Accounting Equation

Module 1:
Foundations of Accounting

Duration:
45-60 minutes

Level:
Beginner to Diploma-Level

➛ Understand the Accounting Equation and why it is the foundation of accounting.

➛ Identify Assets, Liabilities, and Equity in simple scenarios.

➛ Apply the accounting equation to real-life business transactions.

➛ Analyze how everyday business activities affect the three components of the equation.

➛ Accounting Equation
➛ Assets
➛ Liabilities
➛ Equity
➛ Transaction
➛ Capital
➛ Loan
➛ Purchase

The accounting equation is the foundation of all accounting

Assets = Liabilities + Equity
This equation must always stay balanced, no matter what transaction happens.

Assets
What the business owns

Examples
➛ Cash
➛ Furniture
➛ Inventory
➛ Computers
➛ Vehicles

Liabilities
What the business owes

Examples
➛ Bank loans
➛ Money owed to suppliers
➛ Credit card debts

Equity
The owner’s interest

Equity increases when
➛ The owner invests money
➛ The business makes a profit

Equity decreases when
➛ The owner withdraws money
➛ The business has losses

Scenario 1
Owner invests $5,000 into the business

Assets ↑ | Cash increases
Equity ↑ | Owner's capital increases

Equation
Assets + $5,000 = Liabilities 0 + Equity + $5,000

Scenario 2
Business takes a loan of $3,000

Assets ↑ | Cash increases
Liabilities ↑ | Loan payable increases

Equation
Assets + $3,000 = Liabilities + $3,000 + Equity 0

Scenario 3
Business buys equipment for $1,000 cash

One asset ↑ | Equipment
Another asset ↓ | Cash

Equation stays balanced because total assets do not change.

Scenario 4
Business earns $400 from sales

Assets ↑ | Cash increases
Equity ↑ | Profit increases equity

Scenario 5
Business pays $200 of its loan

Assets ↓ | Cash decreases
Liabilities ↓ | Loan decreases

Identify whether each item is an Asset, Liability, or Equity

➛ Bank loan
➛ Cash
➛ Owner’s investment
➛ Inventory
➛ Amount owed to suppliers

Explain how each transaction affects Assets, Liabilities, and Equity.

➛ You buy a computer for $600 cash.

➛ You take a bank loan of $2,000.

➛ You earn $150 from selling products.

➛ The owner adds $1,000 more to the business.

➛ Write the accounting equation.

➛ What happens to equity when the business makes a profit?

➛ Why must the accounting equation always balance?

---

Answers ➧ Here

---

Double-Entry System Basics ➧ Here