# Importance of Accounting Equation – Theory, Examples and Solutions

Firstly, let’s break down what accounting equation is all about. Accounting equation:

• shows the relationship between the assets, liabilities, and owner’s equity of a business.
• forms the basis for all accounting systems.
• serves as the foundation for the double-entry bookkeeping system.
• equates a company’s assets to its liabilities and equity.
• represents Assets = Liabilities + Shareholders’ Equity
• written also as Liabilities = Assets – Shareholders’ Equity
• alternatively shown as Shareholders’ Equity = Assets – Liabilities

## Accounting Equation Example

When a company has started its business, its assets are purchased with either cash which the company received from loans or cash the company received from investors. Therefore, all of the company’s assets arise from either creditors or investors i.e. liabilities or shareholders’ equity. Liabilities and equity are, essentially, sources of funding for companies to purchase assets.

Find out what account classification method is and how to deal with it!

## How to Calculate Accounting Equation

A farmer buys a computer for \$1,000. To pay for the tractor, the farmer uses \$600 in cash and borrows \$400 for the remainder. Now his assets are worth \$1,000, liabilities are \$400 and equity \$600.

Assets = Liabilities + Shareholders’ Equity

Assets = \$600+ \$400

Assets = \$1,00

## How to Solve Accounting Equation

Business # 1 possess liabilities of \$181,000 and shareholders’ equity of \$212,000.

Assets = Liabilities + Shareholders’ Equity

Assets = \$181,000 + \$212,000

Assets = \$212,000 + \$181,000

Assets = \$393,000

Business # 1 can fund the purchase of an asset with assets, for example a \$393,000 purchase of equipment using \$393,000 of cash.

Business #2 holds assets of \$74,800 and shareholders’ equity of \$36,200.

Assets = Liabilities + Shareholders’ Equity

Liabilities = Assets – Shareholders’ Equity

Liabilities = \$74,800 – \$36,200

Liabilities = \$38,600

Business # 2 can fund the purchase of an asset with its liabilities for example a \$38,600 purchase of equipment by borrowing \$38,600.

Business #3 possesses assets of \$30,000 and liabilities of \$21,400.

Assets = Liabilities + Shareholders’ Equity

Shareholders’ Equity = Assets – Liabilities

Shareholders’ Equity = \$30,000 – \$21,400

Shareholders’ Equity = \$8,600

Business #3 can fund the purchase of an asset with shareholders’ equity for example a \$8,600 purchase of equipment by using \$8,600 of retained earnings.

Business #4 maintains assets of \$25,000 and shareholders’ equity of (\$8,800), where equity is in an accumulated deficit position.

Assets = Liabilities + Shareholders’ Equity

Liabilities = Assets – Shareholders’ Equity

Liabilities = \$25,000 – (\$8,800)

Liabilities = \$25,000 + \$8,800

Liabilities = \$33,800

Business # 4 can fund the purchase of an asset with its liabilities for example a \$33,800 purchase of equipment by borrowing \$33,800. The accounting equation is shown in the diagram below:

Image credit: libertyaccounts.com

For now, consider this situation:
Owners (Shareholders) decide to invest £2000 in a new enterprise. The accounting equation would look like the below diagram.

Image credit: libertyaccounts.com

The same business then buys machinery (for £1000) and materials (For £200).

Image credit: libertyaccounts.com

Finally, if the business buys some more material for £500, but for the moment does not pay for it, i.e. it owes the supplier, the equation would look like the below diagram.

Image credit: libertyaccounts.com

Accounting equation represents the relationship between the assets, liabilities, and owner’s equity of a business. The total debits equal the total credits for each transaction. If you have any queries, please do not hesitate to contact us for further clarification and accounting assignment help.

### Armed with this knowledge, one should be able to define the accounting equation and solve it in no time. But if you still need help, feel free to give us a call!

Importance of Accounting Equation – Theory, Examples and Solutions
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