# 5. Accounting Equation ## Explanation of the Accounting Equation The **Accounting Equation** is the foundation of double-entry bookkeeping. It represents the relationship between a company’s assets, liabilities, and owner's equity (capital): \[ \textbf{Assets = Liabilities + Capital (Owner's Equity)} \] - **Assets**: Resources owned by the business (e.g., cash, inventory, equipment). - **Liabilities**: Amounts the business owes to others (e.g., loans, accounts payable). - **Capital (Owner’s Equity)**: The owner's claim on the business (e.g., initial investment, retained earnings). ### Example 1 **Owner starts business with $10,000 cash:** - Assets increase (Cash +$10,000) - Capital increases (Owner’s Equity +$10,000) \[ \text{Assets} = \$10,000,\ \text{Liabilities} = \$,\ \text{Capital} = \$10,000 \] \[ \$10,000 = \$ + \$10,000 \] ### Example 2 **Business buys equipment for $4,000 cash:** - Assets (Cash) decrease by $4,000 - Assets (Equipment) increase by $4,000 - No change to total assets or capital \[ \text{Assets (Cash + Equipment)} = \$6,000 + \$4,000 = \$10,000 \] ### Example 3 **Business takes a loan of $5,000:** - Assets increase (Cash +$5,000) - Liabilities increase (Loan Payable +$5,000) \[ \text{Assets} = \$15,000,\ \text{Liabilities} = \$5,000,\ \text{Capital} = \$10,000 \] \[ \$15,000 = \$5,000 + \$10,000 \] --- ## Diagram: Relationship between Assets, Liabilities, and Capital ```plaintext +-------------------+ | Assets | +-------------------+ | $15,000 | +-------------------+ / \ / \ +-----------+ +-----------+ | Liabilities| | Capital | +-----------+ +-----------+ | $5,000 | | $10,000 | +-----------+ +-----------+ ``` *Diagram showing that Assets are funded by Liabilities and Capital.* --- ## Transaction Analysis | Transaction | Assets | Liabilities | Capital | |--------------------------|--------|-------------|---------| | Owner invests $10,000 | +10K | | +10K | | Purchases equipment | | | | | Takes loan $5,000 | +5K | +5K | | - **Each transaction affects at least two components but keeps the equation balanced.** --- ## Final Answer **The Accounting Equation is always balanced:** \[ \textbf{Assets = Liabilities + Capital} \] It shows what a business owns (assets) and how those assets are financed (by liabilities or owner's capital). Every transaction keeps this equation in balance, reflecting the dual aspect of accounting.