Assets = Liabilities + Stockholder’s Equity is the basic accounting equation. Liabilities are a company’s legal debts or obligations that come from transactions or from business operations.
Stockholder’s equity is capital received from investors in exchange for stock, retained earnings and donated capital. These two portions of the balance sheet added together make up the company’s assets, which represent ownership of value that can be converted into cash.The accounting equation, also known as the balance sheet equation, is how double-entry bookkeeping is established. This means that the accounting equation must balance all the time. Every transaction has a dual effect on the accounting equation.
If the accounting equation does not balance then a company’s financial reports will not make sense and it will assist the accounting department to keep track of financial transactions. In order to understand and be able to read a balance sheet, it is important to understand the accounting equation and what it is made of.The accounting equation and the balance sheet are related in that the components of the balance sheet are made by using the accounting equation. The components of the accounting equation are what make up the information in the balance sheet.
When a transaction occurs, the total assets of the business may change but the equation will remain in balance. The equation serves as the basis for the balance sheet (Kimmel, P. D. ). In order to maintain the balance that was mentioned above each business transaction that is made has an effect on at least two of these components.
For example, if a company borrows money from a lender, the company’s assets will increase but the company’s liabilities will also increase by the same exact amount. The borrowed money becomes an asset but it has to be repaid and therefore it is a liability as well. This would be the same as the owner of a company investing $3,000 more into the company. This adds $3000 to the assets but is also $3000 that the company still owes the owner.
So when one thing is added then assets increase and so do liabilities making each side balance and always are equal.
