This presentation is on the Accounting Equation: assets liabilities + equity.
Balance sheets have an assets section and a liabilities and equity section such as this balance sheet.
The assets here, which include cash and fixed assets, total $45. The $35 of liabilities,
which include a bank loan payable, plus the $10 of equity also
equal $45. The best way to explain the accounting equation is through an
example. Let's take a case of a business that needs cash and goes to a
bank for a $10,000 loan. The bank approves the loan and $10,000 goes into the
business's bank account. Assets increase by $10,000 cash is an asset. The left-hand side of the
equation goes up by $10,000.
At the same, time the business has an obligation to pay back the bank $10,000.
Liabilities increased by 10,000 because an obligation to pay is a liability.
Equity is not affected in this transaction.
The right-hand side of the equation goes up by $10,000.
The accounting equation balances. Let's take another example. Many owners put money from
their own pockets into the business, such as when a business get started. Let's say
an owner contributes $5,000 from his own personal bank account and deposits it into his
business's bank account. Owner capital is an equity account. In this case, equity increased by $5,000.
$5,000 of cash is received and so assets increase by $5,000. Liabilities are not
affected in this transaction and our accounting equation balances. Let's take
one last example of a photographer who purchases $20,000 of photography equipment using cash. Let's
analyze the assets first. Assets decrease by $20,000 because cash
was spent. Assets also increase by twenty thousand dollars because the business owns an
additional $20,000 of equipment which is a fixed asset. The net effect on assets
is $0. Let's go back to our accounting equation. In this case, we said the net effect on assets is $0.
Liabilities were not affected in this transaction nor was equity.
Our accounting equation
balances once again. Now we could have said instead of spending cash our
photographer purchased the equipment on credit. In that case fixed assets go up
because the photo equipment is now owned by the business. Accounts Payable goes up because the photographer
will pay the vendor on a
future date. Equity was not affected in this transaction and the accounting
equation balances once again.
Before I wrap up this video, let me point out that the accounting equation, assets =
liabilities + equity, is the basis of double-entry accounting, which states
that every transaction affects at least two transactions and they
are both important every time you write a journal entry. Click to see my videos on double
entry accounting and writing journal entries. I hope you enjoyed this video. Thanks for watching!