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Accounting Equation
Definition, Meaning Explained, Usage


The accounting equation summarizes the essential nature of double entry accounting systems: Debits always equal Credits, and Assets always equal the sum of Equities and Liabilities.

What Are the Two Accounting Equations?

The term Accounting Equation in fact refers to two equations that are basic and central in accrual accounting and double entry accounting systems.

The term Accounting Equation in has meaning only in accrual accounting. The term does not apply in cash-based, single entry accounting.

  • The first of these equations is the Basic Accounting Equation: Assets=Liabilities+Equities.
  • The term Expanded Accounting Equation refers to the Basic Equation together with the second equation: Debits=Credits.

The Accounting Equation in fact provides two basic rules that distinguish accrual accounting from cash basis accounting, and single entry systems from double entry systems.


The Balance Sheet Balance
The Basic Accounting Equation

Firstly, Basic Accounting Equation is another name for the Balance Sheet Equation, a simple summary of Balance sheet properties:

Assets = Liabilities + Owners Equities

The three elements of this equation Assets, Liabilities, and Owner's equities are the three major sections of the Balance sheet. Through the use of double entry bookkeeping, bookkeepers and accountants ensure that the "balance" always holds (both sides of the equation are always equal). 

Example: Maintaining the Balance

Consider a purchase by a retail merchant, Woofer Pet Supplies. On 2 September, Woofer purchases pet food merchandise inventory from its supplier, Ajax Wholesale Feed Company. Ajax charges Woofer $1,180 for the order. Woofer does not pay Ajax immediately, however. Consequently, Ajax gives Woofer an invoice marked "Payable" for that amount. Woofer's bookkeeper or accountant therefore makes two journal entries for the purchase:

  • Woofer creates a new "account payable" and adds (credits) its value to Accounts payable. Note especially that Accounts payable is a liabilities account, and therefore its balance increases with a credit transaction.
  • The second entry required in a double-entry system is a simultaneous debit to the asset account, Merchandise Inventory. Asset account balances increase with a debit transaction.

Exhibit 1 below shows how these transactions appear in the buyer's journal.

Woofer Pet Supplies
Journal for Fiscal Year 20YY
Date Account Debit
 103  Merchandise Inventory
 200      Accounts payable

Exhibit 1. The buyer purchases merchandise inventory on credit and makes two journal entries. Firstly, the buyer debits (increases) Merchandise Inventory, a Current assets account. Secondly, the buyer credits (increases) a Current liabilities account, Accounts payable.

The Merchandise inventory account is on the Assets side of the Balance sheet, while Accounts Payable is on the "Liabilities + Equities" side. Adding the same $1,180 to each side, of course, maintains the accounting equation balance

Now note that on 5 September, Woofer actually pays the amount due Ajax, using a debit card transaction to Ajax for $1,180. Double entry accounting requires that Woofer's accountant or bookkeeper make two more entries in the accounting system journal simultaneously:

  • Woofer decreases (debits) the Accounts Payable account balance FOR $1,180
  • Woofer decreases (credits) the balance in one of its own Current Assets accounts, Cash, for the same amount, $1,180. (Note that accountants treat the debit card transaction as a cash transaction).
Woofer Pet Supplies
Journal for Fiscal Year 20YY
Date Account Debit
 200  Accounts payable
 150      Cash

Exhibit 2. The buyer pays cash to cover a debt to the seller with two transactions. Firstly, the buyer debits (decreases) accounts payable, because the debit is now paid, and secondly, the buyer credits (decreases cash) for the amount of the payment. These two equal decreases occur on different sides of the Balance sheet, maintaining the balance.

Again, the Accounting Equation Balance holds.

Total Debits Always Equal Total Credits
Accounting Equation Second Meaning

The term Expanded Accounting Equation represents an extension of the Basic Equation to include another fundamental rule that applies to every accounting transaction where double entry bookkeeping is used:

Debits = Credits

The equation summarizes one result of using making double entry debits and credits correctly.

  • Firstly, Debit-Credit equality must hold for every event that impacts accounts. The Journal entries in Exhibits 1, 2, and 3 illustrate this equality. Every transaction brings a credit entry in one account and an equal, offsetting debit entry in another account.
  • Secondly, across any specified time period, the sum of all debit entries must equal the sum of all credit entries. System-wide debit-credit equality must hold, given that every given the same equality for every individual transaction.

Accounting Equation 2, in fact, serves to provide an important form of built-in error checking for accountants using a double entry system. Near the end of each accounting period a short period of time is designated as the trial balance period. At this time, accountants summarize the period's debits and credits for all active accounts in the general ledger. A mismatch between debit and credit totals in this trial balance usually means that one or more transaction postings from journal to ledger are either in error or missing.

See the article Trial Balance for more on the use of Accounting Equation 2 for error checking during the trial balance period.

Example: Total Debits Equal Total Credits

Note, by the way, that the two offsetting entries that follow a single transaction do not need to occur on opposite sides of the Balance sheet. For example, a cash flow transaction to purchase an asset brings a credit to one asset account, "cash on hand" (a credit decreases an asset account) and an equal, offsetting debit to another asset account, perhaps "merchandise inventory" (a debit increases an asset account).

Exhibit 3, below shows how such transactions can appear in the buyer's journal. In this case (Exhibit 3), Woofer Pet Supplies buys pet food inventory with a cash payment made immediately with the order.

Woofer Pet Supplies
Journal for Fiscal Year 20YY
Date Account Debit
 103  Merchandise Inventory
 150      Cash

Exhibit 3. The buyer purchases merchandise inventory with cash and makes two journal entries. Firstly, the buyer debits (increases) Merchandise Inventory, a Current assets account. Secondly, the buyer credits (decreases) the Cash account, another Current Assets account.

The Merchandise inventory account is on the Assets side of the Balance sheet, and Cash is $2,400 from another Assets account maintains Balance Sheet balance and the Debits = Credits equality.

Further Resources on the Role of Accounting Equations

For more examples of both equations in use, and their relationship to each other, and more on debits and credits, see the folowing articles:

Example Balance Sheet Structure and Contents
Detailed Example

The Balance sheet stands as a detailed representation of the Accounting Equation:

Assets = Liabilities + Equities.

Exhibit 4 illustrates the equation with a detailed example Balance sheet.

Grande Corporation                                   Figures in $1,000's
Balance Sheet at 31 December 20YY   
Current Assets
   Short term investments
   Accounts Receivable
      Less allowance doubtful accts
      Net accounts receivable
   Notes receivable short term
      Raw materials
      Work in progress
      Finished goods/merchandise
      Operating & office supplies
            Total Inventories
   Prepaid exp, insurance, def taxes
          Total Current Assets






Long Term Investments and Funds
   Common stock held
   Preferred stock held
   Bonds Held / Sinking funds
   Other Long Term Investments
          Total Long Term Investments

Property, Plant & Equipment
   Factory Manufacturing Equipment
      Less accumulated depreciation
      Net factory mfr equipment
   Store Equip / Selling Assets
      Less accumulated depreciation
      Net store/selling equipment
   Computer systems
      Less accumulated depreciation
      Net computer systems
           Total Property, Plant & Equip






Intangible Assets
   Trademarks and Patents
          Total Intangible Assets

Other Assets
                    Total Assets
Current Liabilities
   Accounts payable
   Notes payable, short term
   Current portion of long term debt
   Accrued expenses, Interest payable
   Unearned revenues
   Taxes payable Other withholding
          Total Current Liabilities


Long Term Liabilities
   Bank notes payable
   Bonds payable, other LT liabilities
          Total Long Term Liabilities
                    Total Liabilities

Contributed Capital
   Preferred stock
   Common stock
   Contributed capital excess of par
          Total Contributed Capital

Retained Earnings
          Total Owners Equity




          Total Liabilities and Equities

Exhibit 4. A detailed example Balance sheet, representing the Accounting Equation: Assets = Liabilities + Equities..