Introduction to Accounting and Business LO 3 – The Purpose of the Accounting Equation

The Accounting Equation LO 3 The Accounting Equation The resources owned by a business are its assets. The rights of creditors are the debts of the business and are called liabilities. The rights of the owners are called owner’s equity. The equation Assets = Liabilities + Owner’s Equity is called the accounting equation. The relationship between assets, liabilities, and owner’s equity is expressed as an equation. The accounting equation is Assets equals Liabilities plus Owner’s Equity.

The Accounting Equation LO 3 The Accounting Equation Assets = Liabilities + Owner’s Equity The resources owned by a business Assets are the resources owned by the business. The assets are used to operate the business. The right side of the equation represents the claims on the assets of the business. The assets of the business are either supplied by creditors (these are called liabilities) or supplied by owners.

The Accounting Equation LO 3 The Accounting Equation Examples of assets include: Cash Land Building Equipment Some of the typical assets found in a business include cash, land, building, and equipment.

The Accounting Equation LO 3 The Accounting Equation Assets = Liabilities + Owner’s Equity The rights of creditors are the debts of the business One of the two sources, or suppliers, of assets to the business is the creditors. Liabilities are the debts of the business. Creditors therefore have a right or claim on the assets of the business equal to the total of liabilities.

The Accounting Equation LO 3 The Accounting Equation Examples of liabilities include: Accounts Payable Interest Payable Notes or Bonds Payable Accrued Expenses Some of the typical liabilities found in a business include Accounts Payable, Interest Payable, Notes or Bonds Payable, and Accrued Expenses.

The Accounting Equation LO 3 The Accounting Equation Assets = Liabilities + Owner’s Equity The rights of the owners Owner’s equity represents an owner’s claims, or rights, on the assets of the business. The rights of the owners to the assets of the business is a residual right. It is equal to the amount of assets that would remain after satisfying the rights of the creditors.

The Accounting Equation LO 3 The Accounting Equation Examples of owner’s equity include: Common Stock Preferred Stock Additional Paid In Capital Retained Earnings Owner’s equity is split into two major categories: the equity invested by the owners, called paid-in capital, and the earnings retained by the business.

The Accounting Equation LO 3 The Accounting Equation Assets = Liabilities + Owner’s Equity Assets – Liabilities = Owner’s Equity Rearranging the accounting equation as Assets minus Liabilities equals Owner’s Equity emphasizes that the owner’s claim on business assets is a residual claim. Assets minus Liabilities may also be referred to as the net assets of the business.

The Accounting Equation LO 3 The Accounting Equation Assets = Liabilities + Owner’s Equity Assets – Liabilities = Owner’s Equity If the assets owned by a business amount to $100,000 and the liabilities amount to $70,000, the owner’s equity can be determined. We can also use this configuration of the equation to compute owner’s equity. For example, if the assets owned by a business equal $100,000 and the liabilities equal $70,000, the owner’s equity can be easily determined by subtraction.

The Accounting Equation LO 3 The Accounting Equation Assets = Liabilities + Owner’s Equity Assets – Liabilities = Owner’s Equity $100,000 – $70,000 = Owner’s Equity Therefore, we subtract the liabilities of $70,000 from the assets of $100,000 to determine the owner’s equity.

The Accounting Equation LO 3 The Accounting Equation Assets = Liabilities + Owner’s Equity Assets – Liabilities = Owner’s Equity $30,000 = Owner’s Equity Assets of $100,000 minus liabilities of $70,000 equals owner’s equity of $30,000.