The Accounting Equation

The details of the activities of a company, or transactions, are recorded in a company's accounting system.These transactions are summarized in a set of reports known as the financial statements. The foundation for the accounting system and the financial statements is the accounting equation.

Assets	=	Liabilities + Owners Equity
The left side of the accounting equation shows the assets of the company: What the company owns.	=	The right side of the accounting equation summarizes who provided those assets: Creditors or the owners.

When a business is first formed, both sides of the equation are equal to zero. As transactions occur, they affect the accounting equation, but the accounting equation must always stay in balance. A transaction can increase both sides or decrease both sides. A transaction could also affect only one side by increasing and decreasing one side at the same time.

APPLY THE CONCEPTS: Analyze Changes to Assets, Liabilities and Owner's Equity

Thomas Company: The table below demonstrates the effect of the first three transactions for Thomas Company. Review the details of each transaction and determine the effect on the accounting equation. Then, enter the updated amounts for the assets, liabilities, and owner's equity accounts (do not record the transaction). Enter all amounts as positive numbers. If an updated balance is zero, enter "0".

Transaction	Assets	=	Liabilities	+	Owner's Equity
Beginning	$0	=	$0	+	$0
Investment in the business: The owner of the company has invested $19,000 cash into the business. This increases the assets of the business from its zero balance. Owner's equity also increases from its zero balance. Make sure the equation stays in balance.	$	=	$	+	$
Borrow cash: The company borrows $9,500 cash from the local bank. This increases the assets from its balance after the first transaction. The company now owes the bank. Thus, liabilities increase from their zero balance. Notice this transaction did not affect owner's equity. The equation still needs to balance.	$	=	$	+	$
Purchase equipment: The company pays cash for a piece of equipment costing $6,500. Make sure that the equation stays in balance. Remember, the left side of the equation summarizes the total assets. The company has merely exchanged one asset (cash) for another asset (equipment); the value of each asset is the same.	$	=	$	+	$

Jones Company: Analyze the accounting equation for another business, Jones Company. Assume that the assets are $57,000 and the liabilities are $22,800. By rearranging the accounting equation, you determine that owner's equity is $. During the year, the owner invested an additional $4,000 in the business. The company also paid off $2,500 of its debt. What would the accounting equation look like at the end of the year for Jones Company? Enter the updated amounts for Jones' accounting equation below.

Assets	=	Liabilities	+	Owner's Equity
$	=	$	+	$

APPLY THE CONCEPTS: Putting it all together

Lets put all the pieces together now. Suppose that you are analyzing Martin Company. You know that at the beginning of the year, the assets equaled $310,000 and the liabilities equaled $170,500. During the year, assets increased by $46,500 and owner's equity increased by $25,275. The change in owner's equity includes all increases and decreases. Further analysis reveals that the changes in owner's equity were caused by revenues of $216,225 and expenses totaling $108,810 during the year, and additional owner's investments of $46,800 in the first half of the year. Because of your understanding of the accounting equation, you realize that withdrawals by the owner must have also occurred during the year. However, you must determine the amount for those withdrawals.

What is the amount of withdrawals made to the owner of Martin Company during the year? $

Complete the equation below with amounts for the end of the year.

Assets	=	Liabilities	+	Owner's Equity
$	=	$	+	$

APPLY THE CONCEPTS: Analyze the Effect of Revenues and Expenses

The owner's equity component of the accounting equation can be affected by more than owner contributions. Owner's equity increases for revenues earned and decreases for expenses incurred. Also in any form of business, money can be distributed from the business to the owners. Withdrawals (in the form of cash or other assets) by the owner decreases the owner's equity account. Smith Company had transactions affecting owner's equity during the past year. The table below demonstrates the effect of these transactions for Smith Company. Review the details of each transaction and determine the effect on the accounting equation. Then, enter the updated amounts for the assets, liabilities, and owner's equity accounts (do not record the transaction). Enter all amounts as positive numbers.

Transaction	Assets	=	Liabilities	+	Owner's Equity
Beginning of the year	$245,000	=	$73,500	+	$171,500
Revenues earned: During the year, Smith Company earned revenues totalling $147,000. The cash has been collected from the customers for all revenues earned this year.	$	=	$	+	$
Expenses incurred: Smith Company incurred expenses totalling $102,900 during that same year. All of the expenses incurred this year were paid in cash.	$	=	$	+	$
Withdrawals: At the end of each quarter, the owner withdraws cash from Smith Company. The sum of those quarterly withdrawals was $4,410.	$	=	$	+	$