CR). Debit refers to an
increase in an asset or a decrease in a liability or shareholders’ equity. A credit in contrast refers
to a decrease in an asset or an increase in a liability or shareholders’ equity.  

As mentioned above, the accounting equation forms the basis for the balance sheet. The
balance sheet is also sometimes referred to as the statement of financial position. The balance
sheet is broken down into three major sections and their various underlying items: Assets,
Liabilities, and Shareholder’s Equity.
 Understanding the Accounting Equation

The financial position of any business, large or small, is based on two key components of
the balance sheet: assets and liabilities. Owners’ equity, or shareholders' equity, is the third
section of the balance sheet. The accounting equation is a representation of how these three
important components are associated with each other.

Assets represent the valuable resources controlled by the company, while liabilities
represent its obligations. Both liabilities and shareholders' equity represent how the assets of a
company are financed. If it's financed through debt, it'll show as a liability, but if it's financed
through issuing equity shares to investors, it'll show in shareholders' equity.

The accounting equation helps to assess whether the business transactions carried out by
the company are being accurately reflected in its books and accounts. Below are examples of
items listed on the balance sheet.

Assets

Assets include cash and cash equivalents or liquid assets, which may include Treasury
bills and certificates of deposit.

Accounts receivables list the amounts of money owed to the company by its customers
for the sale of its products. Inventory is also considered an asset.

The major and often largest value asset of most companies be that company's machinery,
buildings, and property. These are fixed assets that are usually held for many years.

Liabilities

Liabilities are debts that a company owes and costs that it needs to pay in order to keep
the company running.

Debt is a liability, whether it is a long-term loan or a bill that is due to be paid.

Costs include rent, taxes, utilities, salaries, wages, and dividends payable.

Shareholders' Equity

The shareholders' equity number is a company's total assets minus its total liabilities. 

It can be defined as the total number of dollars that a company would have left if it
liquidated all of its assets and paid off all of its liabilities. This would then be distributed to the
shareholders. Retained earnings are part of shareholders' equity. This number is the sum of total
earnings that were not paid to shareholders as dividends. Think of retained earnings as savings,
since it represents the total profits that have been saved and put aside (or "retained") for future
use.

Accounting Equation Formula and Calculation

Assets= (Liabilities + Owner’s Equity) Assets= (Liabilities + Owner’s Equity)

The balance sheet holds the elements that contribute to the accounting equation:

1. Locate the company's total assets on the balance sheet for the period.
2. Total all liabilities, which should be a separate listing on the balance sheet.
3. Locate total shareholder's equity and add the number to total liabilities.
4. Total assets will equal the sum of liabilities and total equity.

As an example, say the leading retailer Miss Smith Corporation reported the following on
its balance sheet for its latest full fiscal year:

 Total assets: $170 billion

 Total liabilities: $120 billion
 Total shareholders' equity: $50 billion

If we calculate the right-hand side of the accounting equation (equity + liabilities), we

arrive at ($50 billion + $120 billion) = $170 billion, which matches the value of the assets
reported by the company.
 About the Double-Entry System

The accounting equation is a concise expression of the complex, expanded, and multi-
item display of a balance sheet. 

Essentially, the representation equates all uses of capital (assets) to all sources of capital,
where debt capital leads to liabilities and equity capital leads to shareholders' equity.

For a company keeping accurate accounts, every business transaction will be represented
in at least two of its accounts. For instance, if a business takes a loan from a bank, the borrowed
money will be reflected in its balance sheet as both an increase in the company's assets and an
increase in its loan liability.

If a business buys raw materials and pays in cash, it will result in an increase in the
company's inventory (an asset) while reducing cash capital (another asset). Because there are
two or more accounts affected by every transaction carried out by a company, the accounting
system is referred to as double-entry accounting.

The double-entry practice ensures that the accounting equation always remains balanced,
meaning that the left side value of the equation will always match the right side value.

In other words, the total amount of all assets will always equal the sum of liabilities and
shareholders' equity.

The global adherence to the double-entry accounting system makes the account keeping
and tallying processes more standardized and more fool-proof.

The accounting equation ensures that all entries in the books and records are vetted, and a
verifiable relationship exists between each liability (and expense) and its corresponding source;
or between each item of income (or asset) and its source.

Limits of the Accounting Equation

Although the balance sheet always balances out, the accounting equation can't tell
investors how well a company is performing. Investors must interpret the numbers and decide for
themselves whether the company has too many or too few liabilities, not enough assets, or
perhaps too many assets, or whether it’s financing is sufficient to ensure its long-term growth.
 Why Is the Accounting Equation Important?

The accounting equation captures the relationship between the three components of a
balance sheet: assets, liabilities, and equity. All else being equal, a company’s equity will
increase when its assets increase, and vice-versa. Adding liabilities will decrease equity while
reducing liabilities—such as by paying off debt—will increase equity. These basic concepts are
essential to modern accounting methods.

What Are the 3 Elements of the Accounting Equation?

The three elements of the accounting equation are assets, liabilities, and shareholders'
equity. The formula is straightforward: A company's total assets are equal to its liabilities plus its
shareholders' equity. The double-entry bookkeeping system, which has been adopted globally, is
designed to accurately reflect a company's total assets.

What Is an Asset in the Accounting Equation?

An asset is anything with economic value that a company controls that can be used to
benefit the business now or in the future. They include fixed assets such as machinery and
buildings. They may include financial assets, such as investments in stocks and bonds. They also
may be intangible assets like patents, trademarks, and goodwill.

What Is a Liability in the Accounting Equation?

A company's liabilities include every debt it has incurred. These may include
loans, accounts payable, mortgages, deferred revenues, bond issues, warranties, and accrued
expenses.

What Is Shareholders' Equity in the Accounting Equation?

Shareholders' equity is the total value of the company expressed in dollars. Put another
way, it is the amount that would remain if the company liquidated all of its assets and paid off all
of its debts. The remainder is the shareholders' equity, which would be returned to them.
Source and References
Investopedia
BY; Jason Fernando
Updated May 04, 2022
Reviewed by
Amy Drury
Fact checked by
Suzanne Kvilhaug
https://www.investopedia.com

Corporate Finance Institute

Written by Jeff Schmidt
Updated March 5, 2023
Reviewed by Scott Powell
https://corporatefinanceinstitute.com